The GAO Report on Immediate Annuities

The Government Accountability Office endorses immediate annuities as a supplement to social security.

Report to the Chairman, Special
Committee on Aging, U.S. Senate
June 2011
RETIREMENT
INCOME
Ensuring Income
throughout
Retirement GAO-11-400

http://www.gao.gov/new.items/d11400.pdf

Guaranteeing Lifetime Income (Yahoo.com , Forbes)

by Scott Woolley
Wednesday, May 13, 2009


If your assets are barely sufficient for your own needs, stiff your heirs. Put your money into an annuity.


As a purely financial matter, it's difficult to die at just the right time. Pop off unexpectedly young and you could rob your family of paychecks it was counting on. Hang on too long and you could exhaust your savings, impoverishing your family or consigning yourself to a decrepit retirement home.

One unexpected side effect of the recent financial crisis: a boom in sales of fixed immediate annuities, which dispense guaranteed income for life. Sales at New York Life, the largest issuer, hit $425 million in the first quarter, up 82% from last year.


For most clients those new annuities are likely to be a good deal. A 65-year-old man who pays New York Life $100,000 today will receive $650 a month for life. That's equal to taking out 7.8% of the total each year, which is double what long-term Treasurys yield. (Because of her longer life expectancy, a woman of the same age would receive $600, or 7.2%.) Wait longer to buy an annuity and the payout is, of course, higher (see table).

Part of the sales surge is because of the crash. Fixed-annuity buyers sailed peacefully through the recent market turmoil with monthly checks intact. Another factor: Many older Americans now find themselves planning for retirement with shrunken portfolios. Instead of living off dividends and leaving the principal to heirs, they need to consume the whole sum for their own needs.
Annuities offer the best way to lock in guaranteed lifetime income, argues Christopher Blunt, who runs New York Life's retirement division. Retirement income generated from a stock-and-bond portfolio requires keeping plenty of assets in reserve in case they're needed to fund a long life or contend with a nasty bear market. Blunt's pitch: Get the same retirement income as you could from a stock-and-bond portfolio, with 25% to 40% less principal.Annuities' ability to generate superior retirement income is conjured by pooling risk. The annuities transfer savings from people who don't need it (because they're dead) to those who do.

This ability to match assets to future liabilities sends academic hearts aflutter. Economists who study the retirement market have long been sold on the merits of annuities and frustrated by consumers' aversion to them. U.S. vendors sold a piddling $6 billion worth of immediate fixed annuities last year. The 2008 figure will likely be around $10 billion. This in a country with $2.7 trillion tucked away in 401(k)s.

One explanation for poor sales is that immediate fixed annuities aren't very profitable for the salesperson. A 70-year-old client who plunks down $500,000 for an annuity and cashes a $3,600 monthly check probably doesn't need much else.

Another impediment to sales has been crummy marketing by insurers. Fixed immediate annuities have gotten a bad rap in part for sharing an association with their deferred-annuity cousins. These are complex vehicles that promise a tax deferral but subject buyers to a multiyear "accumulation phase," during which assets are subjected to all manner of surrender penalties, commissions, fees and insurance charges, before paying out a dime. Most are great deals for the sales reps and lousy ones for clients.

Unlike fee-laden deferred annuities, immediate ones are likely to be a square deal for buyers. The typical buyer receives a string of payments worth (at discounted present value) 95 cents for every premium dollar he pays in. The obvious reason for the efficiency in the pricing is that prices are easy to compare. Someone with $1 million to put in gets quotes from several vendors and takes the best payout.

Insurers do the best they can to make the product more opaque and complicated. Responding to customers' fear that they'll get a really bad deal (by dying young and leaving heirs nothing), vendors offer such features as a guaranteed minimum payout. A 65-year-old man who buys an annuity with a "ten-year period certain" feature has the right to checks for ten years, even if his heirs are the ones to cash them. For this he cuts his annual payout from 7.8% to 7.5%. That might seem like a small price to pay, but the drop-off is so tiny only because the guarantee is unlikely to cost the insurer much. Almost all 65-year-olds live at least into their early seventies.

Assuming you're in good health and keep your product features simple, there aren't a lot of downsides to fixed immediate annuities. One to think about is the risk that the insurer will go bust in your lifetime. However, there are segregated asset pools as well as state-run guarantee funds to make a loss unlikely. In the bankruptcy of Executive Life, some annuity holders lost 20% of their payout. Try to buy from a company with a rating of double-a or better from A.M. Best. New York Life, tiaa and Northwestern Mutual qualify.
A bigger risk is inflation. New York Life offers a rider that increases payouts at a set rate of between 1% and 5% annually but is not pegged to actual price rises. More in keeping with the buy-it-and-forget-it philosophy are payouts linked to the Consumer Price Index, which are available from Lincoln Life Insurance and others. For a 65-year-old man an inflation-indexing feature would cut his initial annual payout from 8% to 5% of his original principal. If inflation averages 4%, the indexed payout would surpass the conventional one in year 12.

Do you want to protect a spouse? That will cost you. If our hypothetical 65-year-old man is married to a 60-year-old woman, he'll cut the annual payout to 6.3% if it has to last until they are both dead.

Immediate annuities aren't a great fit for everyone. If your annual retirement living expenses (including income taxes) come to less than 3% of your assets, you should be able to safely fund your lifestyle by owning a conservative mix of securities, without effectively handing over 7% to an insurer to cover your longevity risk. For everyone else the standard advice is to annuitize the portion of your nest egg you'll need to cover living expenses, including supplemental health insurance. The rest you can invest as you please.
One way or the other, an immediate annuity is an investment you're unlikely to regret buying. If it turns out that the insurer got the better deal, you won't be around to fret about it.


Income for Life

Buy a fixed annuity for $100,000 and what you get depends on your age and gender. Adding a guarantee of ten years of payments (even if you die tomorrow) is surprisingly cheap.

Plain annuity (life)/With 10-year guarantee/With cash refund
Buyer would receive Monthly Check ( Yield )

65-year-old man $650 (7.8%) / $629 (7.5%) / $601 (7.2%)
65-year-old woman 600 (7.2) / 592 (7.1) / 571 (6.9)
70-year-old man 723 (8.7) / 691 (8.3) / 654 (7.8)
70-year-old woman 667 (8.0) / 650 (7.8) / 619 (7.4)
80-year-old man 1,026 (12.3) / 858 (10.3) / 836 (10.0)
80-year-old woman 960 (11.5) / 818 (9.8) / 785 (9.4)


Source: New York Life.

Copyrighted, Forbes.com. All rights reserved.

Safer Strategies for Retirement Portfolios (NY Times)

June 20, 2009
Your Money
For Older Investors, Old Rules May Not Apply
By TARA SIEGEL BERNARD
The stock market’s damage has already been done. And if you’re one of those people near or already in retirement, you already know you’re going to have to work longer, save more or spend less.

But what should you do right now with the money you have left? Should you wade back into the stock market, if you bailed out when the market was plunging? Or if you watched your investments drop and then recover a little in the last few months, should you just hold on? What happens if the market doesn’t fully recover for a long time? (That happened in Japan in the ’90s.)

This economic downturn has been steep enough and frightening enough to undermine the idea that the stock market, over time, will always deliver. So a lot of investors have retreated to a more conservative stance.

The wisdom of that move is debatable. The investment industry warns that becoming too defensive is costly in the long run. Its argument goes something like this: People are living longer, retirement may last 25 or 30 years and stocks are supposed to protect you from the ravages of inflation. And since stocks tend to outpace most investments over long periods of time, the industry says, your savings will do all right in the end.

But some people are no longer comfortable with that logic. There’s even a new study that contends holding stocks over long periods of time may be riskier than previously thought. Robert F. Stambaugh, a finance professor at the Wharton School at the University of Pennsylvania and a co-author of the report, said most investment research only accounted for the risk of short-term market swings around the stock market’s average gain over time. It doesn’t factor in the fact, he said, that the average itself is subject to change.

So what should retirees and pre-retirees make of all of this?

“If another decline in the market is going to bankrupt you or put you out of business or destroy your retirement account, you should not go back into the stock market,” said John C. Bogle, the founder of Vanguard and viewed by many as the father of index investing. “It’s not complicated. The stock market can go up and down a lot and nobody really knows how much and when.”

What’s worked for Mr. Bogle may not work for you, but his method isn’t a bad place to start. “I have this threadbare rule that has worked very well for me,” he said in an interview this week. “Your bond position should equal your age.” Mr. Bogle, by the way, is 80 years old.
That’s a rather conservative recommendation, by many financial planners’ standards. In fact, Vanguard itself offers products that are more aggressive. Its target-date funds — whose investment mix grows more conservative as retirement nears — recommend that people retiring in 2010 (generally, people who are 65) should split their savings evenly between stock and bonds.

Charles Schwab, by contrast, has recently reduced the risk for its target-date funds. The company’s 2010 fund will allocate about 40 percent to stock funds next year, down from 50 percent in the past. “It’s a reflection that our clients’ appetite for risk has changed,” said Peter Crawford, a senior vice president at Charles Schwab Investment Management.

But you shouldn’t simply view your investments through the lens of how much you allocate to different investments (though you will need to come up with a plan). Instead, you should work your way backward. First, consider how much you will need to live when you’re retired and then figure out how you’ll pay for it.
Nearing Retirement

Ideally, you should have started to slowly shrink your stock position over your working career. But some financial planners have become more conservative about that. Before the market’s sharp downturn, Warren McIntyre, a financial planner in Troy, Mich., typically reduced his clients’ stock allocations by about 1 percent each year. Now, for older investors, he ratchets down their stocks by 2 percent each year once they reach 60. So a 65-year-old’s investments would be evenly split between stocks and bonds.
Other planners are taking even more defensive positions. “We are still very concerned about the status of the economic recovery and remain quite defensive as a result,” said Chip Addis, a financial planner in Wayne, Pa., who invests his clients’ portfolios in only 40 percent stocks.

Of course, there’s no one formula. Milo Benningfield, a fee-only planner in San Francisco, for instance, said he put a 61-year-old client in a portfolio with 60 percent in diversified stocks and alternatives (like real estate) and 40 percent in fixed-income (largely split among high-quality, short-term and intermediate-term bonds and cash). But this client can afford to take that risk — the client owns a house, rental property and has other holdings outside the portfolio.
The picture may change for pre-retirees who are 61 and close to meeting their savings goals, but can’t afford to lose any money. “We would ask ourselves to what degree, if any, can you afford equities,” Mr. Benningfield said. If inflation was their only concern, he might invest their money across a ladder of Treasury Inflation-Protected Securities, or TIPS, which are backed by the government and keep pace with inflation.

But since retirees generally spend money on entertainment, health care and food — whose costs often exceed the general rate of inflation — he said he might invest 40 to 50 percent of their money in a portfolio of diversified stock funds (with at least 30 percent of that in international stock funds). But, he added, “Cash is risky, stocks and bonds are risky, life is risky.”

As to those investors who got out of stocks, Mr. Bogle said it might be time for some of them to get back in. “But I would take two years to do it,” he said. “Maybe average in over eight quarters, and do an eighth each quarter. I am just not in favor of doing things in a hurry or emotionally.”

And then? “Don’t touch it,” he said, emphatically. “One of my rules is don’t do something. Just stand there.”

Retirement

Several planners recommended different variations on a similar strategy for retirees. Set aside anywhere from eight to 15 years of your expected expenses — that includes food, utilities, housing, insurance — in bonds and cash. That way, you’ll never have to tap your stock holdings at the worst possible moment.
“Once you have that in place, you feel like you can weather any economic storm,” said Chip Simon, a financial planner in Poughkeepsie, N.Y.

When you have figured out how much it costs to live each year, the next step is to see how much Social Security will cover. Whatever is left needs to be financed by your retirement portfolio. And the general rule of thumb is that you shouldn’t withdraw more than 4 percent of your portfolio (adjusted for inflation) each year. There are different ways to invest your cash and bond holdings.

Rick Rodgers, a financial planner in Lancaster, Pa., invests 10 years of annual expenses in a bond ladder, with an equal amount coming due every six months. The ladder can include high-quality corporate bonds, Treasury notes, certificates of deposit or municipal bonds, depending on the retiree’s tax bracket. Mr. Simon takes a similar approach using a 15-year ladder of zero-coupon bonds. He says that investors can start building the ladder in their 50s, with the first rung coming due the year they retire.

Some advisers also say you can guarantee you’ll be able to cover your basic expenses by purchasing an immediate annuity from an insurance company. The annuity pays you a stream of income until you die. “You can buy four small ones from four insurers if you are worried about insolvency risk,” said Dallas L. Salisbury, president of the Employee Benefit Research Institute. “And if you are just worried about inflation protection, you can do TIPS.”

But you should probably delay any annuity purchases because payouts rise with interest rates. With current rates so low, and the possibility of inflation later, advisers said it’s best to wait a few years. You can also research inflation-adjusted annuities, but you’ll receive lower payouts in the beginning, Mr. Benningfield said, adding: “Less than most people can stomach.”

Morningstar Advisor on Immediate Annuities

Immediate Annuities: The Key to Retirement


by Judith A. Hasenauer | 04-02-09


We love the cartoon of the family gathered around the lawyer's office for the reading of the will with the lawyer stating the will's contents: "Being of sound mind, I spent it all." Unfortunately, this joke begs the question of how can we guarantee that we and our money expire at the same time? Or, at the very least to make sure that the money does not end before we do. Although we all would like to be able to leave some of our hard-earned nest egg to our children, our first obligation is to ensure that what we have gathered lasts us for the remainder of our lives once we retire--particularly with ever increasing longevity and the financial instability rampant in the world economy. After all, it is better to have "spent it all" rather than having to move in with our children because we outlived our assets.

For the very wealthy, longevity is usually not a problem. However, for the vast majority of people, even those we like to refer to as the "working affluent," outliving funds for retirement is a matter of great concern (some politicians and the news media like to refer to the "working affluent" as "rich," but the term "rich" is, in our opinion, very relative). At the time the Social Security system was initiated in 1937 the life expectancy of the average recipient was only a few short years. Today, increased longevity has everyone expecting many times the expected longevity of 1937. It is not unusual for a working person today to expect to spend longer in retirement than she did working! Thus, fewer years are available to garner assets than there will be to spend the same assets in retirement. The actuaries tell us that it is likely that a married couple, with a 10-year disparity in age, where one reaches age 65, have a probability that one of the two will still be alive in 30 years! Thus, the need for longevity planning.

We have all read about the problems faced by the under-funding of the Social Security system and the problems we will all face when the 77 million "baby boomers" retire. It should be obvious to any serious observer that everyone needs to plan for funding their own retirement rather than to expect that employers or the government will handle it for them--particularly not in view of ever-increasing longevity.

So, how do we handle the problem of increasing longevity? How do we ensure that we and our money end at the same time? The only sure answer is with a payout annuity.

Annuities take many forms. Variable annuities are designed to provide a hedge against inflation because of the vast choice of investment options that underlie them. Fixed annuities provide a certainty because of the guaranteed amount of regular annuity payments. Unfortunately, few provide inflation protection. Index annuities provide both the certainty of guarantees plus a potential hedge against inflation because of the availability of an index that can provide for investment growth. Annuities also take different forms relating to premium payment modes and relating to when payouts begin. We are all familiar with the deferred annuities that have become such an important element in the financial market in recent years. Payout annuities--often referred to as "immediate" annuities are less well known, but of great importance in longevity planning.

Virtually all commercial annuities offered by life insurance companies in the United States have annuity payout options that are guaranteed for so long as the annuitant lives. This is true whether the annuity is deferred or immediate. The basic payout option is simple. The insurer guarantees payments for the life of the annuitant and they stop with the payment immediately prior to death. This "straight life annuity" is rarely selected because it does not provide for hedged alternatives that are appealing to retirees. Thus, payout options often include payments for joint lives, or for life and a period certain with payments guaranteed to a beneficiary if the annuitant dies prior to a specified term of five, 10 or 20 years.

Generally speaking, payout annuities used in connection with qualified pension plans provide for payments for the joint lives of the retiree and his spouse. This is to ensure the spouse is not left destitute on the death of the retiree. Annuities used with qualified pension plans can take two forms: They can be "individual retirement annuities" that are treated similar to IRA Rollovers, or, if the pension plan permits, they can be regular annuities purchased by the retirement plan's trustees for the benefit of the retiree. Annuities should be an important component of any qualified retirement plan because most qualified retirement plans do not provide payments that are guaranteed for the life of the retiree. Instead, they merely distribute the proceeds from the retirement plan to the retiree and leave it to her to determine how to invest it and to plan for longevity. Without a payout annuity, there is a significant risk that retirees will outlive the funds they have accumulated for their retirement.

The federal government, in the legislation covering retirement plans, has dictated that distributions from such plans must be for life or for "life expectancy," as determined by the mortality tables published by the Internal Revenue Service. Unfortunately, "life expectancy" is not "life." There is no requirement that retirement plans guarantee that a retiree will not outlive her retirement funds. Moreover, even if a retiree establishes a payout scheme that makes payments for her IRS determined "life expectancy," there is still a better than 50/50 chance she will live longer than the life expectancy established by the IRS mortality tables. The IRS mortality tables state that, at the end of any life expectancy for any age group, half of the group will still be alive. This half will have outlived their retirement funds if they chose to take them for their life expectancies.

The IRS mortality tables also can mislead a retiree because they are based on the total American population--not just those of us fortunate enough to retire with a qualified pension plan. Thus, it is more likely that employed persons participating in a qualified retirement plan will, as a group, live longer than will the general American population that includes drug addicts, homeless persons and those with no employer-sponsored medical plans. This means that the likelihood if people retiring with qualified retirement plans have an even greater risk of outliving their retirement funds--unless they take distribution of some part of their retirement funds in the form of a payout annuity guaranteed for life.

The retirement crisis facing our country for the next 15 years is profound. The Social Security system is under great pressure, lifetime pensions guaranteed by employers have virtually disappeared from the landscape and it is up to everyone to ensure that their funds last for their lives. Immediate payout annuities are the easiest way to ensure that you and your retirement funds expire at the same time. The alternative is not a comfortable one to contemplate.

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