Annuities don’t get enough attention as a tool to bring balance to our relationship with money in retirement.
It’s true that a lot of annuity solutions are marketed and discussed as a way to bring “security” or “peace of mind” to an investor. Or, they are described at a very high level as a component of a client’s overall retirement strategy. This is accurate, but I feel something is lost in translation. I want to show, not tell, what the right annuity strategy can do when aligned with an individual’s retirement plan … particularly if that person worries about running out of money.
It’s a common fear. An Allianz study found about two thirds of retirees dread running out of money more than death. We don’t want to burden our families. We don’t want to liquidate every lasting thing we have earned throughout our lives or work through what should be our golden years.
That fear can grip tight, even when it shouldn’t.
The Fear Is ‘Deeply Personal’
The truth is, a lot of advisor clients are in pretty good shape. In many cases, a mass affluent client who has saved diligently, planned ahead, and lived within their means will have more than enough money to handle the financial cost of retirement or any unexpected emergencies. They are not likely to run out of money in their lifetimes.
But some people can’t be convinced.
A client headed into retirement with $5 million in assets could see dozens of Monte Carlo simulations, each reassuring them that they will be fine, and they will still be afraid. I could have the best advisor-client relationship with this person, and the fear would still not abate.
This is not a hypothetical scenario. I have spoken to several clients like this over the years. I expect I’m not alone. What we might see as a fearful, protection-based relationship with money is perfectly reasonable from the client’s perspective … because it’s their life. They are going to hit age 70, 80, and even 90. The fear of running out of money, or losing the value of wealth to the whims of the market, is deeply personal when it’s your wealth and your future on the line.
Even if my client and I know this rationally, they can still struggle to escape that mindset. They over-save, take over-cautious positions with their wealth, and deny themselves the fruits of a lifetime of labor.
Building the Foundation of Guaranteed Income
The topic of annuities usually enters the conversation when I talk to clients about Social Security. A married couple might have combined monthly Social Security checks of $4,000 in after-tax income. The question is a simple one: “Do you want more of those?”
The answer, often enough, is yes. Who wouldn’t? People with guaranteed income live better, healthier lives, research shows.
BlackRock measured a 22% increase in spending ability among retirees who had some form of guaranteed income. Annuities rise to the occasion here because, frankly, no other industry has a handle on the longevity space. You go to banks for banking, and investment firms if you want your assets managed. But when you need to have conversations about morbidity and longevity, those are the specialties of the insurance sector.
A Numbers Game
Let me provide an example: A client with $5 million in retirement assets opted for a joint annuity. The scenarios below showcase how guaranteed income strategies can vary depending on the age at which the annuity begins and whether income is deferred or starts immediately.
- Scenario 1: One couple, both age 60, opted for a joint annuity starting immediately. They received $23,695 per month, or $284,336.
- Scenario 2: Another couple, both age 65, also opted for a joint annuity starting immediately. They received $25,359 per month, or $304,304.
- Scenario 3: The third couple, both age 70, also opted for a joint annuity starting immediately. They received $27,625 per month, equating to $331,500.
- Scenario 4: The last couple chose to plan ahead. At their age 65, they purchased a deferred annuity that would begin income at age 70. As a result, their monthly income was $31,809, amounting to $381,714.
No two retirees will have the exact same plans, so our approach has to vary between individuals. Some might be able to take annuity income immediately, and others may choose to delay. In the case of a delay, we’ll need a strategy for sequencing withdrawals from other accounts to minimize tax exposure (and maximize Social Security benefits by delaying the initial claim, in many cases).
An Extra Layer of Protection
If someone has enough money to live without fear of destitution, do they “need” an annuity? On paper, no. But in the real world a retiree inhabits, faced with uncertainty, many will trade liquid securities for a promise to receive steady income for the rest of their lives. There is power in establishing a floor of guaranteed, baseline income that will address — if not completely cover — retirement expenses, expected or otherwise.
Additional Reading: Indexed Life Insurance: An Underutilized Savings Vehicle
An inflation-adjusted rider to the annuity can add an extra layer of protection. Inflation will gnaw at the real returns of an annuity, just like it erodes every other kind of investment. But in the specific case of a retiree who needs peace of mind more than purely optimal market returns, the risk of inflation is relatively small.
What do these clients get by giving up liquidity? More often than not, a total financial transformation.
What It Looks Like To Let Go of Money Fear
Let me share a common scenario that tends to follow the implementation of annuities in the retirement strategies of my clients: Money managers tell us how the client changed from a nightmare case — constantly worried and micromanaging their finances — to a dream client who is content to follow their overall investment plan. Why?
These clients knew that, no matter what, they had guaranteed income to fall back on. They could golf with friends, dine out, travel and handle whatever came their way. The relief from fear rippled throughout their lives, to say nothing of their finances. In many cases, these clients stop castling up their investments. They let go of concentrated stock positions. They take more risk-appropriate positions in the rest of their portfolio, opening them to more upside than they would have experienced without guaranteed income … all because they no longer have worry about their day-to-day valuations.
This approach can lead to a healthier, longer retirement, with more money to leave to children or to causes these retirees hold dear. With the missing piece of the puzzle in place, they finally understand they have enough. They can live, instead of just surviving.
Years ago, I wasn’t as positive on annuities. My background is in tax, annuities are taxed at ordinary income rates instead of lower capital gains rates. Nobody is going to knock it out of the park and strike gold with an annuity. But that’s not the point. The enjoyment and reduced stress are the point, and every day I see the difference it makes in the retirees with whom I work.
Howard Sharfman, senior managing director of NFP Insurance Solutions, a wealth-transfer consulting and planning firm, has been recognized as an innovative leader in the insurance business for over two decades. His practice focuses on servicing families with multigenerational wealth, family offices, private equity managers and the advisors who serve ultra-high net worth clients. His firm has additional expertise in executive benefits, corporate benefits, general insurance and risk management.
