It seems that insurance companies are unhappy about their profit margins and risks in sales of variable annuities. To compensate, they are offering new “simplified” products. Unfortunately, these new annuity products have two characteristics that make them even less attractive to purchasers. Rates have increased and benefits have been watered down.
According to this article in the Wall Street Journal, financial advisors are less than thrilled about suggesting these new variable annuity products to their clients. I don’t blame them. Variable annuities are expensive to buy, expensive to own, and make it difficult for the owners to access the invested principal in case of financial crisis. Consumer Reports is very negative about this annuity devaluation.
If people would start earlier with a plan for guaranteed retirement income, they would have better, more secure options.
A Money Magazine reader recently submitted this question to Walter Updegrave, a senior editor and well known personal finance writer:
The 4% rule seems to have become the conventional wisdom for drawing money from your savings in retirement. But I believe the rule is flawed. I think it might make more sense to choose a percentage of your savings that you will withdraw annually and then just apply that percentage to your savings balance at the beginning of each year so you would have more money to spend in years when investment returns are good and less to spend in years when returns are bad. What do you think?
The response listed several available strategies for generating retirement income from available resources. The discussion of the strategies included well-recognized flaws.
1. Fixed Annuities. A fixed annuity can provide a predictable income. There are three negatives: (a) the security of the income depends on the financial stability of the insurance company; (b) you generally lose access to the principal; and (c) most fixed annuities are not indexed to inflation.
2. 4% Withdrawal Rule. This strategy states that you begin year 1 by withdrawing 4% of the value of your retirement income fund. You maintain that withdrawal amount each year, adjusted by the rate of inflation. For example, if in year 1 your income fund had a value of $500k, and the inflation rate is 3%, in year one you would withdraw $20,000. In year two you would increase your withdrawal amount by 3% to $20,600. There are two problems with this scheme. First, if the market tanks like it did in 2008 – particularly if early in your retirement – your money is likely to run out way before you do. Second, if the market does well, you will end up with a lot of money that you could have used for discretionary spending. Instead, it will go to your heirs.
3. Fixed Withdrawal Rate. This is what the reader proposed. Instead of maintaining a constant withdrawal amount (4% of your year-one retirement fund) adjusted by inflation, you apply the 4% rate to the value of your retirement fund at the beginning of each year. In this way, if the market declines, so does your withdrawal amount. Although this strategy is likely to extend the life of your retirement income fund, your income and lifestyle can change significantly from year-to-year. That is counter-productive to what we want in our retirement.
What is the answer? To me, the answer is a Failsafe Retirement Income Plan, using TIPS and I-Bonds, to provide your basic income needs. What is left over you can invest for discretionary income.
According to this article, financial advisers and wealth managers are realizing that they are in the early stages of a huge paradigm shift. Baby boomers are less concerned about growing their retirement nest egg and more concerned about preserving what they have. More particularly, they want to be told what they can do to avoid outliving their money. If their adviser doesn’t have a good plan for that, the client will find someone else who does.
No doubt some advisers will move their clients into annuities. If so, let’s at least hope they will be indexed to inflation. Otherwise, they may not outlive their income, but they surely can outlive their spending power. Inflation is a deadly sure killer of spending power.
You don’t need a financial adviser to tell you how to construct a plan that will provide retirement income that is both guaranteed and inflation protected. Frankly, there aren’t a lot of options for providing that income. The most affordable option is an income plan constructed from TIPS and I-Bonds. That’s the direction I’m heading. How about you?
I read an interesting opinion piece today from the Retirement Income Industry Association. The author was noting how industry members thought only about the products they offer themselves to provide retirement income.
Mutual fund companies think that their funds are the way to satisfy the need for retirement income. Insurance companies on the other hand are all about annuities.
The author went on to say this:
Given the importance of retirement income to baby boomers, the challenge to financial firms is that new players may enter the market, ignore today’s product categories and give many consumers what they’re looking for: a pension substitute and an easier way to keep track of the different pots of money most of us accumulate over the years.
I agree that many boomers are looking for a retirement income plan that works like a pension, assuming that the income benefit is indexed to inflation. Right now, Social Security is the closest to that ideal. The other option: a FAILSAFE RETIREMENT plan.
The Principal Financial Group conducts regular financial surveys of working adults and retirees to arrive at a “Well-Being Index.” The surveys are conducted quarterly and the results are then published for general distribution.
The Well-Being Survey for the third quarter of 2009 was recently published and covers responses received between July 30 and August 11, 2009. The results are interesting but not surprising.
When asked to name the one single financial issue that caused them concern (as in keeping them awake at night), the most common answer for both employees (35%) and retirees (25%) was being able to afford and pay for the basic necessities of life.
What is the only way to eliminate this concern over insufficient retirement income? You must have a plan for generating a guaranteed retirement income that will cover your basic lifestyle needs. The solution is that simple. Creating the plan can also be simple, using the correct tools such as the FAILSAFE RETIREMENT™ System. Completing the plan may be more challenging. But having no plan at all is a sure way to keep yourself up at night with fear and dread.