Over time, many consumers have shied away from annuities in favor of alternative investment vehicles or products with which they were more familiar, such as mutual funds and certificates of deposit. In fact, just over a year ago, these popular investments were performing well, and on paper, the account balances looked good.
Since then, however, the financial markets have suffered, and many individuals have noticed significant drops in their retirement portfolios. As a result, they have been forced to make difficult decisions about their approach to retirement investing. Financial professionals, who have also been slow to warm to annuities, now see that their clients need to protect at least a portion of their retirement savings with the guarantees that only an insurance product can provide. Guarantees are particularly important during market downturns, and cannot be found in today’s traditional investment vehicles.
In a recent MetLife poll, individuals overwhelmingly responded that they are interested in products that provide protections against market risk. The recession, combined with losses in defined contribution plans — such as 401(k) plans — and in other savings and investment vehicles, has created deep fissures in the retirement landscape. To make matters worse, the number of working individuals covered by traditional defined benefit (DB) pension plans had shrunk in February 2009 to approximately 31 percent compared with 56.7 percent 20 years ago, according to the Employee Benefit Research Institute. Today, Americans typically don’t have a guaranteed source of retirement income aside from their future Social Security benefits, meaning that the financial burden has been placed on the individual to generate enough income to last throughout retirement.
Unfortunately, many discover too late that their “bag of cash” is not enough to last through retirement and cover their needs and wants. This can be especially true after the recent market meltdown. However, there are ways you can help clients create their own version of a personal pension plan using income annuities.
A flock to guarantees
Total fixed annuity sales in particular have increased significantly: Sales grew to $28.6 billion, an 11 percent increase from the second quarter of 2008, and year-to-date, sales totaled hit $64.2 billion, a 39 percent increase year-to-date. In addition, the percentage of retirees describing themselves as “conservative” increased from 53 percent in 2008 to 70 percent in 2009.
Like traditional DB pension plans, fixed income annuities are designed to provide guaranteed consistent payments that won’t change, even with market fluctuations. And like any solid retirement plan, they can help pay for fixed monthly expenses using the most efficient, reliable income available.
Individuals must first look at their annual fixed costs such as food, housing, medical, and insurance expenses and decide how much money it will take to cover those items. Then, they’ll need to take into account any future regular income, such as Social Security. Any gap — which would have previously been filled by a DB pension plan — could be filled today by an income annuity, so the client can be comforted by the fact that their monthly expenses are covered. But clients should also consider keeping some of their savings liquid for emergencies, and might also want to keep other assets invested for growth to combat inflation.
Income now, or later?
Most consumers cannot sustain a comfortable living through retirement with only one or two investments in traditional product classes, such as mutual funds and money market accounts. On investments without lifetime guarantees, the risk of depletion due to longevity is just too high.
It is generally understood that annuities may provide guaranteed income for the remainder of an individual’s life — another critical component of any retirement plan, considering that all retirees face the risk of longevity. If a client needs income now, a fixed income annuity may also provide higher payouts than they could generate on their own using traditional withdrawal strategies, thereby allowing the client to stretch their money as far as possible.
For example, a 65-year old male with $500,000 in savings and investments, using what many experts believe to be a safe withdrawal rate of 4 percent, in retirement would receive $20,000 annually before taxes.
If the same person with $500,000 in retirement assets allocates a portion of that amount to an income annuity (one-third, or $165,000 in this example), using current tables and assumptions, the annuity would produce a guaranteed income of $11,900. If the remaining $335,000 assets that were left in savings and investments (two-thirds of the $500,000) were then withdrawn at the 4 percent rate, it would provide an initial annual income of $13,400.
Together, then, this individual would then have a total income of around $25,000 annually before taxes, or 25 percent more than the strategy that didn’t use annuities ($11,900 + $13,400).
By dedicating a portion of savings to a fixed income annuity, the retiree is able to benefit from a three integral facets of immediate annuities:
- Leverage (a higher income-to-asset ratio derived from mortality pooling)
- Efficiency (a relatively high level of income generated from an accumulated investment)
- Guaranteed income for life
Think product allocation
In addition to income annuities, consumers should always consider other retirement income vehicles. For one, they might consider a personalized combination of three different income solutions — systematic withdrawals from traditional investments, variable annuities with guaranteed living benefits, and fixed income annuities — in order to maximize the sustainability of income in retirement. This approach can result in a higher level of retirement income that the traditional withdrawal strategy. It also provides a higher level of guarantees. In essence, it becomes a repair strategy for depleted portfolios, and therein increases the retiree’s peace of mind.
Building a personal safety net
By following the “do-it-yourself personal pension” approach, agents can overcome many of the barriers to selling annuities. Where consumers in the past may have shied away from annuities, now is the time for them to take advantage of a growing need for protection and guarantees for retirement investment vehicles.
By using the pension comparisons to help consumers view annuities as a familiar vehicle, you have an opportunity to rebut many common objections and help bring clarity to a valuable but often misunderstood product. Most importantly, you can help clients create invaluable guaranteed lifetime income in retirement at higher sustainable levels — thereby salvaging the retirement dreams of many Americans.
Holt McGee is a national team leader for MetLife’s Southeast regional annuity sales. He can be reached at [email protected].