Navigating the Long, Forked Road to a Retirement Paycheck

An actuary walks advisors through the maze of retirement decisions

To annuitize or not to annuitize? That’s just one of many questions financial advisors face in the seemingly simple but actually complex effort to produce a paycheck for retirement clients.

The difficulty is especially pronounced for middle-market clients, since the less well-off have few choices other than Social Security while those with ample assets have enough portfolio wealth to obviate the need for a monthly paycheck.

Anna Rappaport, Chairwoman, Society of ActuariesTo help advisors get a global view of the key issues and trade-offs, AdvisorOne spoke with actuary Anna Rappaport (left), chairwoman of the Society of Actuaries (SOA) Committee on Post-Retirement Needs and Risks. Earlier this year, the Schaumburg, Ill.-based organization released a number of issue briefs on key retirement decisions, overseen by Rappaport’s committee.

Rappaport, whose consultancy is based in Chicago, says there are three main approaches to creating retirement income paychecks: income annuities; guaranteed products such as variable annuities; and systematic withdrawals. She stresses that middle-class clients are usually best served by some combination of the choices, and that’s where advisors can help.

“The products are complicated, so there’s room for advisors to help clients sort out what’s better,” she says. They can explain “what the range of options are and choose a good mix for them, and I think the idea of all or nothing is not the right direction” for most clients.

These three methods of generating retirement income have different, sometimes opposite, features involving trade-offs advisors and clients need to discuss. “Who’s going to bear the investment risk, and who’s responsible for making the investment decisions?” Rappaport asks. “Most of the time you give up flexibility and control in exchange for lifetime security.”

So, in deciding on an income approach, advisors and clients should first think about whether they want a guarantee behind that income stream. An income annuity, also known as an immediate annuity, is designed to mimic a traditional pension plan. The client purchases a monthly paycheck with a lump sum that is guaranteed by the insurer to last a lifetime (unless only a fixed number of years was purchased).

The trade-offs include no ability to access principal again, and no death benefit for heirs. But another benefit is higher payouts than other fixed-income products since those who die early subsidize the paychecks of those who live long. “You have some winners and losers,” Rappaport says. “People who live longer get [more].”

But many other decisions, and trade-offs, remain.

Should the income annuity include an inflation adjustment? While inflation drives up a retiree’s lifetime expenses, is the cost of the inflation rider worth the reduction in the monthly paycheck that funds it? Or might there be a cheaper way to buy inflation protection?

Advisors and clients must also assess the financial soundness of the insurance company issuing the guarantee, and may have to give up some additional income in return for increased safety.

Another obvious consideration is price: “You can buy on a basis that’s more cost effective to an individual or less so,” Rappaport says, adding: “You can use a competitive bidding platform like Income Solutions,” which she discloses is a consulting client of hers.

Guaranteed products like variable annuities can overcome some of the deficiencies of income annuities such as loss of control of principal and the lack of a death benefit for heirs.

Especially with VAs containing GLWB riders (guaranteed lifetime withdrawal benefits), clients have access to their funds during the accumulation stage while enjoying the benefits of a paycheck that clients cannot outlive. These products also have a flexible range of investment options, including all manner of equity and fixed-income options.

But here too there are trade-offs. A death benefit to heirs means there is a smaller income payout than is obtainable through income annuities. Also, VAs are famous for their hard-to-compare features, and layers of expenses and surrender charges add to their costs.

Most of the above-mentioned issues do not affect those who derive their income from systematic portfolio withdrawals. But here the trade-off is quite simple, and unnerving, for middle-class clients. There is no guarantee. When the funds are depleted, the paychecks cease—even if the client has many years of life ahead.

Conversely, though, the entire portfolio can go to heirs if the client dies before portfolio depletion. And the account owner never loses control of the funds and can alter investment strategy and income amounts as desired.

To Rappaport, who stresses the advantage of a middle course for most investors, the challenge for advisors is: “How do you make a portfolio that is not all one way or the other, that balances between some guaranteed life income, and leaves some money for investing?

“If you do annuitize the money, then you may be able to be more aggressive with the rest of your investments,” she adds.

All these product choices and feature trade-offs do not begin to exhaust the questions retirees face.

For example, if they still have a mortgage at the time of retirement, do they pay it off prior to annuitizing or keep the mortgage but enjoy a higher monthly income?

When to retire, when to claim Social Security and whether to buy long-term care insurance are a few others.

“People are very appreciative when they understand the range of options they have,” Rappaport says. “For advisors, how you build a portfolio that defines and helps you think about the trade-offs is a really important issue.”

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