ELITE ADVISOR BEST PRACTICES

The Inevitable Anxiety of Outliving Your Money - Part One

One of the biggest stresses on today's retirees is that shorter term safe investments—CDs, bonds, money markets and savings accounts—return almost no interest. Understanding annuities and other insurance options can make you a valued advisor in this low yield era.

By Richard M. Weber

Key Takeaways:

  • One of the biggest stresses on today’s retirees is that shorter term safe investments—CDs, bonds, money markets and savings accounts—return almost no interest.
  • Unlike life insurance, which is based on the probability of death for a given demographic population, income annuities pay a monthly income as long as the policyholder (or spouse) is alive.
  • Many financial planners are reluctant to recommend income annuities because FINRA has expressed concern about selling a similarly named product (deferred or accumulation annuities) to older individuals.

A multipart discussion about planning challenges and insurance options for advisors and their clients

About 78 million U.S. baby boomers are currently turning 65, at the rate of 10,000 per day. That’s a lot of birthday cakes—and a lot of uncertainty about the last one-third of our lives.

Having recently become a statistic in the race to become a card-qualifying participant in the Medicare program, I am keenly aware of some of the anxieties we boomers face. The most pervasive? The one that every so often wakes me in the middle of the night, leaving me wondering if my wife and I will be able to continue to live our retirement years in the “style to which we’ve become accustomed.”

Nothing lavish, mind you. Just a lot of travel with the kids and the grandkids (they’ll always show up if we are the ones paying for the trip), time with friends, pursuit of hobbies and community interests, and—most important—living independently in our home for as long as possible (and ideally not leaving until being carried out in a pine box). That’s the new American dream—at least for most boomers.

Overcoming the anxiety about living financially secure throughout the remainder of our lives is going to take a lot of work. It’s also going to take stable and growing markets for equity and real estate, a solution to runaway medical costs, and the discovery of a magic lantern whose genie will grant us three wishes.

Working against our best interest

One of the greatest stresses on retirees today is that the interest they earn on their CDs, bonds, money markets, savings and other short-term “safe” investments has plunged to near zero percent. On more than one occasion since the near collapse of the economy in 2008 into 2009, T-bills effectively paid negative interest, just for the ironclad assurance of getting back the par value. Just as retirees are at the logical point at which they become more conservative in their asset allocation, their income returns have been cut by 80 to 95 percent over what they had previously enjoyed just a few years earlier—certainly on the shorter end of the duration spectrum.

As new fixed return investments yield less and less (and with the Federal Reserve intending to keep shorter-term rates near zero percent until at least midyear 2014), some retirees feel they can only improve that portion of their investment income by taking more risk—such as investing in bonds of longer duration and/or lower ratings—which has profound implications for a downward spiral of lifestyle and security.

Is it possible to create financial instruments that ensure monthly income no matter how long you live?

Immediate income annuities are the other side of the coin allowing the certainty of death to be insured nonetheless with life insurance. Life insurance measures the distribution of deaths for a group of similar age/health/gender individuals and is priced based on this year’s risk of death, whereas income annuities pay a monthly income as long as the individual (or jointly insured spouse) is alive. Life insurance allows us to “hedge” against the possibility of premature death, whereas income annuities hedge against living too long, and such an annuity is the only financial instrument that is designed to respond specifically to the anxiety and fear of outliving one’s money.

Income Annuities

Yet many financial planners are reluctant to talk about annuities, partly because there exists another product with a similar name: deferred (or accumulation) annuities—the variable form about which FINRA has expressed particular concern about inappropriate sales to older individuals. So it’s important to both distinguish and re-establish the potential value to our clients in considering income annuities as a part of their diversified financial holdings.

1. Fixed income annuities are the traditional form of monthly payment annuity. The amount of income paid is a function of the lump-sum premium (the purchase price), the insurer’s anticipated return on investing that lump sum and the average life expectancy of the insureds. The resulting monthly income is paid for as few—or for as many—months that the insured or joint insureds live. Each monthly check will have two components: a return of principal—which will be free of income tax—and earnings, which are subject to income tax. This exclusion ratio is calculated from life expectancy tables but will remain the same even if the insureds live far longer than those expectancies.

2. A new form of annuity has emerged in the last few years and is generically referred to as a guaranteed minimum withdrawal benefit annuity. While the lump-sum premium is invested into a portfolio of subaccounts offered by the insurer, there is a “shadow account” from which a steady income (often 5 percent) can be drawn on the original principal sum—or the value to which it has grown, if greater—after a predefined waiting period.

3. Another new form of annuity is the equity index annuity for which the insurance company credits the upside but not the downside of volatile stock indexes such as the S&P 500. Yet, unlike a typical variable version, the insurer does not put the premium paid for this type of annuity into the S&P 500, but instead invests in relatively conservative fixed income securities, thus hedging the portfolio against the downside of the equity markets (typically with a 2 percent guaranteed minimum return) while providing some portion of the upside in a good year for the equity markets.

Advisors will need to do their homework

Clearly, today’s innovative income annuities are “not your father’s Oldsmobile” and will take a significant amount of study to learn the technical aspects of the various styles of income annuities and to be in a position to suggest the appropriate proportion of investable assets into which to diversify with these instruments. You’ll also need to spend time learning how best to determine which of the many variations of annuities are in the client’s interest. Another resistance point for advisors whose business model includes fees for “assets under management” is the concern that if $500,000 of a $2 million portfolio is used to acquire annuities, then you’re losing the equivalent of roughly $5,000 a year in fee revenue—that is, unless you actively manage this new portion of diversified assets and are able to include it among the total assets under your management.

Until next time

Insurance products are often dismissed by planners as a necessary evil that should be used as sparingly as possible. But inevitably there are low-frequency risks whose financial consequences are too great to bear (or for which the results are too devastating), and insurance is the only solution. Yet, the selection paradigm tends to be focused on lowest price rather than longest or best value. In this multipart series on the assessment of risk and the subsequent use of appropriate risk management products, we'll try to differentiate myth from truth—and to suggest ways from the advisor’s perspective that sophistication about insurance is in everyone’s best interest.


About the Author

Richard M. Weber is an insurance fiduciary whose firm is retained by wealthy individuals and families to evaluate and actively manage existing coverage and to assist in assembling customized portfolios of life insurance policies that optimize client objectives. More information about Weber and his firm is available at www.EthicalEdgeConsulting.com(or email him at Dick@EthicalEdgeConsulting.com).