This is the fifth in a series of articles that will be published on the annuity space.
Introduction and overview
It’s no secret that baby boomers are rapidly entering retirement. Even for those who plan to stay in the workforce past their normal retirement age, the question of retirement income is top of mind. Most advisors do not currently receive adequate support from their firms relating specifically to retirement income planning, although this is starting to change. There are many organizations that are starting to develop more sophisticated and scalable tools to understand and evaluate the ability of individuals to meet their retirement goals—including income, wealth transfer and a contingency fund for health care or other unexpected expenses.
As a general product type, the features of annuities line up very well to meet many of the new risks that are present in retirement—specifically, longevity and uncertain market performance. However, these products are often sold as stand-alone options without an understanding of how or why they are a better fit than other, lower-cost options, such as mutual funds. While there are a number of strategies devised that incorporate annuities, this article will focus on product allocation models—packaging annuities with investment solutions that provide advisors with a more effective way to help their clients meet their retirement goals.
Before looking at the impact of including annuities into a retirement plan, the evaluation framework needs to be considered. As individuals transition from the accumulation phase to the distribution phase of retirement, they are exposed to many new risks in addition to the new goals and objectives found in Table 1. In order to adequately evaluate any retirement income product or strategy, all of the risks and goals need to be taken into consideration. An approach that focuses on the outcomes during retirement provides a more direct way of comparing products and solutions that have traditionally been difficult to compare.
For example, comparing the results of a traditional systematic withdrawal plan to a plan that includes 30 percent into a single premium immediate annuity is not as straightforward. What age do you assume the individuals live to? What is the value of having an income floor? Does annuitizing 30 percent of the portfolio reduce the chance of meeting the estate goal? These are all difficult questions to answer using a traditional risk-return optimization framework. An outcome or goals-based approach can directly compare these and any other products and strategies to provide the individuals with information to understand their trade-offs.
A quick example of an outcome based framework is found below in Table 2. The real, after-tax and after insurance premium consumption amount is calculated such that 90 percent of the scenarios end with the objectives being met using a full risk framework. The first column has the sole objective of meeting an income goal, and the second column has a goal of leaving the starting assets behind upon death. The results were analyzed using Retirement Analytics™ with a full risk framework that had long-term care expenses, Monte Carlo mortality, variable inflation and stochastic fund returns.