Even in the best of markets, retirement income planning is difficult. Every plan must contemplate three things we don’t know.
- First, how long will you live? It might be nice to live to 100, but it’s also much more expensive.
- Second, what unexpected expenses, such as health care costs, might occur?
- Third, and perhaps the most important of all, what will the returns be on your retirement assets, particularly during the first 5-10 years of retirement? For example, someone who retired in 2009 benefited greatly from the historic bull run. Contrast that to the person who retired at the beginning of this year. The market growth experienced by the person who retired in 2009 made any withdrawals for income purposes almost inconsequential. In contrast, the 2020 retiree will suffer from the back-to-back hits of income withdrawals and lower stock prices.
How to Handle These Unknowns: Income Annuities
Much of this risk can be mitigated if you have a source of income for life other than just Social Security. The fact of the matter is, retirement income planning is much easier for someone who has both Social Security and a pension. However, more and more people are entering retirement without a pension. Yet, few seem willing to create their own by purchasing an annuity from a life insurance company.
While many financial professionals complain that today’s annuities are too expensive and too complex, the basic annuity that provides an income for life is really quite simple. In exchange for a lump sum, the insurance company promises to send you a check (usually monthly) for as long as you live (guarantees are based on the claims-paying ability of the insurer). If you prefer, it can be as long as you and your spouse live. In other words, you have funded your own pension. Yet, according to a LIMRA Secure Retirement Institute study conducted in 2018, only around 20% of middle and upper-income retirees receive any income at all from an annuity. For those who do, annuities represent about 10% of the retiree’s total income.1
Why Don’t More People Have Their Own “Pension Plan?”
First, a lot of people don’t even know it’s an option. A joint study by the Insured Retirement Institute and Jackson National Life found that only 46% of investors realized that annuities provide an income for life. Many of those who do realize this see annuities as a zero sum game rather than a way to manage risk. They fear that if they die too soon, the insurance company will “win.” Yet, people don’t choose not to buy homeowners or auto insurance for fear they won’t have a claim. 2
And likely the biggest obstacle is that while everyone wants a pension, people underestimate how expensive it is and, therefore, choose not to fund it themselves. In a study by Professor Jeffrey Brown of the University of Illinois, people were asked how much they thought a 60-year-old male should be willing to pay to get an income of $100 per month for life. The median answer was $5,875, a fraction of the approximately $20,000 it would have actually required at the time.3
Advisors see this every day when some clients believe they can retire on just $250,000 and/or safely withdraw 10% of their portfolio each year. At the end of the day, despite the desire to have an income for life, people too often just aren’t willing to fund it out of their own retirement assets.
However, there is often a very real cost to such a decision. Those who have not secured a sufficient amount of income for life often have a much greater fear of running out of money. This fear can cause them to be overly conservative when making decisions about how to allocate their retirement income portfolio. The fear of how a sharp drop in the market – one like we recently witnessed – can impact the portfolio will typically cause them to be underweighted on stocks. More importantly, that same fear may make the retiree reluctant to withdraw money and potentially sacrifice their retirement lifestyle. In short, when you worry about running out of money, you think twice about every expenditure.
Consider an Annuity to Create Guaranteed Income for Necessary Expenses
But what if that investor bought an annuity to add enough monthly income to Social Security (and maybe a pension) to cover all of her necessary expenses? Changes in the market would not impact that person’s lifestyle as much. That person may go on that extra trip or take that night out on the town. That person could also consider allocating more money to stocks, which over time may rebuild the retirement income portfolio. Buying an income annuity as a source of retirement income is not about getting the maximum return possible. It’s about creating or adding to guaranteed income to reduce the fear of things that can throw your retirement off track. After all, we would all like to be one of those smiling people on the retirement brochures.4
Scott Stolz, CFP, RICP, is President, Raymond James Insurance Group
Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, Certified Financial Planner™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.
Raymond James & Associates, Inc, is affiliated with Raymond James Insurance Group, but is not affiliated with any companies mentioned. Past performance may not be indicative of future results. Investing in stocks involves risk including the possible loss of capital. Raymond James & Associates, Inc. member New York Stock Exchange / SIPC.
1Sources of Retirement Income, LIMRA Secure Retirement Institute 2018