By Mark Miller
Tribune Media Services
Guaranteed retirement income has become a buzzword in the retirement industry, with financial services companies, planners and even government policymakers looking for ways to reduce retiree exposure to equities and boost sources of sure income.
If you don’t have a traditional defined benefit pension coming to you in retirement, one way to add a guaranteed income component is through an income annuity, which offers regular monthly payments for life in return for an upfront lump payment to an insurance company. A single premium immediate annuity (SPIA) can be a solid strategy for insuring against longevity risk – the risk of outliving your money.
Just to be clear, I’m talking here about a plain vanilla SPIA, not the more complex, expensive variable type of annuities. The SPIA has never played a big role in the financial landscape of retirement products; one estimate suggests they account for only about two percent of current household income for retirees.
Sales were gaining momentum before the 2008 financial crisis and meltdown, more than doubling to a peak of $7.9 billion in 2008, according to LIMRA, an insurance industry research group. Sales have been essentially flat since then; the financial crisis of 2008 and 2009 generated consumer concern about the long-term stability of insurance companies, and interest rates-which drive the pricing and yield of income annuities-also have dampened sales, given current ultra-low rates.
But there are signs that SPIAs may be destined for a brighter future. Insurance companies make headway establishing active sales channels through workplace retirement plan companies, which are starting to talk them up. The U.S. Department of Labor is launching an initiative aimed at encouraging more lifetime income options in retirement plans.
The insurance industry’s pitch: While retirees shouldn’t annuitize all of their assets, income annuities offer unique qualities as an asset class when mixed into a broader portfolio of stocks and bonds. Specifically, an income annuity can offer higher payout rates due to the risk pooling that’s unique to an insurance product-the so-called mortality credit. Simply put, this refers to the fact that premiums are paid by some people who will die earlier than expected, and that contributes to the gains of the overall insured pool-and higher yield to those who live longer.
An income annuity offers an interesting way to insure that living expenses can be met in retirement. First, estimate total monthly expenses, and subtract expected Social Security and any other guaranteed income source, such as a defined benefit pension. The gap amount is what you could consider filling with an income annuity.
That argument makes sense to Harold Evensky, president of Evensky and Katz Wealth Management. Evensky is one of the industry’s most respected financial planners and co-author of “The New Wealth Management: The Financial Advisor’s Guide to Managing and Investing Client Assets” (John Wiley and Sons, 2011).
“I think income annuities will be one of the single most important investment products over the coming decade,” he says. “Most products can only offer dividends, interest and capital gains, but an annuity has that fourth component, mortality return. The risk is that you die ‘early’ and made a bad deal, but you’re dead, so you don’t care! Those who live on get the extra gravy. Since most people are approaching retirement without enough money, this will be one of the best options for not running out.”
The question of yield looms large in the debate over the value of income annuities. On one hand, the mortality credits allow a SPIA to yield much more than a certificate of deposit. At the same time, low rates also depress what insurance companies can earn, which cuts into the cash they can promise upfront to buyers. Those amounts would rise anywhere from 8.5 percent to 26 percent on a typical $100,000 annuity if rates jumped a few hundred basis points. The payouts don’t fluctuate in a straight line with interest rates, since they also are affected by principal and mortality credits.
Still, Evensky isn’t putting his clients into income annuities right now because of current low rates-and because the mortality benefit gets better as his clients age. “We don’t think there is much risk in waiting,” he says. “If you are 70, I’d wait until 72 or 73. I would rather just stay invested in bonds and delay buying the annuity until the fixed income market gets back to a more historical norm.”
Another concern is safety. Picking an annuity provider means picking a partner for life, so concerns about financial stability are well placed. And while rating agency reputations have been tarnished by their role related to derivatives in the 2008 financial crisis, their insurance ratings remain useful. “Are their rankings absolutely accurate in every case? No one knows,” says Brett Hammond, a managing director and senior economist for TIAA-CREF. “But relative to one another the insurance ratings are valuable. And, they got in trouble over derivatives, not insurance.”
Still worried? Consider diversifying your annuity investments among more than one insurance carrier.
Mark Miller is the author of “The Hard Times Guide to Retirement Security: Practical Strategies for Money, Work and LIving” (John Wiley & Sons/Bloomberg Press, June 2010). He publishes RetirementRevised.com, featured recently in Money Magazine as one of the best retirement planning sites on the web. Contact him with questions and comments at mark@retirementrevised.com
This was printed in the July 31, 2011 – August 13, 2011 Edition
