Annuities can help manage income risks in retirement
During their years in the workforce, employees spend decades accumulating retirement savings. But when it’s time to retire, the focus switches from accumulating savings to generating retirement income. The challenge is to develop a retirement income strategy that provides a desired lifestyle without concern over running out of money.
Compounding this challenge is that retirees face longer life expectancies, uncertain financial markets and rising costs.
There’s an ART to managing income risk, and Matt Johnson, manager of product and distribution strategy with American Equity, described what that means during a recent webinar held by the National Association for Fixed Annuities.
ART stands for Avoid, Retain and Transfer, three strategies for dealing with income risks retirees face, Johnson said. Annuities play a role in helping clients manage those risks.
Income can be produced from investments in a variety of ways, he said. The decision on how to obtain that income is based on the three ART strategies for managing risks.
1. Avoiding risk: In this scenario, the client is unwilling to accept significant risk. A client who wants to avoid risk will use Treasuries and certificates of deposit to produce retirement income.
2. Retaining risk: The client in this scenario is willing to assume all risk, and will use portfolio diversification and safe withdrawal rates to produce retirement income from stocks and bonds, managed money and mutual funds, and real estate.
3. Transferring risk: This scenario uses a strategy where a third party assumes risk by using annuities with guaranteed income.
Transferring risks by using annuities provides numerous advantages for a client who needs retirement income, Johnson said. Annuities may help improve the probability of successful retirement outcomes by helping reduce longevity risk with lifetime income payments and helping lessen portfolio volatility by hedging downside risk.
This strategy is ideal for a client who needs to take withdrawal rates higher than those considered safe and sustaining, he said. In addition, clients who are heavily invested in cash or fixed income, or who are nervous about market volatility would benefit from the risk transfer strategy.
Transferring retirement income risk improves outcomes, he said. Putting a portion of a client’s retirement portfolio into an annuity allows that client to put more money into the equities portion of their portfolio to achieve their desired income. This also gives the client flexibility to increase their income when they need it.
Bridging the performance gap
Annuities also bridge the performance gap from retaining risk, Johnson said. A hypothetical 60-year-old with a $731,368 nest egg who desires $75,000 in annual income for life in five years would need an annualized return of 25.45% to reach an amount that can provide the same income as putting that same amount of savings into an annuity with an 8.25% simple return over five years.
When the time comes for a client to convert assets to cash flow, annuities are the choice for clients who want to transfer risk. Johnson showed a hypothetical example of a client who wants to generate $15,000 of annual lifetime income beginning at age 65. A client who wants to use the avoiding risk strategy would need to invest $394,736 in a 10-year Treasury paying 3.8%.
A client who wants to retain risk would need to invest $454,545 in a diversified portfolio with a 3.3% annual withdrawal rate. But a client who chooses an annuity would need to invest only $190,865 in a hypothetical fixed indexed annuity paying 6.6% at age 65 with an 8.25% simple roll-up with income at one year, or would need to invest $146,273 in the same hypothetical FIA with income at five years.
Transferring risk by investing some of a client’s retirement savings into an annuity frees up that client’s capital by using the annuity to generate income and allowing the rest of the portfolio to grow, Johnson said. That excess capital can be reinvested as well to grow over the client’s remaining life expectancy.
“By transferring risk, it doesn’t mean I’m giving up on the long-term growth potential of legacy assets. I’m growing it, not using it for income,” he said.
The advantages to freeing up capital
Freeing up capital and allowing it to grow while using an annuity for income can benefit a client who wants to self-fund future long-term care needs, Johnson said. The freed-up capital also can be used for gifting or for checking things off a client’s bucket list.
Understanding risks and their potential impact on a retirement strategy will lead to better planning decisions, he said. Building a solid retirement income model approach focused on minimizing risk is vital to providing an income strategy for life. Transferring risk through using annuities can provide benefits that increase the probability of a positive retirement outcome.
Susan Rupe is managing editor for InsuranceNewsNet. She formerly served as communications director for an insurance agents' association and was an award-winning newspaper reporter and editor. Contact her at [email protected].
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