The increasingly wide array of new and emerging retirement income products and solutions can be dizzying. Virtually a day does not go by without a financial services provider adding a new or repackaged approach into the mix. Amid this proliferation of options, it can be increasingly difficult for you to know what approach will work best in each client's special circumstances.
So what are you to do?
Even as your options multiply, there appears to be an emerging consensus that income annuities are one of the more appropriate options for many consumers. In short, retirees should be able to do a better job of managing more of their life and financial risks in retirement by properly including both investment and insurance products in their retirement income strategy. More specifically, utilizing income annuities and investments appears to be a sound approach for generating retirement income for many Americans.
Income annuities
First offered in the U.S. in the 19th century and by a private insurer in 1917, income annuities are not new, although they can be underappreciated. Providing guaranteed lifetime income, they provide peace of mind as well as cash flow and are considered by many as an alternative for those not having a traditional pension plan. Any guarantees provided are dependent on the claims-paying ability of the issuing company, so the choice of the insurer is an important one.
Today, however, income annuities are generating increasing interest from such sources as top financial writers and sophisticated financial firms, not only because of their approach to addressing retirees' desires for security, but also because of their ability to provide the retiree with great flexibility. The newer designs of income annuities enable a retiree to choose:
o When income starts -- With most current designs, income starts immediately, although a few newer designs offer deferred income as a form of pure "longevity insurance."
o Whether income payments increase with changes in the Consumer Price Index, newer designs have payments that enable income to grow and reflect inflation.
o How premiums are paid -- Most designs allow only one lump sum premium payment, although new designs enable the annuitant to gradually purchase the income through a series of premium payments in a single contract.
o Income benefits -- Most designs have a limited number of payout options for the spouse and/or beneficiary (e.g., 75 percent to survivor with 10 years certain). Newer designs permit the retiree to customize income benefits.
o Liquidity -- Most designs do not provide access to reserve assets because of the risk of mortality anti-selection. Some newer designs, however, offer limited forms of liquidity.
All of these choices make an income annuity an appropriate option for many retirees as it offers certain flexibility. But just exactly how and when to purchase annuities often is left up to a "best guess" approach. Now, however, the answer to that question is finally becoming clear.
Purchasing income annuities over time
According to research performed in October 2006 by the Income Management Strategies Division (IMSD) at MassMutual, there are literally 1 trillion potential paths in designing a retirement income distribution plan.
But out of all of these possibilities, our findings indicate that the most important decisions are about whether or not income annuities are included into the retirement mix and how much guaranteed income is purchased and over what period.
These decisions appear to be more important than subtle changes, say, in the asset allocation of the retirement portfolio.
To test this notion, IMSD compared three strategies that a typical advisor to retirees may often consider:
o Investment only (no income annuity purchase)
o Purchase of a cost of living adjusted (COLA) income annuity up front with, say, one-third of the available investment funds
o Investment with gradual purchase of a COLA income annuity until the lifetime income goal is reached (a "laddered" approach)
Using Monte Carlo simulations, we compared these three potential approaches for achieving sustainable income for life at age 90. Under today's conditions, and under the assumptions and methodology used in the model, gradual funding of a COLA income annuity over time resulted in the most favorable distribution of income risk. [Our research results are available upon request.]
Advisors who try to pursue this strategy by cobbling together each of the necessary components individually can find it time-consuming, inefficient, and limiting in terms of the number of clients served.
However, now, with the introduction of new tools and new types of income annuities, this approach can be more manageable for advisors to adopt.
For instance, one new investment advisory program and IRA rollover offering includes planning software, account administration, mutual fund model portfolios, and a new-generation income annuity (with most of the features described above), all on one platform. With all of the pieces in one place, an advisor can easily assist the client with the planning and execution of a client's personalized strategy, and still be able to provide those services for other clients.
Gradual funding of an income annuity responds to most retirees' reluctance to give up flexibility early in retirement by purchasing an income annuity with a lump sum on a single date. Gradual funding enables the retiree to retain flexibility in their early retirement years and to achieve security in their later retirement years.
We will likely continue to see more players enter the retirement income space, particularly as the number of boomers retiring increases. Each will promote its product or strategy, some of which might have merit in certain situations. But in the end, for most Americans, investments combined with income annuities and other protection products can help avoid unintended consequences by matching the retiree's risk tolerance; better manage the risks of inflation, longevity, and morbidity; and, very importantly, achieve favorable income results for your client.
Jerome ("Jerry") S. Golden is president of the Income Management Strategies Division of MassMutual.
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