Few workplace savings plans provide resources such as annuities to guarantee that savings will last throughout retirement, according to a recent white paper from TIAA. This “guarantee gap,” it says, undermines the very purpose of the retirement savings plan system, which is to minimize the risk of both poverty among retirees and strain on the social safety net.
“Ensuring that American retirees have sufficient income to last throughout their retirement is among the most critical issues facing our economy,” TIAA President and CEO Roger Ferguson said in a statement.
“For nearly 100 years, employees with 403(b) retirement plans have benefited from access to investments that generate guaranteed lifetime income. All American workers deserve to retire with the same level of financial security — and Washington can play a key role in getting there.”
The white paper notes that Americans today can expect to live 20 to 30 years in retirement. For about two-thirds of married couples who are 65 today, at least one spouse will live to age 90 and nearly two in five will live to 95.
Longer life expectancy, it says, increases “longevity risk,” the chance that retirees will outlive their savings — and most Americans underestimate their life expectancy.
Indeed, concern about longevity risk prompted the Internal Revenue Service to ease rules to make it easier for clients to protect against the risk.
According to the paper, the U.S. retirement savings system has many strengths, but also two major weaknesses in addition to the guarantee gap: Not enough Americans have access to a workplace retirement plan, and even if they have access to a plan, many Americans are not saving enough.
Policymakers and other stakeholders are addressing the coverage and savings shortcomings, but have done little to bridge the guarantee gap. The paper says the gap had its origins in tax law and pension policy changes over the past 25 years.
These changes, it asserts, created substantial disincentives for employers to provide workers the opportunity to invest in options that guarantee income that lasts throughout retirement. There also have been some advertisements that make annuities sound like financial shenanigans forced on unsuspecting clients by predatory salespeople.
TIAA acknowledges that no single policy change will fix the guarantee gap but insists that improvements are needed to broaden access to guaranteed income in retirement. It would start by offering in-plan annuities in retirement plans. TIAA offers in-plan annuities along with other investment and insurance products.
Beyond that, it recommends six solutions for consideration by legislators and regulators to advance lifetime income’s role in retirement savings plans:
Simplify the safe harbor for employers selecting an annuity provider;
Increase the portability of annuity contracts to simplify plan operations;
Broaden the regulations for qualified default investment alternatives to include annuities;
Provide plan participants with an annual lifetime income disclosure statement;
Give participants more access to flexible income distribution options; and
Provide favorable tax treatment for annuity income in retirement.
RMD Is ‘No Enemy’
Advisors should not worry about clients running out of money if they use a required minimum distribution (RMD) for withdrawals from retirement accounts, according to Craig Israelson, executive-in-residence in the financial planning program at Utah Valley University.
“The RMD is not your enemy. It provides sound guidance” for withdrawals, said Israelson, who spoke recently at this year’s FPA Annual Conference in Nashville. “If the RMD is the driver of withdrawals we know we’ll have success. That should give retirees comfort.”
He added that the purpose of the RMD is to insure the government collects taxes on the money that’s never been taxed.
Israelson showed charts of retirement plans using different investment allocations with withdrawals starting in 1970 for retirees at age 70-1/2, the required age for distributions from tax-advantaged retirement funds except Roth IRAs. Each account had $1 million in assets, and the initial RMD was 3.65%. (It rises as the divisor declines to account for the remaining years for the retiree.)
Even the portfolio with 100% in cash had $850,000 left after 25 years. Not surprisingly, a conservative portfolio with 25% stocks had $2 million left after 25 years, and a more diversified account with seven different asset classes rebalanced annually had about $3 million remaining.
“The general fear that pervades retirement land that portfolios can’t persist for 25 years is a notion not supported by the index data,” said Israelson.
Whether a retirement portfolio will provide enough to live on is the challenge, and that is a function of the starting balance and its investments. “The sequence of returns becomes crucial,” he said, noting that it’s important to study rolling periods of returns over 25 years that account for changing portfolio performance.
Using 25-year rolling returns, he showed that the slope of portfolios continued to rise beyond 10 years, then eventually peaked and reversed downward. Retirees won’t run out of money before age 95 if they don’t withdraw much more than the required distribution, according to Israelson.
Connect the Dots
Most Americans are aware that they will have to rely on personal savings in retirement, as Social Security benefits will be insufficient and only 21% can expect any kind of pension, according to Jackson National Life Insurance Co.
Recent survey results released by Jackson show that some 90% of consumers are very or somewhat interested in financial strategies that offer guaranteed lifetime income, but are largely unaware that annuities can provide this.
The online survey was conducted jointly by Jackson and the Insured Retirement Institute, a trade association, in mid-March among 1,000 consumers 25 or older with at least $10,000 in retirement savings, an additional 300 consumers who already had an annuity or worked with a financial professional and 400 financial professionals who had been active financial planners for two or more years at the time of the study.
Thirty-two percent of advisors in the survey reported that three or more of their clients had exhausted their investable assets, mainly through overspending or being overwhelmed by the cost of health care or long-term care.
Some 80% of advisors said guaranteed lifetime income product features have had a positive effect on their clients, and for a third, this was the most important feature of annuities. Fifty-two percent of advisors expected some of their clients who did not own annuities to run out of money during retirement.
The survey found that even though consumers generally perceive the benefits of guaranteed lifetime income in a positive way, and 63% of advisors recommend annuities to their clients, only a quarter of respondents 45 and older planned to purchase an annuity with some portion of their retirement savings.