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Retirement Planning > Retirement Investing

How to Protect Your Clients in the 'Retirement Red Zone'

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Retirement income planning has long been a puzzle. Pre-retirees often haven’t focused on creating income despite their ticking retirement clocks. Financial advisors, companies, and the government have all preached asset accumulation, but paid too little attention to the income Americans will need when they retire, and rising financial markets have made consumers overconfident about their retirement security.

But that was then. Today, the retirement income puzzle is easier to solve. Changing consumer attitudes, new government incentives, and better financial solutions such as variable annuities with lifetime withdrawal guarantees are removing the barriers to effective income planning. It’s easy to see why.

According to the Federal Reserve, the economic meltdown and recession led to the evaporation of $1.3 trillion in personal wealth. Although the markets have rebounded, Americans are still worried about outliving their incomes. In fact, according to the Prudential study “Impact of the Market Crisis on Retirement Preparedness,” almost 90 percent of those surveyed wished they’d protected their money better from market losses, and just over 80 percent said they were more cautious now with their retirement assets.

Furthermore, consumers who experienced 30 percent losses in their 401(k) plans learned the hard way that 401(k)s are vulnerable to market fluctuations, which erode can values today and reduce income streams tomorrow.

Enter Washington policymakers. In a well-publicized move, President Obama announced plans to promote annuities and other forms of guaranteed lifetime income; he believes this will reduce the risks of retirees outliving their savings. Congress is also considering new laws that would provide greater incentives for lifetime annuity or 401(k) payouts, as well as mandate disclosure of projected retirement income on 401(k) statements.

Insurers, too, have responded by redesigning their variable annuities and living benefits to reflect the current economic climate, ensuring their long-term sustainability.

Now that the retirement puzzle pieces have fallen into place, how should you respond? First, help your clients get serious about retirement income planning. Second, help them protect their income from market fluctuations in the “Retirement Red Zone,” the critical years just before and after retirement.

For starters, here are two common planning approaches to consider

1. Keep contributing to a 401(k); then, at retirement, roll savings into a single premium immediate annuity (SPIA)
This approach has the benefits of simplicity and efficiency; however, as recent history suggests, the risk of 401(k) principal loss can be substantial. Plus, clients may decide to take out 401(k) loans and never repay them. When they retire, they might also take their money as a lump sum — and use it for purposes other than income. In fact, according to the Brookings Institution’s Retirement Security Project, only about 2 percent of 401(k) participants choose to convert their savings into annuities at retirement.

When clients do purchase an SPIA, they can receive guaranteed lifetime income and choose among a number of different options that help protect their beneficiaries. And, depending on the option elected and the interest rates at the time of purchase, a SPIA may help individuals increase their income for life. The tradeoff? They will no longer have the ability to:

  • Access their account value in the event of an emergency cash need
  • Determine how their money is invested
  • Forego taking income to help preserve their account value if they prefer

Finally, like all traditional annuitization products, SPIAs require clients to trade control of their retirement savings for guaranteed lifetime income. Where before, they could allocate their money as they saw fit, the insurance company now makes the investment decisions for the assets backing the annuity payments. Plus, with most SPIAs, when annuitants die, their income stops and the insurer pays no money to beneficiaries.

2. Roll over a portion of a client’s 401(k) into a variable annuity with a guaranteed minimum withdrawal benefit (GMWB) feature
By purchasing a GMWB, clients can withdraw a percentage of their account value or income base at retirement. Unlike a 401(k), an annuity with a guaranteed minimum withdrawal benefit has an income base that is usually guaranteed to increase over time and can lock in account value gains for determining guaranteed lifetime income levels, even if the markets subsequently decline.

Guaranteed lifetime withdrawal benefits can help protect consumers against the risk of a down market and a potential delay in their planned retirement date.

Let’s hypothetically compare a SPIA income strategy with a variable annuity with GMWB for a client who intends to retire in five years. The client could leave their money invested in their nonguaranteed 401(k) and convert it to a fixed SPIA at the end of five years. If the client’s account value increases significantly during this period, they will likely generate a higher annual income amount than if they purchased a variable annuity. However, if their account value decreases during the five years, without guarantees on his income base or the income amount generated off that basis, he would likely receive less income when he retires.

But what if the client transfers their money to a variable annuity that ensures their income base will accumulate at a certain rate per year? If their account value decreases, their income base will still be guaranteed to increase, and their guaranteed retirement income level will have been locked in. And if the account value increases, with most variable annuity lifetime withdrawal benefits, the client’s income base will also increase. Alternatively, they could annuitize the account value and receive a similar fixed income stream. The difference would be the additional fees paid for the lifetime withdrawal “insurance” provided by the annuity.

But here’s the key point: Clients adopting a VA/GMWB strategy would not lose control of their money. They can increase or decrease withdrawals, and even skip taking income altogether. If their needs change, they can surrender the annuity for its cash surrender value, foregoing the lifetime income guarantee. With a GMWB, advisors and their clients continue to select the investment portfolios for the annuity even after they’ve started taking lifetime income withdrawals. And when clients die, any remaining cash value is paid to their named beneficiaries.

Now, even though the second strategy has a lot of appeal, it’s important for clients to recognize that the GMWB feature doesn’t lock in account values — it simply locks in gains in those values in order to step up the protected withdrawal base. When selling these products, be sure clients understand this technical, but very important point.

The bottom line
Changing consumer attitudes, government incentives, and products have helped promote reasonable solutions for solving the retirement income puzzle. As a result, you can now:

  • Talk to clients about how to reduce downside risk to retirement income in declining markets
  • Show them ways to create a guaranteed income no matter how long they live
  • Explain how they can have guarantees without losing complete control over their money

The pieces may fit, but where are you? Are you ready to leverage the opportunity?

Jacob Herschler is senior vice president of business strategy for Prudential Annuities. He can be reached at [email protected] or 203-944-7517.


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