“I HATE ANNUITIES AND YOU SHOULD TOO!” We’ve all seen the ads, and the author has done a terrific job of instilling fear and uncertainty into the minds of retirees and pre-retirees, but has he really done them any favors?
Making the blanket statement that you hate annuities is akin to saying that you hate your social security paycheck, your company pension, or your latest lottery payout. When was the last time anyone cursed the government for putting their social security check in your mailbox? I’m pretty sure that when Bubba cashed in his lottery ticket, he was celebrating his winnings all the way to the bank. On the flip side of the coin, operating under the delusion that an annuity is somehow the Holy Grail to financial planning is equally misguided and misinformed.
Like any polarizing issue, the root of the problem really boils down to a combination of misinformation and misconceptions, perpetrated ad nauseam by so called industry “experts”. The real question isn’t who is right in this argument, but rather, how can you take ownership of your own situation to make a properly informed decision that is right for you, and ultimately what is right for your clients? This question will serve as the footing for the remainder of this post….to deliver a simple framework to help you make a simple honest assessment of why these products ultimately exist, and how they can potentially serve you and your clients in an uncertain world.
Fundamental Principals of Income Planning
Let’s start with basic income planning. Do you ever watch the news after a natural disaster such as a tornado or a hurricane claims its victim community? Picture a place like Tornado Alley, across the Central Plains. After a devastating tornado rolls through and they’re taking inventory of the aftermath, what is left to rebuild from? What is left of the homes and buildings? The foundation, right? Your client’s financial plan is no different.
The Great Depression. Black Monday. The tech bubble. The mortgage crisis. These are just a few examples of real life, natural disasters that occur in the financial markets that serve to rock your client’s financial plan to their foundation. And you and we have just as much control over these situations as we do over the next F-5 rolling across the plains of Kansas or Oklahoma. So the question is, what is their foundation built upon? Concrete or sand? For any retiree today, the concrete and rebar that serves as the foundation of their fiscal house is built with guaranteed income sources. We may commonly consider this the “three-legged stool”.
The first leg is their Social Security, the second leg is (or has historically been) their company pension, and of course the remaining shortfall to provide for their basic needs and wants must be provided for from their assets. This is where your expertise comes into play. In your infinite wisdom, how will you ensure that your client’s lifestyle will never be compromised by the outside variables that they ultimately have no control over? Modern portfolio theory supports a systematic withdrawal approach that has historically led advisors to the general rule of thumb in the planning community for determining “safe withdrawal rates”. It’s served as a core principal, albeit an ever-moving target, that was at one point known as the “7-percent rule”, then modified to the “5-percent rule”, and has been once again been updated to the “4-percent rule”. The premise is simple and I’m sure you know it well. This is the agreed upon withdrawal rate from a portfolio with a balance of stocks and bonds (typically 50/50), that a 65-year-old retiree can distribute from their assets with a high probability of having a balance in their retirement assets before they pass, assuming today’s assumptions for mortality.
Whether you agree with the strategy or not is arbitrary for our purposes here. The question is whether this method is more founded in sand or concrete? Does it provide us with a guaranteed stream of income regardless of how long the client lives, and without concern for market fluctuations? The answer here is no, so no matter your level of confidence, this strategy is at least partially founded in sand.
Misconceptions and Misinformation
Once you’ve made your own determinations for your own fundamental philosophies about providing your client’s retirement income, the next issue that you must contend with are the sources of information that influence you and your client’s opinions on the subject. The best way that I’ve discovered to address this with your client is to simply serve as their filter. There is an endless stream of noise in the world of economics and personal finance. How is an individual to decipher what is right and what is wrong, let alone what actually applies to their particular situation? That’s where a financial professional’s advice and guidance is so invaluable, and in my opinion, can never be replaced by a computer or a robot. (a conversation for another day). Only you know exactly what makes your client tick. What are their fears and frustrations? Their goals and aspirations? What has influenced their decisions around finances in the past? At the end of the day, it isn’t so much an argument of right or wrong, but offering a path and a process to ensure that they are able to accomplish two things:
- Understand what the right questions are to ask, so that they are equipped with what we would define as critical information, relative to their unique situation. And…
- Understand how to filter through and apply that information to their unique circumstances to empower them to make an informed and sound decision that is right for them.
If you can offer this guidance and clarity for your clients, you’ll become their hero, regardless of product. Help them acquire real transparency around issues such as (but not necessarily limited to):
- How their existing investments will affect their taxes today and at the time of distribution
- The risk associated with their current investments, and how it correlates with what they say is their actual appetite for risk
- The total expenses associated with their existing investment positions. Not just what they see on their statements, but the hidden fees as well which can quietly cannibalize their principal.
- The reliability of income generated from their existing positions and how market fluctuations could potentially effect that reliability
These questions can go on and on, but the bottom line is, if you help your client establish a process for obtaining clear thinking, you’ll be on the path to a more empowered and engaged prospect and client.
Alright, back to the annuity. Why are there so many misconceptions around annuities in the first place? The simplest answer I can come up with is because there are so many options, with completely unique features, benefits, and applications, yet they’re often lumped into the same generic stigma. Tell me if this sounds familiar?
- Annuities are too expensive!
- Annuities are too restrictive!
- Annuities don’t offer enough liquidity!
- Annuities tie your money up too long!
This is why the process we previously discussed is so important. Because at face value, any or all of the above can be proven true. Annuities are too expensive! Sometimes… Annuities are too restrictive! Sometimes…. Annuities don’t offer enough liquidity! Sometimes…. Annuities do tie your money up too long! Sometimes… Again, the real question is what are you trying to accomplish? Let’s reverse the above bullet points and address them with some clarifying questions.
- What are the total expenses (hidden and otherwise) that you’re currently paying on your current portfolio?
- How would a market correction, or significant volatility affect your retirement income today and in the future?
- How much money do you need each year to satisfy your lifestyle?
- How long do you want your money to last you?
As with most things in life, it’s a matter of context. If the real objective is helping the client achieve maximum efficiency in their plan, the annuity may help you accomplish this in a way that no other financial vehicle can. It can take a speculative rule of thumb like the 4-percent rule, and deliver certain guarantees, removing concern for volatility or potential loss, and potentially deliver as much as 20-40 percent more income than any other investment might project to provide, while mitigating certain risks and expenses in the process.
Annuities may also deliver more predictable upside potential than other similar alternatives, which are designed for capital preservation and principal protection. In addition, the annuity may mitigate other risks often overlooked, beginning with longevity. Longevity is the ultimate risk, because as Tom Hegna says, it’s a risk multiplier. The longer you live, the greater the probability that you have to contend with additional risks impacting retirement, such as market risk, long term care risk, inflation risk, health care risk, etc.
It’s ultimately about utilizing the tool for job it was created for. If we establish the client’s financial foundation in concrete and rebar, you’ll be freed up to be as flexible as you and your client see fit to build the rest of the house, with reduced concern for the inevitable storms that the world will eventually throw our way.