Constructing a solid income plan is essential to ensuring that clients’ retirement needs are met. But with a rapid decline in pension plans, escalating health care and cost-of-living expenses, and decreasing confidence in the solvency of Social Security, the imbalance between income and costs in retirement is growing starker for many Americans. This trend accelerated in the shadow of the Great Recession, and the COVID-19 pandemic only threatens to push savers further behind.
Advisors can help clients tackle this growing shortfall through introducing income annuities. By offering a reliable, protected stream of funding, these products can be mighty structures. But with the current low interest rate environment and the misconceptions about annuities that have taken hold over the years, it can be hard for clients to see how these can be effective solutions for their planning needs. Here’s a road map for advisors looking to introduce their clients to annuities as a bridge to close the retirement income gap.
Set The Scene
To show how beneficial income annuities can be, advisors first must educate their clients on how the retirement landscape has shifted over the years.
In the 1980s, 60% of U.S. companies offered pension plans, which gave employees a guaranteed monthly source of income to provide for their retirement needs. However, in less than 40 years, that percentage has fallen radically to only 4%. And even though many companies still offer 401(k) accounts, only 41% of eligible employees ultimately contribute, and of those who do enroll, many aren’t maximizing the potential of their investments, according to a Financial Freedom Studio report.
It’s also important to remind clients that even if they’re participating in employer-sponsored 401(k)s, those plans do not offer the same assurances as pensions do and can be very vulnerable to an economic downturn. While the upside of a 401(k) may be greater than that of an annuity or pension, there is no downside protection built in.
The goal isn’t to scare clients into an annuity — but instead to show that the path to retirement is not always smooth, and a multipronged approach that offers both guarantees and upside potential is key to developing a sturdy nest egg.
Simplify, Clarify And Demystify
After advisors establish the “why” of income annuities, they can then explore the “how.” Annuities have gotten a bad rap as being overly complex products that cater only to the wealthy, so it is essential to educate your clients about how these products work to support their retirement goals.
Start by highlighting guaranteed income — the very nuts and bolts that make these products stand — and how annuities operate similarly to a pension. Like pension plans, income annuities provide structured, direct monthly payments for a set life span. And unlike 401(k)s, income annuities have a floor to guard against fluctuations from interest rate changes or market volatility. So when downturns hit, the income stream can weather the storm.
The loss of pension plans resonates with many Americans. Perhaps they were forced to take a pension buyout into a 401(k), or they have pension-backed parents who seem far more secure in retirement compared with their own prospects. By putting income annuities into this context, advisors can shatter the myths that surround these products and underscore them as applicable solutions.
Debunk The Myths
Despite the benefits, some clients will be skeptical. One of the most common concerns is that income annuities will lock up liquidity. Between the lump sum sticker price, the structured payout system and the often-confusing concept of risk-pooling, it’s understandable why some clients believe they’ll have less freedom with their money. But advisors know this is a misconception. The best way to address this perception is to reinforce the concept of true liquidity in retirement — the assets remaining only after appropriately setting aside assets to meet basic income needs.
Advisors can really make income annuities shine with this framework. The value of true liquidity with these products is often higher when compared with a traditional retirement portfolio, giving clients more money and more freedom at the end of the day. Still, clients may hesitate at the contrast that would appear between different options — so it’s important to break it down.
A great way to illustrate true liquidity is to walk clients through a case study. Let’s look at a healthy 65-year-old woman with $1 million in assets and a desire to reliably secure $50,000 per year — with a 90% confidence level that she will not outlive her money. Using basic mortality projections, we need to create an income stream that will last until at least age 101 in order to achieve a 90% confidence level — in other words, there is only a 10% expectation that she will live past 101.
With this starting point, we can compare two portfolios using Monte Carlo simulations: a 50% stock/50% bond portfolio, and a stock portfolio with a life-only income annuity. For the 50/50 construction, this client would need to set aside $958,410 in assets to meet her goals, and the initial true liquidity would be $41,590 — so only $41,590 is truly available for other needs outside funding the $50,000 per year income goal. However, with the annuity portfolio, the client can reach her goals with $776,328 in assets and a resulting initial true liquidity of $223,672. What’s more, with the 50/50 portfolio there is a risk that under some market conditions the entire asset portfolio will run out, while there’s no risk of running out of income with the annuity portfolio.
By using a case study like this, a client will be better equipped to understand how an income annuity can allow them more flexibility in retirement.
A Pathway That Brings Prospects
Advisors know better than anyone that the retirement income journey takes some careful navigation. With uncertain market conditions and a protracted economic downturn looming from the COVID-19 pandemic, clients are at a higher risk of encountering gaps in their income plans. However, with the right tools (annuities), as well as the right mechanism (dialogue to alleviate concerns), advisors can help their clients build a strong bridge to a secure retirement.