by Cynthia Harrington
While it may be true that getting older just means getting better, it’s definitely true that more Americans are getting older.
They’re also living longer. The challenge facing most advisors is assuring clients that they won’t outlive their assets. With the potential decline of Social Security and disasters in defined-contribution plan management, tomorrow’s retirees may be seeking other solutions.
And guaranteed income products, like annuities and other life insurance products, could face the biggest changes.
“The longer life expectancies affect all forms of annuitization roughly the same,” says Ron Stopher, FSA, CPA, CLU, and vice president of variable annuities at Lincoln Financial Group, in Ft. Wayne, Ind. “But we might see real changes in the way people use annuities.”
Today, the vast majority of annuity reserves are never annuitized, but assets are held in the contract until death. “We expect more retirees to purchase the payout annuity because they expect to live longer,” said Stopher.
The inhibition on annuitizing is losing control of the assets. Once the income payment stream is selected, the principal value of the contract belongs to the insurance company. Those who die early don’t get the value for their money. “Everybody’s different in their willingness to take risks,” said Edward T. Regan, CPA, CIMA, and managing principal of The Regan Group, in Omaha, Neb. “We don’t work much with annuities and we’ve lost a few million-dollar sales in the past for investors who really felt like they wanted the guarantee that they couldn’t outlive their assets.”
But guarantees come at a price. The amount of the guaranteed payout depends on the level of interest rates at the time of the choice, as well as the expected duration of the income stream.
Benny Goodman, an actuary in the actuarial consulting area of TIAA-CREF, in New York, reports the difference on a $100,000 policy at 6 percent interest for a 65-year-old policy owner. Today’s payout would be $692 per month. Fifteen years ago, the same annuitant would have received $747.
Transferring the risk of not outliving assets to the insurance company places another risk in the investor’s life. “The risk with annuities is whether the policy owner will have enough in tomorrow’s purchasing dollars,” added Regan.
Planners with The Regan Group prefer a diversified portfolio of mutual funds both as an inflation hedge and for higher after-tax returns. “We did a study several years ago of mutual funds versus annuities,” said Regan. “You have to go out a great distance before the taxes on the ordinary income from the annuity payout become an advantage over the capital gains treatment from mutual fund investing.”
Similarly, financial advisors with Buckingham Asset Management, in St. Louis, prefer planning to meet lifetime income needs without insurance.
“Generally, the investor is going to do so much better with a diversified portfolio,” said Susan Shackelford-Davis, a principal at Buckingham Asset Management and a member of the firm’s insurance advisor, Bemiston Insurance Services. “The annuity is not going to solve their problem of maintaining a desired lifestyle considering the effects of inflation.”
“We plan that the client is going to live forever, and guarantee their income for life, following the method of the prudent withdrawal rate,” Shackelford-Davis added. “This method takes from the portfolio only what it can stand over time.”
Insurance companies take note of lengthening life expectancies. From an average of age 48 for females and 46 for males born in 1900, the numbers have nearly doubled in the last century, to 80 for females and 74 for males born in 2000. “The longer life expectancies mean annuitants get less for their money in each payout,” said Goodman. “However, if you’d bought the annuity 20 years ago with the shorter life span expected, you’d be making out quite well.”
Insurance companies have shifted the way they do business, given the longer life expectancies. One way is to build the longer life spans into each contract in the mortality table. Insurance companies choose one of two methods. The company either subtracts a flat amount from each age, or it chooses a dynamic method that assumes a specific improvement for specific ages.
“The life expectancy of a 65-year-old woman today might be 24.8 years, so we might use 26 years on an annuity’s mortality table,” said Goodman.
The industry also answers other concerns with changes to policy structures. The guaranteed income benefit for variable annuities is the industry’s attempt to address the fear of inflation. “With a lifetime guaranteed minimum income, advisors have an easier time planning for their clients,” said Stopher. “But the investor still can participate in the upside of the market with the equity choices in the contract.”
Period-certain annuities address the concern of losing the assets by dying too early. With a period-certain policy, annuitants choose a guaranteed payment period, meaning that the payments continue to a beneficiary if they die during the period. The option is popular — about 80 percent of TIAA-CREF annuitants choose it — but it comes at a cost. At TIAA-CREF, a 60-year-old person with a 10-year guarantee receives 1.4 percent less income; a 70-year-old person with a 20-year guarantee reduces their monthly payment by 14.2 percent.
While not recommending annuities for everyone, Buckingham Asset Advisors lists several instances where they feel there are clear advantages. Investors of moderate wealth could benefit from buying an annuity over a bank CD. Shackelford-Davis advises closely held businesses or small groups that haven’t yet had time to set aside dollars for retirement to consider the 412(i) defined-benefit plans. “The low guaranteed rates force high contributions into these plans,” she said. “Groups like doctors’ practices with a majority of highly compensated people can really take advantage of this.”
Longer lives bring another expectation into clear focus. “Expectations for the guaranteed income stream depend wholly on the quality of the insurance company,” said Shackelford-Davis. “With the numbers of companies being downgraded today, this is a very important consideration for investors.”
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