Refocusing your clients’ financial goals for a new retirement timeline
by Adam PolitzerMr. Politzer is Chief Product Officer for Athene. Visit www.athene.com.
The volatility of the current economic environment paired with the struggles seen with historical retirement approaches have led financial professionals to rethink strategies for helping clients manage longevity risk.
Once considered tried and true methods for helping clients prepare for retirement, traditional models such as the defined benefit pension have proven inadequate to meet the needs of current and future retirees. In the past, the defined benefit pension led to significant savings for individuals covered under the plan. But companies weren’t adept at managing the funds at their disposal and the costs to maintain the program often proved unsustainable for employers.
Other retirement strategies such as the 60/40 portfolio, which emphasized shifting savings to bonds as an individual neared retirement, depended on a 30-year bond rally and an inverse correlation between equities and bonds – trends that have not continued in recent years and even less so in the current market environment. The approach in the decumulation phase was even worse. Members of these target funds were advised to take out 4% of their wealth each year without considering the risk of outliving this amount if their assets underperformed.
Lackluster contribution plans and rising inflation have left an increasing number of Americans wondering how they will generate long-term income after they stop working. In fact, a 2022 study by Athene found that more than half of Americans (55%) fear they will outlive their retirement savings. When other concerns are factored in, such as the unknown length of a retiree’s lifespan, the advances in medical technology that will allow Americans to live longer, and couples needing to plan for upwards of 20 years of retirement according to the Department of Labor, the need for new solutions to meet the changing retirement landscape becomes clear.
To overcome these challenges, growing numbers of retirees are turning to fixed indexed annuities – a contract backed by an insurance company that can provide lifetime income and help eliminate the risk the beneficiary will outlive their savings. Annuities can be customized based on how long the recipient believes they will live, when they need payments to start, and whether they want to leave their income stream to a family member after death. Choosing the right annuity plan can help guarantee retirees a steady stream of lifetime income, offer tax-deferred growth potential that can be passed on to loved ones, and provide a hedge against inflation and volatility, regardless of market conditions.
The Benefits of Annuities
The surging price hikes and shifting economic landscape of the past few years mean that today’s retirees need more than Social Security and investment savings to provide for their daily needs during this next stage of life. Financial professionals have examined this problem and can build unique retirement savings strategies for retirees and those approaching the end of their career.
Annuities, specifically fixed indexed annuities have emerged as one key financial tool in this difficult environment. These contracts are made possible through a basic insurance concept: the pooling of risk. By underwriting a large number of policyholders, insurance companies can guarantee that everyone within the pool receives a check as long as they live.
While some annuity contracts require an initial investment that grows tax-deferred through an accumulation period, typically lasting anywhere from 10 to 30 years, other contracts skip this step and move directly to the disbursement phase. In the latter case, lifetime payments can begin as soon as the initial principal is funded.
As all the risk in the contracts of some annuities is transferred to the insurance company, beneficiaries can have peace of mind that their payments are guaranteed in any economic environment. Additionally, with fixed indexed annuities the insurance carrier must make these payments as long as the recipient lives, removing the risk that the holder will outlive their funds.
Annuities also help serve as an effective check against inflation. In the current economic climate, retirees must develop a plan that manages both uncertainty and longevity amid price hikes. Although the purchase of Treasury Inflation-Protected Securities (TIPS) was a common practice for retirees in the past, buying these securities today can provide insufficient income and can create excessive risk.
However, a fixed indexed annuity (FIA) is an innovative option that helps deliver protection from inflation. Using this investment vehicle, insurers take advantage of risk pooling on the asset side and invest the funds of policyholders in a diverse set of fixed-income assets, leading to a more stable and higher-yielding portfolio.
FIAs are tied to indexes like the S&P 500 and offer interest credits based on the performance of these equity options. When the stock market climbs, the investor receives a portion of the gains. However, policyholders’ baseline annuity payments are still guaranteed during a market downturn, offering lower risk and higher potential rewards. Several studies have shown that these products are likely to outperform traditional bond funds and have a better chance of producing returns that can help keep up with inflation.
The benefits of certain annuities aren’t limited to the owner of the contract. Customizing an annuity policy can give policyholders the option to share joint ownership with a loved one, such as a spouse. If the policyholder dies after payments have begun, the surviving spouse may have the option to assume ownership of the policy and continue receiving income. If a couple isn’t suited to joint ownership, the annuity owner can name a beneficiary who will receive any outstanding funds in the contract at the owner’s death.
Emerging Annuity Strategies
Financial professionals have expanded the scope of their annuities offerings in recent years, but the emerging slate of products that have materialized in the Covid era also owe their existence to the public sector. In January 2020, Congress passed the SECURE Act, a comprehensive bill that aimed to reform the U.S. retirement system and prevent older Americans from outliving their assets.
Among other provisions, the SECURE Act allows annuity issuers to better access the employee market segment, relaxes the fiduciary responsibility of employers when choosing an annuity provider, and most importantly, makes it easier for sponsors of retirement plans (such as 401(k) plans) to offer annuities.
The regulations have ushered in a new wave of annuities products that offer greater flexibility for policyholders and some of the most efficient income solutions to date. For the first time, the standard defined contributions plan has been transformed into a slate of financial tools that offer real longevity protection for customers.
Some of the more innovative products introduced let participants simply elect to receive their accumulated 401(k) balance in the form of guaranteed annuity payments. Other more sophisticated solutions aim to embed lifetime income into a target fund in a manner that maintains some liquidity while keeping the product easy to use.
Although the SECURE Act was highly publicized, other sources of innovation in the annuity space, such as the use of private equity investment strategies with the goal to create higher-yielding insurance products, are not as well-known. For years, insurance companies have managed their portfolios through cautious investment strategies, using lower-quality bonds to achieve returns.
With the help of private equity managers, insurance companies are now investing in assets that have historically only been available to institutions or the very wealthy. Thanks to the practice of securitizing hard assets, insurance funds can sacrifice asset liquidity in exchange for higher yields at lower risks, leading to significant improvements in long-term fund performance.
Downsides and Solutions
Legislation such as the SECURE Act has helped revitalize the annuities space, but bills passed in earlier years have worked against the retirement industry. Regulations such as KYC – a series of guidelines that require financial professionals to collect client information and complete a detailed review of each sale – can sometimes make the process of buying an annuity without the help of a financial professional difficult.
While these suitability rules are meant to provide comfort to consumers by ensuring that the annuity is a suitable investment for the policyholder, they can add further complexity to the sale. Retirees may find themselves overwhelmed when evaluating the variety of annuity products on the market, especially since the same product may have unique features at different companies.
To simplify the annuity process, consumers can work with a financial professional to build a retirement plan and select the annuity that best meets their needs. A recent study from Athene revealed that, among those saving for retirement, 75% of annuity owners reported feeling on track toward to reach their retirement savings goals, marking a 26% increase in confidence over the general population.
Another common concern surrounding annuities involves the early withdrawal penalty. Many Americans avoid annuities due to the fear they will need to withdraw funds from their principal before age 59½, an action that would trigger a 10% penalty tax. While policyholders do incur a surrender fee if they remove their money too early, annuity holders should understand that they won’t be charged further if they paid for the annuity with money that had already been taxed.
In this period of uncertainty and economic instability, annuities have emerged as an effective tool for Americans in their effort to prepare for life after work. Spurred on by new legislation, the annuities space has entered an exciting period characterized by innovation and effective new products. The long-term security, peace of mind, and guaranteed lifetime income some offer make them a valuable and crucial consideration for retirement strategies.