The number one fear of many retirees is running out of money before they run out of life. For clients who share this concern, new research suggests that they use annuities to replace certain portions (or all) of a client's portfolio that would normally be allocated to bonds and other fixed income investments. Doing so, studies show, may significantly extend the life of a client's assets.
While this strategy has advantages, such as reducing portfolio risks associated with market downturns or longevity, the benefits come at the expense of liquidity and upside potential.
Related: Annuities for retirement income
One reason this approach may make more sense in today's environment is the heightened level of interest rate risk advisors believe now exists. With interest rates still hovering near all-time lows, they see only one direction in which the rates can move — up.
(Note: Some still believe that interest rates will continue to fall, especially in the event of another economic slowdown or recession, to such an extent that negative interest rates will exist.)
If interest rates move higher, client's bond and bond fund prices will likely decline. And if clients need to sell those assets to support lifestyle needs, they may be forced to "lock in" those losses.
Using a single premium immediate annuity (SPIA) to replace the bond portion of a client's portfolio can effectively eliminate or substantially reduce a client's interest rate risk (on this portion of their assets). This is especially true if the SPIA incorporates inflation protection in the form of a cost-of-living adjustment (COLA).
The use of SPIAs offers one additional benefit beyond bonds: mortality credits. If clients live long enough, a portion of their annuity income will be attributable to others who have purchased an annuity but were not as fortunate in the longevity department.
Sure, it's possible that your client could end up being the "too-soon-to-make-it-worth-it" death, but there's generally no way to know that in advance. And if running out of money is the client's primary concern, an early death is actually a mitigating factor.
What about those who are not concerned about running out of money, but rather, are primarily motivated by legacy goals and wish to leave as much as possible to future beneficiaries? Would the use of a SPIA to replace bonds still make sense? Quite possibly.
It all depends on a couple's longevity. Much like the decision of when to claim Social Security benefits, there is a break-even point for this strategy to make sense from a net liquid assets point of view.
Related: Do's and don'ts of indexed annuities
Redirecting to a SPIA the 50 percent portion of retirement portfolio assets normally allocated to bonds can result in a great legacy heirs, writes Jeffrey Levine.
