Top Story: Catching the tidal wave in income distribution planning

Though baby boomers will swell the ranks of the retirement population by nearly 100% over next 30 to 40 years, they have not done a great job of saving for retirement, said Michael Tripses, executive vice president and chief actuary of Creative Marketing International Corp., Overland Park, Kan., during a March 19, 2008 webinar hosted by The National Underwriter Co. and Old Mutual Financial Network. This means "they'll have an increasing need for guaranteed incomes for the rest of their lives," he said. Producers should revisit their marketing materials to determine whether they're effectively promoting annuities as part of an income distribution strategy to retirees, said another panelist, Jeff Foley, who is assistant vice president of broker-dealer and marketing relations at Old Mutual. One solution that can assure clients of a lifetime income and that is deserving of producers' attention, Tripses added, is the fixed indexed annuity. A chief advantage of the product, he said, is that clients can earn interest exceeding the minimum rate of interest guaranteed in traditional fixed annuity contracts. The factors used to determine this excess interest–the participation rate, yield spread and cap rate–credit to the annuity a percentage of any gain in the index. The fixed indexed annuity's principal is also protected against market downturns, Tripses said. A key feature of the product, an annual reset or ratchet, ignores losses experienced by the index. So if the index declines in a give year, the contract treats the loss as a zero percent gain and credits zero interest for that year. "By trading a [traditional fixed annuity] offering a stable and level interest credit for one [fixed indexed annuity] that has some volatility, the client could end up with a long-term average interest return of from 5.5% to 6.5%," said Tripses. "At worst, the client will get a zero credit in one year, but potentially upwards of 25% in a good year." Tripses acknowledged that equity investments unfettered by caps on market gains, such as stocks and mutual funds, have a place in income distribution planning. But he insisted that a portion of pre-retirees' assets should be invested in a vehicle offering guaranteed income they can't outlive. Clients would be ill-advised to invest 100% of their assets in equities, he added, in part because of their volatility and the impact that market gyrations can have on retirement savings, particularly when the client suffers a poor sequence of returns during income distribution. Tripses noted that a hypothetical portfolio of $400,000 yielding a constant 9% rate of return would allow the client to withdraw 9% (or $36,000) annually and maintain the invested principal over a 20-year period. But if the 9% average is a result of negative returns in the early years and positive returns in later years, the retirement account could quickly be depleted over time. In the example Tripses used, the client runs out of money after the 12th year. In recommending an appropriate investment allocation, advisors also need to weigh clients' risk tolerance and their ability to sustain losses, he indicated. "If the client can only tolerate a loss of 10% in any given year, and the maximum possible loss in equities is 50%, then only 26% of the portfolio should be invested in equities," said Tripses. "The rest should be put into principal-protected products, such as market funds, CDs or fixed indexed annuities." Returns aside, annuities have other benefits to recommend them as a part of a sound distribution strategy, said Tripses. In the case of variable annuities offering living benefit riders, he said these include, the ability to make full or partial withdrawals (without incurring withdrawal charges) to cover cash needs stemming from unemployment, a terminal illness or nursing home care; and the ability to secure a guaranteed income or growth in the account value, irrespective of market conditions. For all their benefits, Tripses said that annuities have at times been unfairly criticized by the financial press, most notably with respect to the products' surrender charges and the loss of control upon annuitization. "Some people in the media say annuity investors should have full liquidity at all times with a guaranteed upside and no loss [of principal], which of course is not possible," he said. "But the product is occasionally pilloried for not having those characteristics." Old Mutual's Foley said producers should beef up their expertise and presentation capabilities. To that end, Foley said producers need to pursue continuing education courses in retirement planning and invest in software that can assess income planning needs and risks. They also need to partner with CPAs and attorneys who can provide tax and legal counsel, he said. Producers should also ally themselves with a marketing organization that can be depended on to provide the technical, sales and marketing support services required, continued Foley. Among the "underutilized" income solutions that potentially are of interest to client prospects, he said, is an annuity rider that ties the payout to increases in inflation; medically underwritten immediate annuities that can provide a higher income payment for clients who have a below average life expectancy; and the guaranteed minimum withdrawal benefit on annuities. "With a GMWB rider, you can start and stop withdrawals penalty-free at any point," said Foley. "This addresses the objection that many prospects have about not wanting to give up control of the asset." "The GMWB option gives clients the ability to guarantee not only principal, but also secure income for life, without ever annuitizing," he added. "The rider offers the best of two worlds, combining the benefits of annuitization and a guaranteed roll-up rate."
The webinar, titled "Taking Action: Using Annuities to Secure Retirement Income," can be viewed by clicking here.