There has been more attention than ever centered around annuities, prompted by discussions at the federal level about the benefits of adding an annuity to individual retirement portfolios. At the heart of the discussion is the fact that consumers need to protect themselves from outliving their savings by adding a reliable, guaranteed retirement income source to their retirement funds — retirement funds that have been diminished by the decline of pension plans and by the recent financial crisis. This broad recognition of a need to establish a “personal pension” brings to light the value of immediate annuities as part of the solution to the retirement savings risk that millions of families are facing.
Before 2008, the addition of an income annuity to a retirement plan started to become a standard part of planning decisions because the guaranteed paycheck for life provided consumers with a necessary guaranteed income source. As a result of this awareness, sales of income annuities industrywide grew significantly — up more than 50 percent between 2005 and 2008.
Then the “Great Recession” took hold. The stock market declined by more than half its value, and the average 401(k) and IRA value plummeted, negatively affecting retirement plans. For many retirement-aged people who had less time to recoup their losses, it hinted at disaster. In fact, the market meltdown caused the reduction of retirement nest eggs by up to 40 percent in many cases, meaning that a $500,000 retirement nest egg could be worth as little as $300,000 and would generate significantly less income in retirement. While the markets have somewhat recovered, many are still down 25 percent or more.
Retirees need to find a way to replace the loss, maximize the rest of their nest egg, and ensure that retirement savings last a lifetime. The immediate annuity offers a time-tested solution. By using income annuities as part of their retirement income portfolio, people found a way to recoup the lifetime retirement income stream they would have had with a $500,000 nest egg.
How is that possible? A 2007 academic study, “Rational Decumulation,” conducted by professors at the Wharton School and Brigham Young University, demonstrated that by using income annuities, consumers could generate a stream of secure lifetime retirement income for 25 to 40 percent less money than it would cost to create an equally secure lifetime income stream using a traditional portfolio of stocks, bonds, and cash. With the benefits of risk pooling available only from life insurers, income annuities help replace the retirement income stream lost when funding income needs with only stocks, bonds, and cash. In other words, that $300,000 portfolio can still provide lifetime income equal to the income that the $500,000 portfolio of stocks, bonds, and cash used to generate.
Additionally, by covering at least basic living expenses with income annuities, there is much greater flexibility in other areas of a retirement plan, including the ability to take on more investment risk, according to one’s risk tolerance, with the remaining portfolio — an added benefit that also helps retirees who need to recoup the ground that was lost during 2009.
The heightened dialogue around annuities recognizes that against the backdrop of economic weakness and the volatility in the financial markets, Americans increasingly value safety, security, and stability, and make retirement decisions with these qualities top-of-mind — retirement decisions that include choosing products and financial institutions in which to entrust their nest egg. Choosing a company with a track record of safety and security is critical to fulfilling a 20, 30, or possibly 40-year commitment to guaranteed income.
While immediate annuity sales were rising significantly before the crash of 2008, a high-quality, no-risk investment that guarantees a paycheck for life, no matter what is happening in the markets, has become a lifeline for many pre-retirees and retirees in 2009 and 2010. Now that the academic community has studied and validated the high value and low cost of income annuities for generating guaranteed income in retirement, growth in this part of the annuity universe is expected to continue at strong rates in the future.
Chris Blunt is executive vice president of New York Life, in charge of retirement income security business. He can be reached at [email protected].