Annuities, insurance, investments: A triple crown retirement income strategy

The use of a single-life annuity, rather than a joint-and-survivor annuity, proved helpful in these scenarios because it allowed the couples to take advantage of higher payout rates (a single-life annuity will typically pay out more than a joint-and-survivor annuity, which must consider the risk of longevity for two lives). However, as noted in the research, the single-life annuity becomes more feasible if a whole life policy is maintained as well. 

The whole life policy in these scenarios gave the surviving spouse the ability to manage his or her own longevity risk by providing a death benefit that could be used to fund an annuity product for the surviving spouse if 401(k) assets were depleted earlier in retirement. If sufficient 401(k) assets remained, the surviving spouse would have options for preserving the insurance death benefit as a legacy for his or her heirs.

A combined annuity-life insurance strategy is also useful in managing sequence of return risk, which can prove problematic if only a 401(k)-type account is used. Sequence of return risk is a market volatility issue surrounding the order in which returns on a client’s investments occur. Essentially, if a greater proportion of low or negative returns occur during the early years of retirement, the client’s overall returns are going to be lower than if those negative or low returns occurred at a later point in the client’s (and the investment’s) lifetime. 

The annuity portion of the strategy serves to remove a piece of the client’s assets from the pool of assets that would be impacted by sequence of return risk. By allocating a portion of a client’s assets to an annuity product that provides for a guaranteed level of income, the client is able to temper the risk that the market will perform poorly in the early years of retirement, diminishing his or her asset base.

Conclusion

Essentially, Professor Pfau’s white paper uses financial data to illustrate the benefits of a well-diversified retirement income portfolio—and concludes that by adding the flexibility of whole-life insurance into the mix, the client’s annuity and investment-based vehicles can be more efficiently used throughout retirement.

Originally published on Tax Facts Online, thepremier resource providing practical, actionable, and affordable coverage of the taxation of insurance, employee benefits, small business and individuals.  

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