An old adage says, “Fool me once, shame on you; fool me twice, shame on me.” Learning quickly from your experience presumably leads to wisdom, good decisions and a life well lived.
Unfortunately, most of us have no experience to inform our momentous financial decisions when it comes to de-risking for retirement and the post-retirement asset allocation and income-producing judgments. Many are practically one-time decisions. Also, though we learn many things via second-hand experience from family and friends, the subjects of finance, money and investments still remain a social taboo. American financial preparation has become inextricably linked to the defined contribution 401(k) vehicle. Unfortunately, a pension plan designer interviewed on “60 Minutes” characterized the typical 401(k) investor as a novice: “They don’t know a stock from a rock.” As to the quality of investment options therein, the interviewee noted, “Half the funds are really dogs and shouldn’t be listed.” Critically, plans offer little that can effectively de-risk clients as they approach retirement. All this leaves people unprepared for more critical decisions as they approach in-service withdrawal options after age 59 ½, their “normal retirement,” and then mandatory distribution requirements. When do they take the money? Do they set up systematic withdrawals from a diversified bond/equity portfolio as many planners have recommended? Do they guarantee a lifetime income stream through annuitization? Should they choose some combination of these options?
A number of scholarly and technical papers have been written analyzing optimal decision-making for annuitizing for life. I’ll review some of the results next month, but let me address a sea change occurring right underneath our noses. Mathematical models and general financial reasoning suggests that people should be lifetime annuitizing at much higher rates than the low six in 1000 we have experienced1. David Babbel and Craig Merrill have summarized the reasons well2. I believe the most important to be:
- Loss of Value – I might die too soon, or I want to leave a bequest to heirs.
- Loss of Liquidity – I might change my mind on income amount or want to stop or restart should we experience a financial crisis.
These reasons might NOT be the cause of underannuitization. Maybe we just aren’t marketing in the right way, or people are just ignorant. I doubt it; people generally respond to incentives in their best interest. Underannuitization isn’t over yet, but it is already crumbling, thanks to the advent of income benefit (GIB) riders on fixed annuities. In fact, according to LIMRA, 70% of all indexed annuity sales (up from zero in 2005) already have these riders attached. Why? Because these riders address those sizable objections by allowing for value to be left after death, unlike the irrevocable lifetime annuitization, as well as flexibility to start and stop payments at will.
For example, a top-of-class GIB today for a $100,000 premium provides for immediate income of $6,600 annually, whereas a similar SPIA yields a $7,086 payout for a male aged 65. In other words, you trade a 6.8% lower payment for a high degree of liquidity. This seems like a minimal premium to buy liquidity. Many people don’t want an income guarantee this early. For the same 65-year-old, compare a 2.5% deferred rate for 10 years with resulting funds buying a SPIA (assuming today’s rates, income equals $12,122) versus a SPDA with GIB roll-up at 10% simple interest (income equals $13,260). You get paid to have more liquidity! The new stacked benefit riders from Annexus and Security Benefit, which allow for indexed interest plus a roll-up rate, yield even higher potential income: $13,184 to $23,154 based on median scenario backcasting.
The underannuitization problem is well into the process of being solved. If you haven’t yet become an agent of this sea change, find out more from your Creative Sales Consultant today.
Mike
FOR AGENT USE ONLY. NOT FOR USE WITH THE GENERAL PUBLIC. 12301 – 2012/5/8
1 US Individual Annuity Yearbook. LIMRA, Published 2011.
2 Babbel, David and Craig Merrill. Rational Decumulation. Wharton Financial Institutions Center, May 22, 2007.