Developing effective retirement income solutions is a complex challenge. Many of today’s retirees want the assurance of a guaranteed stream of income without giving up control of the underlying assets. Others are concerned about the risks of inflation, expensive medical bills or outliving their money. “No one has found the magic bullet for retirement income,” says Todd Perala, director, Strategic Initiatives at Retirement and Trust Services, BMO Global Asset Management. “It’s hard to help people understand the issues and make informed decisions when they reach retirement age.
With an estimated 10,000 Baby Boomers retiring every day, according to a 2012 Social Security Administration report, demand is growing for retirement income solutions. “About one-third of investors have a strong desire for a predictable cash flow,” says Jim Sandidge, product director, retirement products for PNC Asset Management Group.
That demand is spurring sponsors of defined contribution (DC) plans such as 401(k)s, individual investors with IRAs and SEP-IRAs, and financial service providers to find products and strategies to turn a retiree’s accumulated assets into guaranteed income with the flexibility to address changing needs later in life.
As Gerry Katz, senior vice president, Institutional Markets, Transamerica Retirement Solutions, says, “Federal regulators, the media and many investors are paying more attention to retirement income, and many providers are focusing on educating investors about the issues.”
In the past few years, financial providers have created more versatile annuity products in order to help retirees achieve the goal of a predictable income stream. Generally offered by life insurance companies, annuities come with a wide variety of features that appeal to different types of investors. Today, the options include:
• Single premium immediate annuities, which are often purchased by retirees who want to turn their accumulated retirement assets into a lifetime stream of income.
• Single premium deferred income annuities that can provide income beginning later in life, such as age 80 or 85. “Because this product has 20 years to build up the account balance, it can manage the risk of outliving your money for a relatively modest amount of money,” says Perala.
• Variable annuities where income is derived from funds invested in various asset categories. “Variable annuities appeal to dividend stock buyers,” says Sandidge. “They want to buy growth in a comfortable way while receiving a guaranteed stream of income.”
• Fixed income annuities, which can be an alternative to traditional fixed-income investments without the interest rate risk.
• Accumulation-oriented annuities that provide guaranteed lifetime income but do not offer other potential benefits.
Many providers now offer no-load and low-load annuities with drawdown provisions that provide retirees with more options in the future. These investor-friendly features – along with the Baby Boomer retirement wave – are helping to drive the growth of annuities in the U.S.
Annuity sales reached $61.4 billion in the second quarter, up 8 percent from the prior year, according to an August report from the LIMRA Secure Retirement Institute. For the first six months of 2014, total U.S. annuity sales increased 10 percent, compared with 2013.
“Despite declining interest rates during the first six months of this year, fixed annuity sales continue to drive overall annuity sales growth,” says Todd Giesing, senior analyst, LIMRA Secure Retirement Institute Annuity Research.
New options for DC plans
Annuity sales are likely to continue rising, as Washington addresses some of the regulatory obstacles that have held back adoption in DC plans. “Fiduciary responsibility remains a prime concern for DC plan sponsors,” says Sandidge. “We need the Department of Labor to bring clarity to sponsors around making guaranteed income products a default option for participants.”
Katz adds that DOL recently issued new regulations that allow DC plans to add Qualified Long Annuity Contracts (QLACs) to their investment menus. “This would allow participants to allocate a portion of their portfolio to a deeply deferred annuity that might not provide payments until age 80 or 85,” he says. “Life expectancy is one of the more difficult challenges with guaranteed income, and QLACs provide a solution to dealing with longevity risk.”
Even without clear guidance from federal regulators, DC plan sponsors can take a close look at guaranteed income options and evaluate products from different providers, says Katz. “Sponsors can evaluate the creditworthiness of the various insurance companies, and those ratings can provide solid insights.”
In addition to annuity settlement options, the financial services industry has developed in-plan annuity products with full accessibility, Katz adds. That allows participants to cash out the market value of the annuity without penalty, or to transfer their balances to this option, increasing the level of lifetime guaranteed income.
“The annuity products are getting better and are becoming more transparent,” Perala says. “Just as we have seen a shift to auto enrollment, auto escalation and target date funds (TDFs) in DC plans, it’s likely that a retirement income product will be built into the plan as well. However, it’s not clear how soon that will happen without a regulatory guarantee.”
Changing investment behaviors
From a broader perspective, many DC plan sponsors are striving to educate participants about how their accumulated asset balances translate into income. For example, a participant might feel that $250,000 in assets is enough for a comfortable retirement ¬– until she sees that total will only produce $10,000 a year in income assuming a 4 percent return.
Because every individual has different goals and risk tolerances, a financial advisor can play a pivotal role in educating plan participants and other investors about retirement income.
“Advisors have to take a personalized approach to every client,” Sandidge says. “That begins with having them articulate a clear vision of what they want in retirement. While this should be a time of new beginnings, retirees are leaving the familiar workplace behind and that can lead to uncertainty and stress. If you’re an advisor you have to understand the psychology of the investor as well as the income-generating products.”
Advisors can also help retirees analyze how their Social Security payments fit into the overall income picture. “There are a lot of factors that go into a Social Security income strategy,” says Perala. For instance, if both spouses worked it may make sense for one spouse to postpone filing for benefits for several years.
While guaranteed income products address the risk of market volatility, they usually don’t provide protection against inflation risk. Therefore, a portion of a retiree’s investment portfolio should include equities, real estate or other growth-oriented assets that tend to rise in value during periods of inflation, says Perala.
That might mean constructing a retirement portfolio divided into three segments: an immediate annuity for lifetime income, a single premium deferred annuity for income after age 85, and assets that can continue to grow in value throughout the retirement period.
As Sandidge says, “It’s very important for investors to understand their options with regard to retirement income. Rather than taking an autopilot approach, retirees need to create a diverse portfolio and review it regularly in order to be sure it meets their changing needs.”
