A tidal wave of baby boomers is rolling into retirement and about 76 million people—roughly 10,000 a day—will turn 65 over the next two decades.
But as they enter their golden years, boomers—and their investment advisors—face daunting obstacles to achieving a rewarding retirement. Unlike current retirees, most boomers can’t rely on pensions and Social Security to fully fund retirement. IRAs and 401(k)s have been hit hard by two major market drops, leaving many investors spooked, risk-averse and poorer. Inflation from growing government deficits is lurking on the horizon. Above all, boomers are worried about outliving their assets.
So what is the good news? With retirement imminent for so many, investment advisors and clients are taking proactive steps to prepare for retirement.
A new generation of products and strategies is coming to the marketplace that addresses the growing need for guaranteed retirement income. Targeted to fee-only advisors, these new products eliminate commissions, surrender charges and costs associated with other products; provide open access to mutual funds and ETFs; and put advisors squarely in control of managing assets.
These new retirement planning tools can protect clients’ future income generation as they move from asset accumulation to generating retirement income. Three risks pose the greatest threat—both during this transition and throughout retirement:
Longevity. The good news is that Americans are living longer. Projected life expectancy, for example, rose to 78.7 years in 2010, and the U.S. Census Bureau estimates that the number of centenarians will increase nearly eight-fold to 600,000 by 2050. But for advisors working to ensure that clients don’t outlive their assets, longevity poses significant risks and challenges.
Inflation. Inflation—both the short-term spikes in interest rates and the long-term erosion of purchasing power—is an ongoing and constant concern for clients planning for or already living in retirement. It needs to be a primary consideration when constructing a retirement income portfolio that’s built to last.
Volatility and Sequence of Returns. As clients move into retirement, stock market volatility and sequence of returns risk grows significantly. Market losses during the transition into retirement can have a severely negative impact on the income generating potential of a client’s portfolio. That’s because clients will need to begin withdrawing portfolio funds immediately to produce income, severely impacting the ability of the portfolio to “catch up” during subsequent years. Protection from volatility is crucial at this transition.
Building a successful retirement plan is an ongoing concern for advisors and clients. One effective way to overcome the risks outlined above is constructing what Dr. Moshe Milevsky of York University calls “personal pension plans” that will pay clients a guaranteed income for life.
One vehicle for this approach has been the variable annuity. While some advisors do use VAs to address client needs for lifetime income, fee-only advisors have tended to shy away from VAs, largely because of the embedded compensation, lack of liquidity and limited investment options found in many of these products.
But new offerings are now available that provide guarantees that make more sense for fee-only RIAs. A December 2011 paper by Tamiko Toland of Strategic Insights, “Bringing Retirement Income to the World of Fee-Only Advice,” reports on one such product “custom tailored” for the fee-only market that marries a living benefit guarantee with a portfolio of mutual funds or ETFs.
The New Generation of SALBs
Called a stand-alone living benefit, or SALB, this product allows clients to purchase a living benefit guarantee on assets held outside of an annuity in a portfolio of low-cost mutual funds and ETFs.
“The SALB simply adds a guarantee on top of assets that the investor owns directly, unlike VA subaccounts,” according to the paper. “As such, there is no commission or death benefit, reducing contract fees and avoiding the structure and expense of the VA subaccounts. Assets remain fully under the control of the advisor within existing systems, unlike many annuities, which often end up as orphaned holdings.”
The SALB design is also highly complementary to the fee-only RIA business model, providing advisors with an open architecture marketplace of mutual funds and ETFs and control over management of the guaranteed assets.
SALBs can provide a tax-advantaged investment structure in a non-qualified account, as income and long-term capital gains are taxed at preferential tax rates as opposed to VA distributions, which are taxed as ordinary income. In addition, they can offer the opportunity for inflation protection through floating income guarantee rates that are tied to the 10-year U.S. Treasury Bond yield.
Because SALBs are insurance products requiring appropriate licensing, advisors will either need to be licensed or they will need to access distribution platforms that meet licensing requirements.