Are retirement income
solutions missing the boat?
Setting aside the somewhat persistent theme that
Americans are not saving enough, the more important
question may be, "Can retirees manage their money well
enough to ensure their savings last as long as they
While success is uncertain, the goal is certainly
worthwhile. With traditional pensions increasingly scarce
and Social Security on shaky footing, dwindling numbers of
Americans can count on receiving a regular stream of income
capable of covering their basic living expenses through
retirement from sources other than their own efforts. Many
will rely instead on nest eggs they have accumulated in
defined Âcontribution plans. Yet, few have any idea how to
make sure their savings last a lifetime, as any number of
surveys readily attest.
For these investors, financial services firms are
introducing a raft of new products seeking to duplicate, as
best they can, the features of a group defined benefit plan
at the individual investor level. Most revolve around some
sort of annuity—that's what well-designed pension plans
typically provide, after all—with some new bells and
whistles: inflation protection, payouts guaranteed for a
minimum number of years, and opportunities to fund the
annuity over a period of years rather than with a lump sum.
Few of the new products incorporate all these features, and
no provider would suggest that any one of them is the right
solution for every retiree. However, they do offer
investors new ways to address longevity risk—the risk of
outliving your assets.
Despite the tarnished reputation of traditional variable
annuities that carry exorbitant price tags, opaque pricing,
and are sold primarily as tax-avoidance vehicles, Boston
University professor of finance and economics Zvi Bodie,
author of Worry-Free Investing, says the new class of
income-oriented annuities makes sense for the many retirees
who are not willing or able to take on that longevity risk.
He notes, for example, that many financial advisers now
recommend investors withdraw no more than about 4% of their
retirement assets annually.
By contrast, he says, some immediate annuities
that, as the name suggests,
begin payout immediately today yield more than 6%. "That's
a huge difference."
Bodie also dismisses the argument that, because retirees
face a Â20- to 30-year retirement period, they can accept
equity risk in their portfolios and ignore the advantages
of an annuity. "If you're going to invest a lump sum and
not touch it for 30 years, that truly is a long time
horizon, and it doesn't matter to you what the sequence of
returns is," he argues. Indeed, a tenet of retirement
savings has long been the curative powers of time with
regard to market cycles. "However, when you retire and are
withdrawing money, the sequence is very important," Bodie
notes. "Let's take a period of 20 years during which the
average return is 12% per year and you withdraw 10% per
year. Now, suppose that, during the first eight of those
years, the return was 0%. At that point, you'd be
completely out of money." Unfortunately, retirees generally
are unable to time their retirement "draw downs" to
accommodate those cycles.
Genworth Financial tried to address some of the biggest
objectionsÂ to annuities with its new ClearCourse offering,
a group variableÂ annuity designed to be offered to
participants still in defined contribution plans, right
alongside traditional investment options (see below,
"Annuities: A New Breed"). To answer concerns that the
purchaser might die before recouping her investment, for
example, Genworth guarantees the investor's payout for a
minimum 20 years. If the investor dies before that time,
her Âbenefits pass on to her Âbeneficiaries. To address
concerns that income annuities sacrifice any opportunity
for growth, Genworth also passes on to the investor
earnings in the underlying investment vehicle—currently,
the GE Total Return Fund—that exceed what is required to
meet the guaranteed minimum payout.
Many of the new annuity products are priced far more
competitively than traditional variable annuities, too.
Investors in ClearCourse pay 85 basis points for the
insurance Âcomponent of the product plus the cost of the
underlying investment vehicle. "We have organizations out
there using ClearCourse where the total expense ratio
combining those two costs is about 130 basis points," says
Fred Conley, president of Genworth's Institutional
Retirement Group, "and we are entering into an arrangement
with an index fund provider where we are able to have the
asset management fee for an indexed balanced fund between
eight and 20 basis points, depending upon the size of the
assets in the plan, so that the whole thing combined can be
offered for about 100 basis points or less."