There are some crazy and absolutely true metrics about the percentage of clients who, when offered guaranteed lifetime income by their financial advisors, refuse to take the advice. And it’s a high percentage. Since I pride myself on clear communication, I don’t think the challenge, for my own clients, was my failure to describe what it is, what it isn’t, why it’s a good thing, and what are any potential gotchas. I think it’s fear.

Even the G-word–guaranteed—doesn’t seem to help.

We fear committing to something we do not understand. We fear the opportunity cost of having the money elsewhere when the future feels so uncertain. We fear the bad opinion of people who opine and opine but may not have a secure retirement themselves or understand what a secure retirement should look like. We can’t imagine living into our 90s. (Sigh.)

I never take it personally.  But it sure is frustrating.

So let me take a shot at this again: Guaranteed(!) lifetime income is another expression for “pension.”  And “pension*” is another expression for “annuity.” And an “annuity” is the financial instrument that provides a monthly stream of income that you cannot outlive. The simplest example is your Social Security benefit because that’s an annuity, a government pension, and a stream of income. 

Technically, there are other solutions that can be used to produce “lifetime income.” But those require active management and come without the guarantee(!). I’m also going to pay lip service to the research of Dr. Michael Finke that concludes that people with investments, annuities, and permanent life insurance have better retirement outcomes than those who only have investments. To be clear:  That does not mean that they die with the biggest portfolios. It means that they have the lowest likelihood of running out of money while they’re alive. Smart folks are sounding the warning that because we are all living longer, the risk of running out of money in retirement (especially for WOACA) is increasing.

More guaranteed(!) income is the solution to that problem.

What is it?

An annuity is an insurance contract. In exchange for a lump-sum or regular contributions, it guarantees(!) an interval payout—usually monthly—for a specified term. The most common term is “for the rest of your life.”  Sometimes it’s “for the rest or your and your partner’s lives.”  But it could also be for just a few years.

An annuity comes in two basic flavors with some variations: an income annuity and a variable annuity. Sometimes the variable annuity, which includes a market portfolio or index, is called an “accumulation” annuity. Annuities are either immediate (they start paying now) or deferred (they start paying at a later date). I’ll stop there. I can already see your eyes starting to glaze over. No worries. Stay with me.

When do you use them?

Lifetime annuities increase the amount of guaranteed(!) income for your household in retirement. If guaranteed(!) income can cover our fixed monthly expenses, that means that the rest of our investments can continue to grow with little fear that a market event will compromise our lifestyle. It also means that we are less likely to need to take money out of our investments during a bear market. 

Here’s a real example from my own household. We are counting on 2 x Social Security: Fred’s federal military pension and my Qualified Longevity Annuity Contract (QLAC,) a solution I’ll explain shortly.

In other words, with four sources of guaranteed(!) income, all of which increase for inflation, we figure fully 2/3 of our regular monthly spend is covered by guaranteed income sources. With only 1/3 coming out of our assets, these assets will continue to grow happily. And the amount of cash we need to have on hand to make up the difference and avoid taking money out of a bear market is not that great. I even have a backup (a “placeholder” annuity) waiting in the wings if I want to have more guaranteed(!) income in retirement.

So, what’s the problem? 

The problem is that some annuities are terrible instruments, and some people are terrible people. A good fiduciary will tell you why she is making an annuity recommendation, and also give you both the pros and cons. A great fiduciary will help you understand how the right annuity can improve the success of your financial plan and help you sleep soundly at night.

Let’s address the terrible people first. There are financial advisors—and entire financial firms—who will tell you that you don’t need lifetime income to have a successful financial plan. That is a true statement, sometimes. It’s more accurate to say that, in a world of retirement modeling, if you are fully funded for retirement according to the model, you won’t need an annuity to avoid running out of money. That, however, describes a very small portion of our population. Medical expenses can easily eat up millions of retirement dollars very quickly. Not everyone is quite that secure. More likely, the person managing your investment accounts doesn’t want to lose the money under management to the insurance company.

Shame on them.

Then there are the people who either do not understand their own terrible products or cannot supply anything other than what they have. That’s the “one-size-fits-all” problem, wherein banks and individuals put entire portfolios into a variable annuity, forcing clients to pay annuitization fees for the entire portfolio, when they’ll only actually turn a portion of it into an income stream. Or they recommend a variable annuity to a client who is within 10 years of distribution, but the product has a 10-year surrender fee. Or they willfully misstate the way the value is credited to grow the portfolio, and it barely outperforms the annual fees.

Yikes.  Just yikes.

A good variable annuity has its place. But it’s not for you unless you’ve held it, as a placeholder, for more than 10 years and it has reasonable fees, excellent growth crediting formulas, and protections for market changes. Let’s get out of the weeds on that. The takeaway is that financial advisors and annuity solutions are not all created equal: caveat emptor.

As for the income annuity, its challenge is the lack of liquidity that comes with the commitment.  Once you create the contract, the money is inaccessible to you until you start taking your stream of income.  I’m not sure why that bothers people so much, but it does. There are ways to guarantee(!) the return of the principal (what you’ve contributed) and even more if you’re nervous. You can even “ladder” multiple income annuities if you want to create more guaranteed(!) income later. The insurer will tell you exactly how much money is promised at the time you sign the contract.

What will help us in retirement?

An income annuity (or two) may help you have a more successful retirement. On one hand, its calculations may be more opaque than a variable annuity; but its execution is simpler. It may even have an inflation rider, which I certainly recommend. Best practice dictates that no more than 1/3 of our liquid assets go into an income annuity. And, since it represents fixed income, it makes sense to take it from the fixed income (bond) portion of our portfolios.

That has the effect of making the rest of our assets look more aggressive. And that’s fine by me. We have plenty of time to create an income annuity: within the last few years before retirement, when the retirement portfolio has grown, is time enough.

As for the QLAC, recall that with a little attention to my health, I’m likely to live into my 90s. And I’m likely to have a lot of Required Minimum Distributions (RMDs) to take from my IRA, no matter how many Roth conversions I do.

The QLAC solution, which was created by the IRS barely 10 years ago (in 2014), will help me with that.  I’m able to carve off up to $200,000 of fixed income, and the insurer is guaranteeing(!) Fred and me a monthly payment plus a 3% inflation rider for as long as we live. The payments will start at 75, which coincidentally is the same year my RMDs begin. However, if I’m feeling good about my longevity, I can push the start date to age 80 (QLACs let you start as late as age 85) to avoid RMDs and ensure I’m not spending down too soon. By any other name, I’ve created a pension. The principal is guaranteed(!) to be refunded to our beneficiaries if we die early.

Professionals are so concerned about our retirement savings shortfall as a population, that they are recommending large employer 401(k) plans include income annuities in their distribution solutions for employees. Even there we must be vigilant. TIAA was deservedly dinged in a class-action lawsuit for a terrible annuity solution. As a result, I always recommend having a personal relationship with a CFP® professional and not automatically using the 401(k) platform default unless it’s the best solution. Do the research and act in your own best interest here. #WeRescueOurselves

Whew! It took two cups of coffee to write this one.  I expect it may have taken two to read it. Well done to everyone who stayed to the end and is interested in learning more about guaranteed(!) income in retirement. I just love the G-word.  And I hope you do too. #NotYoungNotDone

Watching and Reading: Dr Michael Finke

  http://www.michaelfinke.com/research.html

*The word “pension” refers to employer and government provided plans.  However, colloquially, it is synonymous with an annuity.  Sometimes, an annuity is referred to as a “personal pension.”

Copyright Madrina Molly, LLC 2024

The information contained herein and shared by Madrina Molly™ constitutes financial education and not investment or financial advice.