Navigating the Long, Forked Road to a Retirement Paycheck

To annuitize or not to annuitize? That’s just one of many questions financial advisors face in the seemingly simple but actually complex effort to produce a paycheck for retirement clients.

The difficulty is especially pronounced for middle-market clients, since the less well-off have few choices other than Social Security while those with ample assets have enough portfolio wealth to obviate the need for a monthly paycheck.

To help advisors get a global view of the key issues and trade-offs, AdvisorOne spoke with actuary Anna Rappaport (left), chairwoman of the Society of Actuaries (SOA) Committee on Post-Retirement Needs and Risks. Earlier this year, the Schaumburg, Ill.-based organization released a number of issue briefs on key retirement decisions, overseen by Rappaport’s committee.

Rappaport, whose consultancy is based in Chicago, says there are three main approaches to creating retirement income paychecks: income annuities; guaranteed products such as variable annuities; and systematic withdrawals. She stresses that middle-class clients are usually best served by some combination of the choices, and that’s where advisors can help.

“The products are complicated, so there’s room for advisors to help clients sort out what’s better,” she says. They can explain “what the range of options are and choose a good mix for them, and I think the idea of all or nothing is not the right direction” for most clients.

These three methods of generating retirement income have different, sometimes opposite, features involving trade-offs advisors and clients need to discuss. “Who’s going to bear the investment risk, and who’s responsible for making the investment decisions?” Rappaport asks. “Most of the time you give up flexibility and control in exchange for lifetime security.”

So, in deciding on an income approach, advisors and clients should first think about whether they want a guarantee behind that income stream. An income annuity, also known as an immediate annuity, is designed to mimic a traditional pension plan. The client purchases a monthly paycheck with a lump sum that is guaranteed by the insurer to last a lifetime (unless only a fixed number of years was purchased).

The trade-offs include no ability to access principal again, and no death benefit for heirs. But another benefit is higher payouts than other fixed-income products since those who die early subsidize the paychecks of those who live long. “You have some winners and losers,” Rappaport says. “People who live longer get [more].”

But many other decisions, and trade-offs, remain.

Should the income annuity include an inflation adjustment? While inflation drives up a retiree’s lifetime expenses, is the cost of the inflation rider worth the reduction in the monthly paycheck that funds it? Or might there be a cheaper way to buy inflation protection?

Advisors and clients must also assess the financial soundness of the insurance company issuing the guarantee, and may have to give up some additional income in return for increased safety.

Another obvious consideration is price: “You can buy on a basis that’s more cost effective to an individual or less so,” Rappaport says, adding: “You can use a competitive bidding platform like Income Solutions,” which she discloses is a consulting client of hers.