Retirement Strategies That Beat Father Time

How deferred income annuities can be a powerful option in creating a successful retirement plan.

While most people refer to him as Father  Time, in the financial industry we have a more accurate, yet slightly less friendly, name for him: longevity risk.

If longevity risk—the risk of outliving one’s money—was an easy problem to solve, most companies would probably still be offering pensions. But, for most people, that benefit is long gone. And with reports projecting that Social Security trust funds will run dry by the year 2033, this problem only looks to become more complicated.

However, with a well-developed retirement strategy that incorporates the use of deferred income annuities (DIAs), boomers and seniors can establish a floor of essential retirement income using fewer assets, while also leaving room for liquidity, additional growth and opportunity, and legacy goals. If implemented correctly, advanced laddering techniques can lessen longevity risk, combat inflation and even provide extra income to deal with long-term care needs that arise. In addition, by incorporating the right kind of option riders, installment or cash refund and life or joint life with period certain, you preserve and protect your principal deposit and some guaranteed growth dead or alive.

why living long has become so complex

If you look back just 100 years ago, the average U.S. life expectancy was close to age 50. Now, data shows us that if you take a married 65-year-old couple, there is a 50 percent chance that one spouse will live to 92, and a 25 percent chance one will live to 97. Also consider that centenarians, the age group of people 100 and up, are the fastest-growing age segment in the United States. People are living longer and longer, and what used to be a 10- or 15-year retirement may now be 35 years or more. That is a long time to go without a salary! Retirees are exposed to numerous other risks, including those associated with:

• Health care

• Long-term care

• Sequence of returns

• Market volatility

• Inflation

• Deflation

If they only live a few years into their retirement—say they retire at 65 but only live to 68—none of these risks will likely matter. From a financial standpoint, their retirement will likely be successful, although short. However, the longer they live, the more exposed they become to all the other risks, any of which could have a devastating impact on their portfolio. For instance, consider the impact of inflation. Let’s assume 2 percent annual inflation (which is less than most financial advisors would). Over the course of 10 years, the purchasing power of $1,000 goes down to $817. While this is a steep drop, most likely it would not completely ruin a person’s retirement plan. However, if you consider the same inflation rate over a 35-year period, $1,000 would decline to a measly $493 of purchasing power. That’s like taking a 50 percent pay cut! Inflation and longevity alone can have major consequences, but with the other retirement risks mixed in it can become deadly. 

dias: the best cure for father time

DIAs, basically a single premium deferred annuity with an  income annuity component, are the ideal vehicles to create a floor of essential retirement income. Just like the single premium immediate annuity, the income payments are known and fully defined at the time of purchase. In this case, however, the income payments can be delayed from as little as 13 months to up to 50 years into the future. Modern DIA contracts may also allow a change date rider and some flexibility of the actual start date even after the purchase of such contract. With no fee drag, favorable tax treatment, mortality credits and the option for built-in inflation protection, DIAs provide the opportunity to create more income using fewer assets, which allows room in the portfolio for liquidity, growth and legacy objectives. Because the annuity is deferred, it allows the principle more time to grow over an established period, and thus can generate a high payout rate for the annuity holder. In short, it pays to delay.  DIAs also can help mitigate the sequence of returns risk.

The worst time for your clients to take a major hit to their portfolios is the five years before and after they retire, frequently referred to as the retirement “red zone.” A major financial hit during this stage can dramatically decrease the amount of money they can safely withdraw each year and increase the chance of living too long. With the DIA, a person could invest their money at age 55 with a 10-year deferral, protect it from market volatility and know the exact income payments they will begin to receive at age 65.

Advisors must always prepare clients for inflation and the high health care costs associated with living beyond 90. One option is to mix a DIA with a fixed index annuity (FIA) or variable annuity (VA) that has a guaranteed withdrawal benefit (GWB) rider so that clients can start taking income if needed. This approach allows the FIA and VA assets to accumulate over a longer period of time and, if the FIA or VA is needed for additional income, it will provide higher withdrawal rates at older ages. Some contracts even allow for turning the income on and off. If the income is not needed, it can be used for the client’s legacy goals. Another option provides an increased payout if your client requires long-term care. By managing health care risks this way, you reduce the likelihood that your client will have to dip into legacy assets to pay for long-term care expenses.

While Father Time presents a complex problem for retirees, with new product developments and some creative financial planning, advisors will be able to make their clients money last as long as they need. The key is to take the retirement income they have into consideration and determine how much more they will need to maintain their lifestyle. Then DIAs can offer a powerful option to fill that income gap and create a solid foundation upon which to build a successful and long-lasting retirement.

by Curtis V. Cloke, LUTCF for the Winter 2012 issue of The Wealth Channel Magazine

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