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Retirement Planning > Saving for Retirement

Top story: What to know about mortality credits and other annuity facts

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By Warren S. Hersch

New York City – If there’s one concept absolutely not to overlook when talking about life income annuity features with a prospect, it is the product’s mortality credits–i.e., the reallocation of contributions of those who die to those who survive.

That was a key message of Tom Hegna, a chartered financial consultant and vice president of New York Life, New York, during a meeting here.

“The reason you buy a lifetime income annuity is to get paid mortality credits–and all lifetime income annuities offer them,” he said at the March 2009 Boomertirement Road Show.

“The older you are, and the longer you live, the more mortality credits you get paid. You also get paid more mortality credits when you place fewer guarantees on the contract, such as a cash refund rider or guaranteed death benefit.”

Hegna related a hypothetical scenario involving 5 women, each 90 years old, who agreed to share evenly, in each of 5 successive years, $500 placed in a box for their benefit. In the second year, one of the 5 women dies, leaving the remaining 4 with $125, a 25% gain over their original allotment. In the 3rd year, a second dies, increasing the total $167 each, a 67% return. With each additional death in subsequent years, the amount apportioned to surviving women increases in like fashion.

Likewise, Hegna observed, annuity manufacturers can offer progressively higher interest rates on their products as clients age. The example he used showed individuals age 65, 75 and 85 receiving payouts of 8%, 10% and 16%, respectively. They can do this precisely because of these mortality credits, a feature not available on alternate financial products.

How much of the client’s money should go into a lifetime income annuity? The “mathematically and scientifically correct” answer, said Hegna, is an amount that will at least cover basic expenses.

But he also noted that clients cannot optimize retirement income using the balance of their investable assets without rounding out the portfolio (including bonds, cash and various classes of mutual funds) with a second lifetime income annuity.

Without a life income annuity, the only way to optimize income in retirement is to know the day the client will die. Though that’s not possible on an individual basis, Hegna said insurers can determine when, on average, a pool of individuals will die, thereby enabling the carriers to pay as though they knew when each person within the pool would die.

Annuities can be especially attractive to conservative investors during the current economic downturn, the executive pointed out. That’s because the products allow policyowners to recoup losses they may have suffered in the equities markets, he indicated.

To illustrate, he related a real case involving a husband and wife, each 75 years old, whose brokerage account had declined to $300,000 from $650,000 within 9 months.

The couple subsequently closed the account; and, after weighing the merits of reinvesting in a CD, which would have yield a 3% annual return and a payout of $9,000 per year, they purchased a joint-life with 30-year period certain income annuity. Result: The couple’s income increased to $22,000 annually for the duration of each of their lives. Should they have died immediately after the purchase, the guaranteed death benefit to beneficiaries would have totaled $663,000–exceeding by $13,000 the starting balance in the brokerage account.

Hegna added that annuities can also be creatively used to establish a multi-generational legacy. He recalled a case in which a grandfather bought a joint lifetime income annuity with a starting investment of $100,000, naming himself and his 5-year-old granddaughter as joint annuitants. The annuity also carried a 50% death benefit for the granddaughter’s beneficiary.

This product pays the grandfather $6,000 per year for life, and, when he dies, it will provide the granddaughter with an equal sum for the duration of her life (to age 100), each payment falling on her birthday. With an annual 5% inflation rider attached, payouts to grandfather, granddaughter and her beneficiary total, in Hegna’s example, nearly $4 million.

“What product other than an annuity allows a grandparent to transfer almost $4 million to 2 generations with a starting investment of just $100,000?” he asked.

“On the day he dies, that beautiful granddaughter will get a birthday present from her favorite grandpa every birthday for the rest of her life. She’ll always remember his name.”

On the topic of living benefits, Hegna said that a guaranteed minimum accumulation benefit (GMAB) option, when attached to a variable annuity, can eliminate exposure to market volatility by establishing a floor for the client’s invested principal. The rider locks in growth or a guaranteed return during a set term. At the end of that term, the account value will be either the contract’s value or the GMAB’s value, whichever is greater.

Benefits aside, Hegna cautioned attendees to avoid marketing “bad annuities” that entail unacceptably high surrender periods (10 years or more) and commission rates of 7% or more. Such products will only harm clients and the producers’ own reputation. He also urged participants to buy only from insurers that boast high credit ratings; and companies that offer both high interest rates and money-back guarantees on their products.

Hegna said the “bread-winner” of a household should delay taking Social Security benefits as long as possible, preferably until age 70. He cited the example of a boomer couple. Should the higher-earning husband pre-decease his wife, she can begin receiving his Social Security checks. If the husband had begun receiving Social Security payments at age 62, then he would lock her into a lower benefit upon death then if he had waited to age 65 or 70.

He also noted that a Social Security recipient who begins receiving checks at age 62 can ratchet up the monthly benefit by subsequently reimbursing the Social Security Administration, then reapplying for benefits at a later age.

Assuming a diversified portfolio, said Hegna, 25% of retirement accounts will “fail,” declining to zero before the retiree’s death. The failure rate increases as the annual withdrawal percentage increases: assuming withdrawals of 6%, 7% and 8% year, the portfolio failure rate increases to 50% 75% and 90%, respectively.

Key reason: the order of returns. While average annual returns on investments will determine how much money a client has at retirement, the order of returns during distribution will dictate whether the accumulated savings will last the length of retirement. Significant negative returns during the early years of retirement, followed by positive returns in later years, will drain retirement funds faster than when the order of returns is reversed–even though average annual returns are the same in both cases.

“If you lose money early in retirement, it could devastate your savings,” said Hegna. “Losses later in life will have much less of an impact.”

The meeting was hosted by the Partnership for Retirement Education and Planning, a coalition of non-profit associations representing financial service professionals, including the founders Million Dollar Round Table, National Association of Insurance & Financial Advisors, and Society of Financial Services Professionals.


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