Annuities, Revisited
Not only are annuities good for a midsize retirement portfolio; they're also good for a retiree's mental health.
In case you missed it, annuities are hip. After dipping in the early part of the decade, sales of annuities have surged, thanks to new products that add flexibility and remove some of the more onerous restrictions of older offerings.
Baby Boomers Strike Again
As with much else about our culture, you can hold the baby boomers accountable for the annuities surge. For them, retirement is just around the corner: The first boomer to file for Social Security, Kathleen Casey-Kirschling, born Jan. 1, 1946, will be eligible to collect benefits in January. Many others have opted for early retirement.
At the same time, Social Security is stretched so thin, it's practically squeaking. Seventy-six million boomers are lining up to receive their monthly checks in the next two decades, and they will enjoy life expectancies unparalleled in American history. Even the system's biggest fans believe that benefits are likely to diminish. Social Security now replaces just 40% of a retiree's income, and is expected to account for even less going forward.
Finally, there's the problem of sequence of returns. As anyone who retired in 2001 can attest, making withdrawals in the midst of a bear market can put you in a hole that is virtually impossible for you to climb out of.
So it's no surprise that planners are giving annuities a look. In fact, the problem with annuities now may be that they're too good—or at least that they offer too many options. Want inflation protection? No surrender charges? Death benefit? Living benefit?
Deciphering the Riders
Much of the activity centers around living-benefits riders. These typically come in three varieties and are designed to overcome the objections that both advisors and clients have had in the past.
One type is the guaranteed minimum income benefit, which insures future income at a specified minimum level.
The second type is the guaranteed minimum withdrawal benefit, which allows the insured to withdraw a predetermined percentage of the investment annually, and sometimes for life, without requiring annuitization—even if the account balance drops due to market performance.
Third, the guaranteed accumulation benefit assures that a policyholder's nest egg won't lose value even if the underlying investments sink. This benefit is best suited for risk-averse investors who want to participate in potential market gains while mitigating their losses.
While the industry has made headway in simplifying some contracts, the riders are still plenty complicated. For example, the guaranteed minimum withdrawal benefit is most appropriate for investors who plan to annuitize their savings, thereby creating a pension-like income stream. Otherwise, the rider is a waste of money. There's usually a lock-in of several years, and investors are limited in the amount of investment risk they can take, so it's not a vehicle for aggressive maneuvers.
The Price of Security
"Most middle-class people want something that resembles Social Security, in that it's inflation-adjusted, lasts for a lifetime and is not subject to the ups and downs of the market. Of course, advisors have no trouble acknowledging that running out of money is a very real possibility for people with no guarantees in place.
"Anything that's guaranteed is going to end up giving up return. "What an annuity does is stop the growth at a certain point. The insurance companies keep the growth and give you a guarantee. By creating a growing portfolio over decades of saving and investing—including the post-working years—should provide a large enough base from which to make prudent, systematic withdrawals in retirement.
There's research suggesting that annuitizing can lead to happiness, an income stream that funds at least 25% of retirement spending boosts life satisfaction to almost 70%. And people who derive most of their retirement resources from an annuity display fewer symptoms of depression than those who don't. They also perceive themselves to be wealthier than those who have the same amount of money, but not in an annuitized form.