- 7-Minute Article
- Nov 16, 2017
The Role of Annuities in the Changing Retirement Landscape
Adapt traditional retirement planning strategies to provide greater income certainty.
The shift from pensions to self-funded retirement accounts over the past 40 years has inspired financial advisors to take action. Working with their clients, they developed new investment strategies and withdrawal plans that helped retirees turn their savings into sustainable income. Yet recent demographic and market trends have put these well-established techniques under pressure.
Rising life expectancy and surging healthcare costs have increased the amount that clients must save. At the same time, low interest rates have reduced the amount of income that can be produced from fixed-income investments. Many people have responded by investing more of their savings in stocks, taking on a greater risk of market downturns.
Advisors and clients must adapt again. Annuities offer a powerful way to strengthen portfolios to help address the needs in the new retirement landscape. With many different types of annuities available, these tools can complement and strengthen other retirement-related assets by offering features such as exposure to market growth with a degree of downside protection. What’s more, annuities’ guaranteed income options offer advisors and clients greater flexibility when deciding how to withdraw or invest other assets.
Yet some advisors still struggle to incorporate annuities into their retirement tool kit, and only a third of consumers report a high familiarity with annuities.1 The key to capitalizing on annuities’ benefits is to use them to address a particular need or set of needs in an individual’s retirement plan. When annuities are framed as a solution to a specific problem, more than half of clients see them as desirable additions to their retirement plans.2
Here are three roles annuities can play in a retirement plan:
Today’s savers won’t receive as much guaranteed retirement income as previous generations did, in part because only 8% of private sector jobs today offer any kind of pension.3 Social Security will help, but the Social Security benefits are relatively small—the average is only $1,369 a month or $16,428 a year.4
As a result, advisors and their clients have leaned heavily on investments such as stocks, bonds and mutual funds—mainly in retirement accounts such as 401(k) plans—to create a pool of assets they can tap for retirement income. But even a well-diversified mix of these investments can’t truly deliver the income stability that retirees need. Market downturns are inevitable and unpredictable, exposing clients to sequence-of-returns risk—the possibility that losses early in retirement will undermine the sustainability of the investor’s income stream.
Consider this hypothetical example. Two retirees, each with a $1 million investment portfolio, withdraw $50,000 a year beginning in their first year of retirement. Both earn the same returns over the next ten years, but in reverse order: One retiree’s investments fall steeply during the first three years of retirement and deliver high returns later; the other enjoys strong returns during the first three years of retirement and suffers the steep losses during years eight, nine and ten.
The retiree whose losses came early in retirement would finish the period with roughly half the savings of the retiree whose portfolio enjoyed strong gains early (see the table below). A market downturn early in retirement leaves clients with a difficult choice: Either draw down investments as planned and face increased risk of running out of money later in retirement, or reduce withdrawals and risk not having enough income to cover expenses.
Here are two examples:
- Option 1. A retiree can choose an immediate income annuity to cover expenses early in retirement. The income from the annuity may enable the retiree to ride out market downturns and leave other retirement assets untouched until later.
- Option 2. Retirees who don’t need to tap savings for income immediately upon retirement, such as those who plan to work part time early in their retirement years, might be more concerned about market downturns in the future. These retirees can use variable or indexed annuities to protect against potential income gaps later in retirement. They might purchase a variable annuity, whose value may grow based on a mix of underlying investments, or a fixed-indexed annuity, which earns interest based on a portion of market gains up to a specific limit. The value of either annuity can be tapped for income later in retirement.
Life expectancy is rising. Women age 65 have nearly a 35% chance of living to 90, while men age 65 have a better-than 20% chance of reaching 90.5 Clients are acutely aware of the risk of longer lifespans—running out of money in retirement is the top fear of most clients, according to a recent survey of financial planners.6
People planning for retirement today must prepare for it to last 30 to 40 years. As a result, rules of thumb like the 4% withdrawal strategy may no longer be dependable. Annuities can help address longevity risk by offering guaranteed lifetime withdrawal options. Placing a portion of savings into an annuity with a guaranteed lifetime income rider ensures that some funds will be there no matter how long the client lives, as long as the terms of the rider are met.
Consider a hypothetical example in which a 55-year-old woman plans to retire in 10 years. She decides to purchase a deferred income annuity with a guaranteed lifetime income option. The woman makes a total purchase payment of $92,000 by age 64: She initially invests $7,000, then increases her annual purchase payment by $500 each year, paying $7,500 in year two, $8,000 in year three and so on.
She can begin withdrawing $6,374 from her annuity each year, beginning at age 65. That income will continue no matter how long she lives or what happens in the markets. If she lives to age 85, she will receive $127,480 worth of income; if she lives to 95 the figure will climb past $190,000. Most important, she’ll know that she can rely on this income for as long as she lives.
For this example, Guaranteed Income Builder income payments were based on multiple purchase payments, Lifetime Income with Cash Refund income option for a female and the hypothetical annuity purchase rate developed on 10/17/17 and are not to be construed as a guarantee or estimate of amounts to be paid in the future. This example assumes purchase payments are made at the beginning of each contract year, and income payments start at least 13 months from the date of last purchase payment. The following information applies to the hypothetical examples in this brochure: The Cash Out Option has not been elected. Future income payments are based on the annuity purchase rates available on the day you make a purchase payment into the Guaranteed Income Builder. Please ask your financial professional to provide you with a Guaranteed Income Builder quote that shows the actual future income payments you would receive if you made a purchase payment into the Guaranteed Income Builder on the day the quote was run. In MA and MT, unisex annuity purchase rates are used to determine income payments.
Healthcare costs are a common source of anxiety in retirement planning for good reason. By one estimate, a couple age 65 should expect to pay about $260,000 on health care during retirement.7 A critical illness or accident could push those bills even higher, forcing retirees to withdraw additional funds from their retirement accounts—increasing the risk that they’ll outlive their savings.
An annuity can help protect a retirement plan against the threat of high medical costs. Income from an annuity can help cover everyday expenses, giving a retiree more flexibility to tap into other retirement assets for unexpected medical bills. Annuity income also can be used to help pay fixed medical expenses, such as premiums for additional insurance products to help protect against unexpected spikes in medical costs—for example, Medicare Supplement Insurance or Long-Term Care Insurance.
Identifying solutions and gaining client buy-in
Research has shown that clients are more likely to recognize the value of an annuity when they understand exactly how it is being used in their overall plan. Understanding the benefits that an annuity provides also can help clients feel more confident about the rest of their retirement strategy. For example, retirees with a strong foundation of guaranteed income to meet current expenses may be less likely to worry about market fluctuations that affect the value of their equity investments. Likewise, an annuity’s guaranteed lifetime income might help a risk-sensitive client protect against longevity risk while holding less savings in volatile assets.
The three roles for annuities outlined here are just some of the ways they help to strengthen the retirement planning strategies developed in recent decades. Above all, annuities can add greater certainty to a retirement planning process that must contend with powerful unknowns, such as life expectancy and market fluctuations—helping advisors and their clients implement financial strategies that can succeed despite the dramatic changes in the retirement planning landscape.