Generating sufficient retirement income is and always has been the primary objective for clients engaged in planning for the financial future. Ever-increasing longevity rates, while obviously highly desirable for all, have combined with today’s low interest rate environment and the widespread disappearance of employer-sponsored pension plans to make creating a sustainable retirement income stream more challenging than ever.
Many clients are considering purchasing annuity products to provide steady income during retirement, but the question remains: Will this income be sufficient in the face of increased life expectancy rates and soaring medical expenses? A new study by the Society of Actuaries may provide a surprisingly effective solution to this dilemma so that annuity products will provide income that is not only steady but also sufficient.
A new ballpark for retirees
Unlike their parents, the vast majority of today’s generation of retirees does not have the pension plan safety net to ensure that their retirement standard of living remains in line with what they have become accustomed to expect. Achieving this goal is a personal task in today’s world, and many have done an admirable job in contributing to retirement accounts and seeking out the advice of financial professionals.
Unfortunately, the last five years have brought about yet another change in the retirement landscape — namely, consistently low interest rates that, in many cases, have prevented retirement assets from appreciating as expected — and seem destined to continue to do so for the foreseeable future. In addition to this, low interest rates have lowered the payout rates that insurance companies are able to offer on investment products, such as annuities, that retirees often rely upon.
As most know, the payout rate on an annuity contract is determined both by the client’s life expectancy and the investment returns that the insurance company expects to generate on that client’s investment in the product. The payments that an insurance company can be expected to offer a client who begins annuity payouts today are, because of low interest rates, substantially lower than they were for clients who began annuity payouts in 2007, when interest rates were higher. This creates a problem for retirees who had engaged in planning assuming higher interest rates.
The waiting game
Late in 2012, the Society of Actuaries released a study that examined today’s retirement income generation problem and posited a simple solution that can produce better results than most would have imagined—waiting. The study shows that waiting just one extra year before beginning the annuity payout period will increase benefits by about 9 percent on average and that working for five extra years can increase annual payouts by an average of about 50 percent.
For many retirees, the extra 9 percent in annual income that can be achieved by waiting one extra year can be sufficient to bridge the gap between the retirement income that they had anticipated 10 years ago and the retirement income that they can realistically expect in today’s market. For some, waiting an extra five years could ensure that medical and long-term care expenses — which are typically higher later in retirement — are manageable.
The study also shows a difference in the expected increase in benefits based on income level; waiting an extra year can increase the annuity payout rate by about 16 percent for lower earners, for whom the extra year of savings will likely represent a higher percentage of lifetime savings. Five extra years of earning can increase payout rates by a staggering 98 percent for this lower-income group.
For many clients considering retirement, waiting an extra year — or five — to retire may be undesirable from a personal and emotional standpoint. Educating these clients as to the substantial positive impact that waiting can have on their quality of life during retirement can provide the motivation that these clients need to ensure that their retirement income will be sufficient to meet their needs.
For previous coverage of strategies for ensuring sufficient retirement income in Advisor’s Journal, see The New Retirement Income Game: Ousting the 4 Percent Rule.
For in-depth analysis of planning for individual clients’ financial needs, see Advisor’s Main Library: C—Considerations Underlying the Investment Decision.
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