By Casey Weade
The world we live in today isn’t the world in which your parents or grandparents grew up. But if you continue to plan for your clients the same way they planned for themselves, you might as well be driving down the road looking in the rearview mirror.
Today’s retirees face a war on seniors with lower interest rates than any living generation can recall. Retirees are living longer than ever, with some potentially spending more years in retirement than they spent in their working career. Stock market volatility is reaching all-time highs, and the risk of losing big in those first few years of retirement has never been higher. And finally, the era of the gold watch and lifetime pension is coming to an end.
When thinking about how to help clients in this changing environment, you can begin by focusing your attention on the fixed income market. The bond market is in shaky territory today with high quality bonds yielding barely 3 percent and often requiring terms well beyond a decade. Making the situation worse is that many municipalities are up to their ears in debt. The past decade has seen some of the biggest bond defaults in history over the last decade and they have created anxiety among advisors and investors alike.
Enter the fixed index annuity with shorter terms and typically more potential than what you would find in the bond market, not to mention a higher degree of safety. FIAs are becoming the alternative that clients need for their retirement portfolios. How would your client feel about a 60/40 portfolio without the interest rate and default rate risk present with the typical bond/equity mix? This is yet another reason the FIA may be appropriate for your clients today.
Guaranteed lifetime income is the reason the FIA was first invented in the first place. Pensions gained popularity in the 1920s and ’30s as a way to create a guaranteed lifetime income for retirees. Many uneducated investors may say they hate annuities, but those same people never say they hate their pensions. They love their pensions. The pension has given them the ability to spend their life savings without the worry of the stock market ripping their beloved retirement right out of their hard-working callused hands. Well, that’s what an annuity with a guaranteed lifetime withdrawal benefit can do for your clients.
My cross-country coach always told me that the closest distance between two points is a straight line, so take the inside line. The same thing should be true for your clients’ income planning. Find the most efficient vehicle to accomplish that specific goal. Annuities generate more guaranteed income than any other investment tool, so use them for the purpose for which they were originally designed - income.
With that, please keep in mind that annuities aren’t the solution to all of your client’s needs. Annuities are only one piece of the puzzle giving them an outlet for conservative growth and guaranteed lifetime income. Equities, exchange-traded funds, options, bonds, alternative investments and insurance still have their place.
You may think that you can help your clients achieve their financial goals more efficiently through the use of securities, such as individual bonds. I think you will most often find that your retired client is willing to sacrifice potential growth for the peace of mind they can achieve through a fixed annuity. There is a reason that a fixed annuity doesn’t fall under securities regulations and it’s because that a fixed annuity gives your client a guarantee of principal that securities cannot provide.
One of the most important tools a financial advisor has is the internal rate of return calculation. Internal rate of return is a simple calculation helping you determine the effective rate of return you are receiving from a series of cash flows, which is exactly what your clients are buying with that fancy income rider. You may be surprised to find that the guaranteed 7 percent your clients are getting with that income rider is equivalent to less than a 2 percent rate of return at their life expectancy. Other riders with lower roll-ups may be giving your client an effective rate of return exceeding 4 percent at their life expectancy, but you will never know without running the numbers for yourself. Remember that it’s not about how big the roll-up is, but how big the withdrawal rate is on the back end.
You should also not discount the idea of using more than one company to satisfy your client’s lifetime income. We all know that the guarantees provided to your clients are backed by the claims paying ability of the issuing insurance company, so diversifying your client’s income streams makes sense. On another note, you may be able to deliver more income to your client by generating income streams from different companies over different time periods. While one company might offer the best guaranteed income over the first 10 years of retirement, another may deliver the best guaranteed income with a 10-year deferral.
Finally, don’t forget the low interest rate environment that we are in today won’t last a lifetime, so don’t lock your clients in for a lifetime. Watch your fees, spreads and caps. This will give your client the ability to move the funds down the road if interest rates rise. It may be prudent to avoid income riders altogether and seek a simple protected growth strategy. Thinking of the future will benefit both of you.
It’s your responsibility to ensure your clients live a confident retirement. It is not your job to make them rich, it is your job to ensure they will absolutely never be poor. Annuities give you that ability.
Casey B. Weade, CFP, RICP, is president of Howard Bailey Financial in Fort Wayne, Ind., and is author of The Purpose-Based Retirement. Casey may be contacted at [email protected].