From the April 2006 issue of Investment Advisor • Subscribe!

Meeting the Need for Income

Manufacturers roll out products to keep the cash flowing in retirement

A host of financial services firms are coming out with new products to help advisors protect their retirees' income streams--everything from annuities that offer longevity protection and inflation protected funds, to products that offer income guarantees within defined contribution plans. Here's a rundown of some of the companies' offerings.

First, let's talk about the new-fangled annuities that offer what's being called "longevity insurance." New York Life added a longevity protection rider, the Changing Needs Option, to its MainStay Lifetime Income Annuity last October. With immediate annuities, policyholders give the insurance company a lump sum, and the insurer, in turn, starts paying out a monthly income immediately. The Changing Needs rider allows policyholders to increase their payments at a future date of their choosing to, for instance, deal with an expected increase in health care costs. Payments can also decrease, at the policyholder's request, by up to one-half of the original amount put in, notes Bill Formon, VP in the Individual Annuity Department at New York Life. According to an example provided by New York Life, retirees can choose to have higher payments earlier in retirement if they have a mortgage that will be paid off in a few years, and then elect to have their payments decrease once the mortgage is paid in full. Formon says the rider is most suitable for retirees who are 65 or older, noting that the income needs would vary based on a client's age and gender.

The Hartford recently released its Income Security product, a single premium tax-deferred annuity that "guarantees lifetime income at a future point," says Tim Benedict, a Hartford spokesperson. While the product is available now, Hartford is in the process of rolling it out through its broker/dealer, Woodbury Financial Services, according to Bene-dict. The annuity became available to other independent broker/dealers in early April. "Longevity is the one great unknown," Benedict says. One of the biggest challenges of planning for retirement is knowing "how long I am going to need to make my money last." Under the terms of the policy, if a client is 65 years old today and he wants to receive a guaranteed income of $1,000 per month at age 75, then he'd have to fork over a lump sum of $76,600. The client would invest $45,350 at age 65 if he wanted to start pulling in a $1,000 monthly income at age 80. If he wanted to receive the $1,000 monthly income at 85, then the client would need to invest $23,750 at age 65.

Benedict offers another example: say you're a 60-year-old male and you invest $50,000. If you elect to take income at age 75, you can draw $1,000 per month. At age 80, your income stream from the annuity jumps to $1,900 per month, and at 85, it becomes $4,000 per month, he says.

Srinivas Reddy, head of product strategy and packaging at ING, says the company hopes to start "building out" its own longevity protection product this year.

Inflation-protection features are also popping up left and right these days. In December, Metropolitan Life Insurance Company (MetLife) introduced an inflation-protection feature to its Guaranteed Income Program, which provides that income payments will rise with increases in the Consumer Price Index for All Urban Consumers, or CPI-U. There is also no limit on payment increases--which means that there is no annual or cumulative payment "cap," according to MetLife's explanation of the product. "In an extended period of high inflation, benefit payment adjustments that are limited by an annual cap can significantly lag inflation," according to MetLife's release announcing the inflation protection feature. "As a result, 'capped' inflation adjustments can fail to protect an annuitant's purchasing power throughout retirement. Also, there is no reduction in benefit for deflationary periods. An income payment will never fall below the prior year's payment level."

In February, Charles Schwab Investment Management launched the Schwab Inflation Protected Fund, which the company says is a mutual fund designed for investors who are in or near retirement. Schwab says a team of fixed-income experts will be running the fund, which will invest at least 80% of the fund's net assets in inflation-protected fixed-income securities issued by the U.S. government, foreign governments, and U.S. and foreign corporations. The remaining 20% of the assets can be invested in fixed-income securities not structured to provide inflation protection, including 10% of assets in high-yield securities, according to Schwab.

In announcing the fund, Kim Daifotis, co-manager of the Schwab Inflation Protected Fund, said, "Unlike the typical TIPS (Treasury Inflation-Protected Securities) fund, the Schwab Inflation Protected Fund is able to seek inflation protection from a variety of sources--including inflation-protected corporate bonds and overseas inflation-linked investments--while at the same time not passing up opportunities to seek growth."

DC Income Guarantees

Another hot trend are products that provide income guarantees within defined contribution plans, like Genworth Financial's product called ClearCourse, which is a group variable annuity designed specifically for DC plans. DC investment options typically offer either equity market growth potential or guaranteed rates of return, but ClearCourse--which was launched last April--provides both in a single investment within a 401(k) plan.

Fred Conley, president of the Institutional Retirement Income Group at Genworth, says ClearCourse was designed "to be liquid during accumulation--participants can transfer money in and take money out and take loans" if the 401(k) allows for that. Providing this type of flexibility "was one big component of making [ClearCourse] work within a 401(k) plan," he says. "We thought if we were going to put a product that provides guaranteed income in a 401(k) plan, we needed to make sure that it operated in a way that was consistent with the way participants, plan sponsors, and recordkeepers were used to. We didn't want it to be walled off into some completely different operating environment."

ClearCourse also helps investors manage inflation risk, Conley says. As investors make contributions to ClearCourse they're "buying a specific level of retirement income," he says. "In our product, that becomes your floor; so you know when you retire that's the minimum amount you get. Because it's a variable product, you're invested in an underlying balanced portfolio--so to the degree the balanced portfolio outperforms the guarantee, you have upside potential." He adds: "We think having that floor protection gives people the downside protection, but having it invested in a balanced fund with a 60/40 type equity-to-fixed-income ratio gives them some inflation protection in that they're going to get market returns over time."

Milevsky's Research

In January, Genworth Financial commissioned Moshe Milevsky, PhD, associate professor of finance at York University and executive director of the Individual Finance and Insurance Decisions (IFID) Centre in Toronto, to study the increased pressures facing defined contribution plan sponsors. His research compares the value of guaranteed versus non-guaranteed annuities and quantifies the value of having access to a variable income annuity, with downside protection, inside a defined contribution plan. You can view the entire report at www.ifid.ca.

Milevsky says "the Achilles Heel of defined contribution plans is that regardless of how much money plan participants manage to accumulate in their accounts, and despite how successful they might be in managing their financial affairs, in the words of pension economists, they have lost their longevity insurance." Clients "have lost the guarantee of lifetime income that is an integral part of a defined benefit plan." Milevsky added that his research "supports the argument that variable payout annuities (VPAs) should form the backbone of one's retirement income portfolio."

MetLife provides this type of option through its Personal Pension Builder, which is a deferred income annuity that can be offered within a 401(k) plan. MetLife originally launched Personal Pension Builder in April 2004, and Merrill Lynch began offering it as an investment option within 401(k) plans in January 2005. To date, 18 plan sponsors have signed up with Merrill to offer the product to their employees.

By contributing to their 401(k) through payroll deductions, employees are essentially securing a guaranteed future income. "If you were to put in $100, you would know exactly how much income that was buying for you at age 65," says Jody Strakosch, national director of strategic partnerships at MetLife. Calculators are provided to employees using Personal Pension Builder so that they can "figure out what your purchase will get you at the time you retire." Of course, the income amounts vary depending on how much money is being contributed and the workers' age. By making these monthly contributions to their 401(k) plan, though, workers are investing over time and can use the dollar cost averaging approach to purchasing a future income stream. "Right now we're in a relatively low-interest-rate environment," Strakosch notes. "Rather than plunking all of your money in at one point in time, such as at retirement, this [Pension Builder option] gives you the opportunity of buying at different interest-rate cycles."

Keep your eyes peeled for more innovative income-generating products to come down the pike. That's the whole reason financial services executives teamed up to the launch the Retirement Income Industry Association (RIIA), which is based in Washington, D.C. RIIA held its second annual conference in Boston in late February, and the event was more than twice the size of last year's get-together, according to Francois Gadenne, RIIA's founder. RIIA's goal is to not only act as a think tank for new income-generating products, but it also plans to offer a retirement specialist credential for advisors.

Melanie Waddell, Investment Advisor's Washington Bureau Chief, can be reached at mwaddell@investmentadvisor.com.

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