Benefits Products & Services
By Thomas A. McCoy, CLU
BRINGING ANNUITIES INTO THE RETIREMENT DISCUSSION
Principal Financial study, legislative progress signal opportunities
Baby Boomers who are preparing to enter the retirement ranks are faced with the decision of how to invest their retirement income nest egg to carry them through the years ahead. For advisors who help them through this process, that job can be bigger than simply crunching numbers. To make the numbers work, advisors may need to be part of the retirees’ personal decisions relating to retirement.
“Advisors are becoming more and more like life coaches,” says Srinivas D. Reddy, senior vice president, retirement and income solutions for Principal Financial Group. “It’s not entirely about the money. It’s about helping people plan for retirement with questions like:
‘Have you decided what you’re going to retire into? How are you going to stay active and engaged? Do you and your spouse have similar visions of retirement? Are you planning on a part-time job—that’s going to affect how much money you need.’ Or, ‘I know you thought about retiring at 65, but realistically, you should consider working longer.’”
Sorting out the retirement product options requires careful analysis as well. Should they plan on continuing to invest—rolling over their entire defined contribution (DC) balance to an IRA? If they do so, can they come up with the right combination of stocks and bonds to pull them through the years ahead?
Principal recently commissioned independent research that compared the results of a strategy of investing a retirement plan nest egg solely in stocks and bonds to one that included both stock and bond investments and a guaranteed lifetime income product. Success was to be measured according to which strategy would do a better job of enabling the retiree to draw sufficient income to cover expenses, not outlive their money and have funds remaining as a legacy.
Researchers at The American College who conducted the study for Principal ran simulated income and spending patterns for three sets of individuals, ages 55, 65 and 75, over their lifetimes—with and without the annuity added to the mix of other investments. Among all three, the study concluded that “Adding an income annuity to their retirement portfolio enabled the retiree to get the same or higher income with a lower risk of outliving their savings.”
A key reason for those results, Reddy points out, is that “having the income guarantee lets retirees be more aggressive with their other investments.”
In addition to the financial calculations, the researchers also interviewed retirees who owned income annuities and found that peace of mind was a significant additional dividend to them. This confirms results of a 2014 study of 20,000 older Americans conducted by The University of Michigan, which found that increasing levels of guaranteed income resulted in improved satisfaction in retirement.
Peace of mind is a good thing for retirees, who face multiple changes to their everyday lives when they leave the workplace. Putting a portion of their DC account balance into an annuity provides a hedge against a downturn in the stock or bond markets.
“When the financial crisis of 2008-2009 hit, people whose retirement accounts included an income guarantee tended to stay the course, and their accounts recovered,” Reddy remembers. “Others without a guaranteed income product were more likely to give up on equities at the wrong time. The same behavior occurred last December when the stock market declined sharply and then recovered and went higher.”
Having an annuity also can help prevent retirees from spending too little of their retirement savings, Reddy points out. “Often, those without the guaranteed income product wind up investing too conservatively and taking out less from their retirement funds than they should.”
Traditionally, a common objection to an annuity purchase has been that the outlay required for an annuity depletes funds that would otherwise be available to the person’s estate. As part of Principal’s study, interviewers asked people with an annuity about their attitudes toward leaving a legacy. They found that “many who made the decision to buy an annuity felt greater freedom in giving away wealth once they knew that their basic expenses were taken care of through guaranteed income.”
Principal is one of the five largest providers of income annuities in the United States. Reddy says the company’s immediate annuities and deferred income annuities are having “record sales years.” He believes these guaranteed income products are on the threshold of still greater growth as the needs of Baby Boomers entering retirement evolve.
“The first Boomers turned 60 in 2006, so there’s a period of 18 to 20 years before they all start getting into retirement,” Reddy notes. “A lot of the early Boomers were still covered by some form of defined benefit. It may have been a frozen benefit, but they may have worked for an employer at one time that had a defined benefit pension plan. Given the trends we saw in the late ’80s with a lot of pension plans being frozen or going away, more and more individuals who retire are going to lack those guarantees of security. That will make the guarantees of annuities that much more meaningful.”
Legislation moves forward
The House of Representatives recently passed the SECURE Act (Setting Every Community Up for Retirement Enhancement), which updates a wide range of regulations for retirement savings, both in and out of the workplace. Prospects for passage of the act into law are considered good because similar legislation has strong support in the Senate.
Reddy is enthusiastic about two provisions of the act related to annuities. One is a safe harbor provision for employers offering annuities within a defined contribution plan. If they follow the safe harbor, employers only need to consider insurer health at time of selection.
The other provision allows for product portability, Reddy explains. “Effectively, if the employer offers an annuity product and then decides to no longer offer it, that will become a distributable event for participants. So even if they are still employed, they’ll be able to roll over the product into an IRA and preserve the guarantee.”
The act also would allow unrelated businesses to establish multi-employer defined contribution plans. “We’re excited about the multiple-employer plans,” says Reddy. “A large percentage of Americans currently do not have access to a retirement savings plan. Just getting people to start having access will make a huge difference.” The bill would also extend eligibility to long-term part-time employees.
Another provision raises the amount of pay that employees can defer automatically under their DC plan from 10% to 15%. Reddy sees this as a positive move.
“In 2006 when the Pension Protection Act came out, it allowed for automatic enrollment up to 10%, but the example the Department of Labor gave at that time was 3%, which is where a lot of employers auto-enrolled their employees. That is too low to drive a level of savings that leads to adequacy, so I’m excited that it could be raised from 10% to 15%. Directionally, it signals to employers that they need to think about raising it from where they are now.”
Last April, Principal announced plans to acquire the Institutional Retirement and Trust business of Wells Fargo. The acquisition, which is expected to close in the third quarter, will boost the total number of Principal’s ranking it among the three largest providers in the United States.
“One of the primary reasons for making this acquisition is that to continue to have product innovation and make the necessary technology investments, you need scale,” says Reddy.
Principal’s acquisition of the Wells Fargo business represents a serious commitment to the retirement market. Benefits brokers and financial advisors can make their own serious commitment to serving that market. It starts with understanding the needs, both psychological and financial, of retiring workers, and then offering creative ways to fill those needs.
Whatever success these workers may have had in building up their retirement plan balances, large numbers of them may need guidance in choosing products that provide a guaranteed income stream.
Thomas A. McCoy, CLU, is an Indiana-based freelance insurance writer.