Louis Presley Financial

Retirement Income

RETIREMENT INCOME

 

This issue of Annuity Notes will deal exclusively with income during retirement.  For the past twenty-two years I’ve been an advocate of fixed annuities.  Many years ago I heard something that has stuck with me.  “How much of your money do you not want exposed to market risk?”  It’s never been my mission to recommend that everyone should have all of their money in fixed annuities.  But, it’s always made sense to me that a well crafted financial portfolio should include some principal protected assets such as fixed annuities.

 

For the past few years much of my annuity emphasis has shifted to guaranteed lifetime income.  There is a huge segment of our country, i.e. 76 million Baby Boomers, who need or will need retirement income. While our parents have always lived below their income, most baby boomers live up to and sometimes above their income.  The question is how will they survive financially into their late 60’s, 70’s 80’s and even 90’s?  As their financial advisor, what guarantees have you put in place for at least a portion of their future income needs?  Let’s take a closer look at what guarantee lifetime looks like going forward.

 

Types of Lifetime Income

There are only three ways to guarantee a lifetime income.

Pension

Social Security

Annuity

 

Pension

Is any worker today, besides a government employee or union member, covered by a pension plan?  A pension is a Defined Benefit retirement plan.  For all practical purposes pensions have been replaced by the 401(k) as the retirement plan of choice for most businesses.  A 401(k) is a type of Defined Contribution retirement plan.  It transfers all the choices, responsibility and investment risk to the employee.  So, the majority of employees today do not have a guaranteed lifetime income from their retirement plan at work.

 

Social Security

With the state of our country’s debt issue what will happen to Social Security?  Can Social Security be sustained in its present form?  It seems like both parties are at least now willing to discuss “entitlement reform.”  It just seems to me that decades of excessive government spending will have an effect on all programs.  Look at what has been happening in Europe when austerity measures are mentioned.  Will the USA look like that too?  When the massive numbers of retired baby boomers has its full effect on the Social Security system will it break under its own weight?  It HAS to change.  Doesn’t it?

 

Annuity

Immediate (Income) Annuity

Since the annuity is the only way we can guarantee a lifetime income for our clients, let’s take a look.

 

In its most basic form, an annuity is a contract with an insurance company that converts your lump sum into a stream of guaranteed income, for either a set period or for your lifetime.  Its primary purpose is to hedge against longevity risk – the risk that you outlive your income.  Barron’s June 30, 2011 article, Best Annuities.

 

While I agree with this definition of an immediate annuity or annuitizing a deferred annuity, it is the least used annuity.  My experience shows that less than 5% of annuity purchases are for immediate annuities.  The Barron’s article even states, some economists are baffled by the low level of participation in these products, given their benefits.  Even the United States Government recommends immediate annuities.  The Government Accountability Office (GAO) recently released a study to the Special Committee on Aging, U.S. Senate. In part, the GAO found that financial experts advised retirees toconvert a portion of their savings into an income annuity to cover necessary expenses… 

 

But, why do so few people choose an immediate annuity?  My theory on this is, for a whole host of reasons, the advisor is reluctant to recommend a financial product that immediately goes from liquid to illiquid.  The same holds true for the retiree.  They are hesitant to go from liquid to illiquid.  Again, why?  Life happens.  They think they may need the cash.  This is in spite of the fact that an immediate annuity traditionally provides the highest income and is guaranteed for life.

 

Income Riders (Guaranteed Minimum Withdrawal Benefits)

A deferred annuity is a “safe money” place to park some money that you don’t want to risk in the stock market.  The interest rate is either declared every year, guaranteed for a number of years or linked to an index.  It has a surrender charge as short as one year or as long as twelve years.  There is a 10% penalty free withdrawal each year during the surrender period.  For our discussion, let’s assume the deferred annuity receives a 5% bonus ($5,000) and earns 3% every year.  Further, let’s assume your client is a female age 55, has $100,000 and wants to retire at age 70.  She is interested in a guaranteed income for life.

 

Income riders are added to a deferred annuity, usually an index annuity.  How does a Lifetime Income Rider work?  In a nutshell, an income rider allows you to take withdrawals in amounts so large you would never consider without a safety net.  At age 70 her Account Balance is $163,586.  The income rider allows her to withdraw $18,319 from her annuity every year.  Keep in mind she doesn’t need permission from the insurance company to take a withdrawal no matter what the amount.  The surrender charge was over five years ago.  But, by taking $18,319 from her $163,586 this amounts to a withdrawal of 11.19%!  Now remember, her annuity is still earning 3% every year.  We all intuitively know that withdrawing 11.19% from an account earning 3% will deplete the account sooner or later.  Ten years to be exact.  But, even when the account becomes depleted, she will continue to receive $18,319 for the rest of her life.  And THAT is the benefit of a Lifetime Income Rider.  During this time of deferral and withdrawals, she always has control of her Account Balance.  Exercising her right to lifetime withdrawals is always optional, not mandatory.  At her death, the remaining Account Balance, if any, is paid to her beneficiary.

 

We, as financial professionals, know that annuitizing always provides the greatest amount of lifetime income, right?  The fascinating discovery I made a couple of years ago was if you can defer starting your income for a few years the income rider will provide more income than annuitizing.  If she were to annuitize her account balance of $163,586 at age 70 it would only pay her $10,207 for the rest of her life compared to $18,319 from the rider.  The income from the rider pays her 80% more than annuitizing.  This discovery caused me to have a paradigm shift of thinking about these income riders.  When you get more flexibility, never lose control of your account and receive more income, that’s a win, win, win.  

 

Summary  

Everyone needs an income.  Everyone needs an income guaranteed for life.  Very few people will have a pension at retirement.  Social Security is not all that solvent.  Wouldn’t you agree?  Isn’t the government now paying out more in Social Security benefits than they are collecting in Social Security taxes?

 

Annuities are the only way, you as an advisor, can guarantee a portion of their retirement income from their savings and/or investments.   Make annuities part of your overall retirement income planning.

Website Builder