Retirees are weathering retirement under “substantial risk and uncertainty” by not choosing a deferred income annuity, a product “that specifically targets longevity risk” and is much loved by economists, according to retirement experts. In their Brookings Institution report — “Can Annuities Become a Bigger Contributor to Retirement Security?” — Martin Baily and Benjamin Harris write that despite the benefits, the use of deferred income annuities “has seen close to zero take-up in recent years.”
Academic research on annuities has analyzed the benefits of deferred income annuities, the paper states. Such a policy could be purchased at the date of retirement, or earlier by making contributions to a policy during working life.
A deferred income annuity policy pays nothing until the person reaches old age, say 80 or 85 years, at which point it pays a fixed amount each month or quarter. Someone in their 60s or 70s can then plan their expenditures, knowing that if they live into their 80s or 90s they will be covered financially by the payout from their annuity policy plus their continuing Social Security benefits, the paper explains.
“Economists have shown that under a range of assumptions about people’s attitudes to risk, a deferred income annuity policy makes people better off,” the paper states. In economic models, “People are made better off because deferred annuities offer an opportunity to purchase insurance against longevity risk cheaply — allowing retirees to keep much of their portfolio of assets intact for other purposes.”
Deferred income annuities are “cheaper” than immediate income annuities, the paper asserts, “in that the stipend they provide is high relative to the amount they cost for two reasons.” First, the annuity company can earn a return on the premium paid for many years before they start paying out benefits.
Second, “a fraction of those that buy deferred annuities will die before their annuity pays out, so their premiums go to support those that live into their 90s,” the authors state. “This is the same as homeowners insurance where those whose houses do not burn down subsidize those whose houses do burn down. Despite their obvious value, almost no one buys deferred annuities in practice.”
Baily and Harris also note that the Setting Every Community up for Retirement Enhancement (Secure) Act, which is tied up in the Senate, seeks to shield employers from fiduciary liability in choosing an annuity. The Secure Act attempts “to get more annuities into workplace plans by making it easier for employers to protect themselves from future liability,” the authors write.
Both the Retirement Enhancement Savings Act (RESA) and the Secure Act “contain safe harbor provisions developed largely by the insurance industry to protect employers from potential fiduciary liability for their selection of annuity providers. As fiduciaries, employers are still expected to undertake an objective, thorough, and analytical search for annuity providers, but the legislative safe harbor provisions are intended to simplify and clarify this process, making it much more explicit, objective, and attainable,” the paper states.
Under this safe harbor, “employers would not be responsible if the annuity provider enters insolvency as long as they have followed a reasonable path when choosing the provider,” the authors explain. “If concern over liability is indeed a major obstacle towards employer take-up of annuities, this legislation should lead to a rise in annuity offerings.”
On the healthcare front, there is good news for clients on Medicare earning more than $85,000 as individuals and $170,000 as couples filing jointly. Starting next year the income brackets linked to surcharges for Medicare Parts B (medical services and drugs) and D (prescription drugs) will be indexed to inflation for the first time since 2010. The updates come as Medicare hosts its yearly Open Enrollments Period for 2020, which runs through Dec. 7.
There are five income brackets linked to different surcharge percentages, ranging from 33% to 201%; these are applied as an additional cost to the base premium. The top income bracket, above $500,000 for individuals and above $750,000 for couples, won’t be indexed to inflation until 2028.
With the renewed indexing of incomes, “Americans will need to have higher income levels to be subject to the added cost of surcharges — a positive development for current and future Medicare recipients,” according to a new report from HealthView Services.
But, CEO Ron Mastrogiovanni explains, “given the pressure on the Medicare Trust Fund, retirees should expect additional changes and cost shifting to make up for lost revenues.”
The Trust Fund will collect less money from Medicare beneficiaries as a result of the inflation indexing while health care costs continue to rise, putting even more pressure on the program. “To maintain the solvency of the Medicare Trust Fund, revenue no longer generated from surcharges must be recovered from other sources,” the report notes.
According to the latest Medicare Trustees report, the trust fund for Medicare Part A, for hospital insurance, will be exhausted in 2026, resulting in an 11% cut in spending if no financing changes are made. Medicare Parts B and D funds are not projected to be exhausted, because the government can simply raise the premiums paid by beneficiaries to cover the programs’ rising costs.
The HealthView Services report notes that reductions in Medicare benefits are already underway. The government has already eliminated supplemental insurance Plan F (the most popular supplemental plan) and Plan C as of Jan. 1, 2020. Both plans help beneficiaries cover the gaps in costs that they are required to pay. (See: www.hvsfinancial.com/wp-content/uploads/2019/09/2019-HVS-Medicare-surcharges.pdf).