Building good retirement income plans is not easy. A truly optimal plan can require high levels of personalization incorporating each household’s distinct situation and preferences.
Two types of products and solutions that retirees often consider are those that offer some type of guarantee and those with some type of longevity protection. Across these two dimensions there is a matrix of potential solutions. I think that most of the related innovation will likely be in the longevity-protected space, in terms of guaranteed and nonguaranteed longevity-protected solutions.
While selecting the optimal product within each quadrant is important, considering the full array of products for each client is a lot more significant. In other words, ensuring that a retiree has the appropriate amount of longevity-protected income generally outweighs the specific product/type.
As the space evolves, financial advisors need to up their knowledge on the products available if they want to ensure that their clients experience the best possible retirement outcomes.
The Risk Tradeoff
People tend to prefer products and solutions that offer guarantees around returns or outcomes. Guaranteed investment-focused products are offered by sources as varied as the U.S. government (Treasurys), banks (certificates of deposit) and insurance companies (annuities). There are quite a few such options, but most investment-focused products offer a relatively low return for their lack of risk.
Non-guaranteed investments, like equities, have historically offered a higher return than guaranteed products but with significantly more risk. It’s called the “equity risk premium” for a reason.
Products and solutions with longevity protection are receiving increased attention among those concerned about funding a retirement of uncertain duration. As defined contribution plans, such as 401(k)s and 403(b)s, become more central means to prepare for retirement, the need for additional longevity protection is going to grow.
It's possible to think about different longevity solutions from the lens of what’s guaranteed. Social Security retirement benefits, defined benefit plans and lifetime income annuities are types that offer explicit longevity protection.
Technically, there are nonguaranteed products that also offer longevity protection. These would broadly be referred to as tontines, with a pool of individuals whose payouts evolve based on the investment experience of the portfolio and/or the mortality experience of the pool, depending on the structure. Tontines are still relatively rare, but this product structure is receiving increased attention.
Here is a matrix of these potential solutions.
The Longevity Protection and Guarantee Matrix
Source: PGIM
A Broader Outlook
Many advisors may focus, somewhat myopically, within a given solution set. For example, many prioritize building efficient portfolios while mostly (or entirely) ignoring solutions or strategies that provide explicit longevity protection. I think this is a mistake. The optimal level of longevity protection is probably more important for most retirees than selecting the absolute most efficient portfolio.
Annuities address both the guarantee and protection spectrum; they aren’t all just single-premium immediate annuities. This versatility is important considering that many advisors ignore annuities when building retirement income portfolios. They may not work for every client, but the suite of products continues to grow.
And while there are important distinctions within lifetime income annuity products, the actual differences in retirement outcomes among products that offer explicit, guaranteed longevity protection are going to be relatively minor compared to a product that is neither and does not offer any longevity protection. The specific lifetime income annuity selected is a lot less important than just getting a client to use one in the first place.
In other words, while we as an industry can spend countless hours debating whether a deferred fixed annuity or guaranteed lifetime withdrawal benefit is better, what we really need to focus on is designing products and solutions that retirees — and their advisors — are interested in using as part of a retirement income plan.
David Blanchett is a portfolio manager and head of retirement research at PGIM.
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