The best way to demonstrate the impact of poor early portfolio performance is to show it. The table on this page details 2 outcomes for an investor who retires with a portfolio of $600,000 and plans to withdraw $30,000 per year (adjusted for inflation) for 30 years. The left side shows that, if the market declines in the first few years of retirement, the investor runs out of money by year 18 (as denoted in the blue highlighting). But, if the order of returns is reversed, with positive returns at the beginning of retirement and negative returns near the end (see the right side), the investor still has substantial assets after 30 years.
In short, the “sequence of performance” makes a difference.
The rap against living benefits is that they add to annuity costs. But, guaranteed protection is not free, and, as is the case with living benefits, not cheap. Fees for living benefits vary by company and type of benefit purchased, but they typically cost anywhere from 0.25% to 0.60% of a clients account value each year. That fee may be a charge against account value on a daily basis, or it may be a single annual charge. In any case, the extra cost of the optional benefit can dampen growth of account value.
Another potential drawback of living benefits is that the cost absorbed can be more than just the fee. For instance, some living benefits require election of certain asset allocation programs or use of specific funds. Depending on the funds available with a living benefit, that ultimately can limit an investors investment choices, which can compromise the full range and flexibility otherwise enjoyed. Also, this could dampen an investors participation in a period of aggressive market growth.
Finally, investors and, in some cases, even their investment professionals may not fully understand the available living benefits, including limitations and time horizons required for benefits to work.
The first truth relates back to the point about “bad” fees for living benefits. With living benefits, clients are buying the “insurance” that protects the money invested in an annuity. Like any insurance protection, however, there is cost and risk assumed by the insurance company. This is not a new idea in risk management. It is the cost for transferring risk from the individual to the insurance company. This occurs every day with homeowners insurance, auto insurance and life insurance. The fee is paid to protect your clients against a loss they do not want or cannot afford.
A second truth is that living benefits are popular, dynamic and continually changing. One kind of benefit does not fit all clients, and investment professionals need to develop and maintain education and training on whats available and understand how these protective guarantees work.
Finally, heres a truth the annuity industry knows well: One thing you cannot put a price on is the clients self-security. When they are suitable, optional living benefits can protect clients against unnerving market fluctuations and provide a paycheck for life.
is president of Prudential Annuities, the domestic annuity business for Prudential Financial Inc., Newark, N.J. He can be reached at [email protected]
Reproduced from National Underwriter Edition, February 25, 2005. Copyright 2005 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.