Recalibrating The Clock And Rethinking The Income Challenge

How longevity trends are impacting retirement planning and product design

by Eric Henderson

The study of aging—and the ways we can slow down the aging process—are helping us recalibrate the clock to live longer and healthier lives. The upside is huge. But one thing is clear. As people are living longer, the “Retirement Income Challenge” is real—and growing.

The traditional retirement safety net is shrinking, and more of the responsibility has shifted squarely onto the shoulders of individual Americans. Converging trends from longer lifespans, to record low interest rates, to COVID’s impact on portfolios, have caused many to revisit their financial goals, recalibrate their investment strategies and rethink their retirement income plans.

Clients’ concerns are real. But they don’t know what they don’t know. A 2020 study by the Society of Actuaries found that Americans overall are likely to underestimate their life expectancy—and over half misestimated by five years or more. The good news is that more investors are now working with advisors and financial professionals, according to our sixth annual Advisor Authority study.

Our industry is positioned to help Americans prepare for and live a more secure retirement. It starts with understanding longevity trends, prioritizing guaranteed income, balancing growth and protection, and innovating products to meet these urgent needs.

Lifespans—and Longevity Risk—on the Rise

Lifespans have been increasing worldwide for over a century, more than doubling since 1900, according to a 2019 report by the University of Oxford Global Change Data Lab. But this is not without setbacks. The most devastating impact was the Influenza outbreak of 1918. In the United States, life expectancy plunged from 50.9 years in 1917 to just 39.1 years in 1918, according to a report by the CDC.

Since then, life expectancy for the average American has been rising, from 39.1 years in 1918, to 68.2 years in 1950, to 78.8 years by 2019. A more recent CDC report revealed that last year life expectancy in the U.S. slipped from 78.8 years in 2019 to 77.8 years in the first half of 2020, largely due to the COVID-19 pandemic. But longevity trends are not likely to slow down for long—and are expected to keep climbing—thanks to decades of innovations in public health, medical technology and other important factors.

According to a 2015 report by The Brooking’s Institute’s Hamilton Project, a 65 year-old man has an 90% chance of reaching 70, a 62% chance of reaching 80, and a 22% chance of turning 90. A 65 year-old woman has a 93% chance of reaching 70, a 71% chance of reaching 80, and a 34% chance of turning 90. What’s more, there are now over half a million people aged 100 or older worldwide, according to the World Economic Forum. And the U.S. is home to 97,000 centenarians—the highest number in the world.

Guaranteed Income is Key

Living into their 90s—and even beyond 100—is now a reality for more of your clients. Have they saved enough? If not, can they work longer, spend less, or both? How will volatility and sequence of returns impact the duration of their portfolio? What’s the right withdrawal rate that won’t deplete their portfolio? More importantly, do they have sources of guaranteed income?

When a finite amount of assets must provide income for life, guaranteed income is key. While there are effective withdrawal strategies for generating retirement income—from the 4% rule, to bond-laddering, to bucketing assets for short-term needs and long-term growth—the fact is that none of these can eliminate the risk that clients won’t run out of money. And with interest rates still near 30-year lows, clients face tough choices. Do they reduce their withdrawals, take on riskier assets or increase the chance of depleting their portfolio and outliving their savings?

Social Security currently provides guaranteed lifetime income to nearly 70 million people and is financed with the payroll taxes from over 180 million workers and employers. But with the U.S. population aging, while birthrates are declining, the Social Security Board of Trustees projected more than a decade ago that a reduction in benefits or an increase in payroll tax rates would be needed to continue paying benefits in the future.

Pensions plans have been an important source of guaranteed income. But the number of pension plans has been declining dramatically in the U.S., from a peak of more than 112,000 in the mid-1980s, to fewer than 22,000 in 2018 according the Pension Benefit Guaranty Corporation.

Workplace qualified retirement plans such as 401(k)s, 403(b)s and 457(b)s have become a predominant source of retirement savings, along with IRAs and Roth IRAs. There are advantages to starting early and maxing-out contributions for more tax-deferred growth potential. But the reality is, most of these plans are built for accumulation—not income distribution. So where else can clients turn?

Demand for Annuities Growing

Annuities are one of the only products that can guarantee income for life. They’re an important source of more tax-deferred accumulation after maxing out qualified plans. And according to Advisor Authority, the demand for annuities is growing—especially among younger investors, who are more risk averse, more likely to live longer and more likely to bear even greater responsibility to save for their own retirement than the generations before them.

Annuities can supplement other sources of retirement income or help bridge the gap before Social Security starts, to help ensure clients won’t outlive their savings. Annuities can help manage market risk, so clients can continue investing a portion of their portfolio more aggressively, for greater growth potential, to fund a retirement that could last two to three decades—or more. Because guarantees and protections are subject to the claims paying ability of the issuing insurance company, it’s important to look for an insurer with superior ratings and financial strength.

More than three-fourths of advisors and financial professionals say annuities are a critical component for clients’ holistic financial plans, according to our sixth annual Advisor Authority, conducted in 2020. Annuities can provide income when clients need it and the right balance between growth potential and downside protection to help them reach their long-term financial goals. As longevity increases, and interest rates remain lower for longer, it is driving innovation of both commission-based annuities and new categories of fee-based annuities. So, what kind of annuities make sense for your clients?

Income Now—or Income Later?

For clients nearing or already in retirement, single premium immediate annuities (SPIAs) offer an immediate stream of guaranteed income. With interest rates still at record lows, it may be more effective to ladder SPIAs. Rather than locking-in substantial assets at current low rates, laddering a series of SPIAs over a period of years gives clients the potential to earn higher rates and payouts greater.

For clients with a longer time horizon, there are many annuities that allow them to accumulate more after maxing out their qualified plans, and then turn on guaranteed retirement income when they need it, through annuitization or a living benefit. According to Advisor Authority, 84% of advisors and financial professionals said the use of an annuity with an income guarantee is important for supporting a sustainable withdrawal rate. Living benefits and income guarantees are optional riders that may be available on certain annuity products for an additional cost.

In recent years, one of the most popular living benefits is a guaranteed lifetime withdrawal benefit (GLWB). These riders allow the contract holder to withdraw a fixed percentage of income each year for life, regardless of market performance. Recent analysis from Goldman Sachs Asset Management suggests that allocations to annuities with GLWBs can create more income with less risk than systematic withdrawals alone.

GLWBs may guarantee an income benefit base roll-up at a fixed percentage every year during the accumulation period and a step-up to lock in the highest contract value if underlying investment options outperform the roll-up. More recent innovations in GLWBs, like Nationwide’s L.inc+, can help clients as lifespans get longer by offering up to 100% equity exposure for greater growth potential, or a front-loaded stream to fill an income gap, or the ability to roll forward any unused income.

Balancing Growth and Protection

Clients across a spectrum of risk profiles seek to balance different degrees of growth potential with different levels of protection. Fixed indexed annuities (FIAs) and registered index-linked annuities (RILAs) can offer growth potential based on the performance of an underlying stock market index. This could include traditional indices such as the S&P 500 or NASDAQ 100. Recent innovations include specialty indices that dynamically allocate assets, manage volatility and use other unique strategies. These products are not exposed to and do not directly participate in the stock market

For conservative clients who need a safe alternative in this persistent low rate environment, fixed indexed annuities offer growth potential linked to an underlying index, combined with guaranteed principal protection. With a FIA, clients can’t lose their initial investment or credited earnings, even if volatility is rising or the market is falling. According to economist Roger Ibbotson, with bond returns at historic lows, FIAs can help provide a viable alternative to help de-risk portfolios and generate income for life.

For clients who want more upside potential and are willing to accept more market risk in exchange, registered index-linked annuities may be a better fit. RILAs also provide growth potential of an underlying index, combined with different degrees of protection through a floor or a buffer, depending on a client’s risk tolerance.

For conservative to moderate clients, especially those concerned about steep downturns or a prolonged bear market, RILAs with a floor are a more recent innovation. The floor provides a clearly defined level of protection, set at the maximum loss clients are willing to accept. With a floor set at 10%, clients will never lose more than 10% regardless of whether the market falls 20%, 30%—or more. There are unique innovations like Nationwide’s Defined Protection Annuity, which has a floor that can provide three defined levels of downside protection, while also offering uncapped upside potential.

For moderate to aggressive clients, especially those concerned about ongoing volatility, RILAs with a buffer can protect against losses within a specific range. But if markets fall below that range, it leaves clients exposed. If their buffer is 10%, and the market falls 10%, they’re protected. But if the market falls 30%, the buffer only protects the first 10% and clients lose the next 20%.

For your more aggressive clients, variable annuities (VAs) offer underlying investment options that invest directly in the market. As a result, while VAs offer greater earnings potential, there is also greater risk, including loss of principal. Clients may be able to purchase optional guarantees for an added level of downside protection.

A More Secure Retirement for More Years

As more Americans rely on their workplace qualified retirement as a predominant source of retirement savings, the passage of the SECURE Act has helped to lead one of the most recent innovations, the growing category of in-plan guarantees.

Designed for use in qualified plans, in-plan guarantees offer low or no minimum investment requirements, the ability to make regular tax-deferred contributions through payroll deductions, plus liquidity and portability without penalties, should a client change jobs and need to move to a new qualified plan. Led by a handful of innovators, including insurers like Nationwide and Lincoln, and asset managers like AB and American Century, more in-plan guarantees are becoming available to help client generate income, protect principal—or both

Clients are living longer. While they can’t turn back the hands of time, they can buy more time for their retirement income plan. The right annuity, including many of these recent innovations, can provide income when clients need it and balance between growth potential and downside protection to help them reach their long-term financial goals for a more secure retirement—whether they live to 90, 100 or more.