Retirees' first steps into the income-distribution phase of their lives come with a great deal of stress - and fear. The standard rules of thumb don't apply to the distribution side of the investment curve, and many advisors have been caught rolling down alongside their clients when the bottom falls out.
Distribution planning is a science and an art. The science revolves around knowing what tools are available to achieve the our clients' goals, and the art is being able to explain why the strategies make sense.
Many articles have been written about the negatives of annuities - specifically variable annuities. We've heard the arguments: they are more expensive than most mutual funds, they often have long surrender periods in which clients' money is locked up and illiquid, and there is the underlying theme that these products are intentionally difficult to understand.
Many annuity products fit those descriptions, but the industry has changed dramatically over the last decade - living benefit riders, for example, are offering guaranteed income streams while also providing participation in the markets. If the markets perform well, you may take a larger income. If the markets do poorly, your income remains the same. These riders come at a cost, naturally, as what you are doing is buying an insurance policy on your future income. This policy allows participation in more risk (and possible reward) than would otherwise without a safety net of the guaranteed income.
Retirement income tools range from fixed annuities (one premium in, one income stream out for life) to 100-percent mutual fund investments (no guarantees, but very liquid and relatively low fees). Variable annuities are somewhere between the two. Each end of the spectrum will seem more appealing than the other at some point - when the markets are in a long decline, a fixed income stream is very attractive - during a bull market the mutual fund portfolio can do incredibly well.
Ask anybody who retired in 2000 which end of the retirement income spectrum they wish they've landed on, and you'll probably be hearing a different story than from somebody who retired in 1995. In both cases, insurance on the income stream would have made for a more peaceful ride.
Retirees' fears revolve around outliving their assets. As we are all living longer, this fear has merit. Approaching the retirement income question with a combination of market participation and income protection, variable annuities with income guarantees offer a good balance within the income spectrum.
One concern is the ability of the insurers to make good on their promises - we're hearing this more now than ever. Although past articles bashing VA issuers claimed the insurance offered on the annuity business was too expensive to the consumer, recent discussions have revolved around fears that the cost of insurance is now too cheap. Insurers are changing their product offerings to help spread the risk of insuring their guarantees - in the form of investment restrictions, increasing fees, changing annuitization rates, and other actuarial adjustments. By no means does this imply that good tools are not still available to advisors who do their homework, but the retirement income world is changing even as we write this, and more homework is needed to find the best solutions in the evolving VA space.
With any investment strategy, especially those involving income generation, there are good ideas and bad ideas, and the right tools specific to the clients' needs can be found if you do your research. Variable annuities can fill the income gap if utilized correctly, and can smooth out what could otherwise be a very rocky retirement landscape.
Mark A. Cortazzo, CFP is senior partner with MACRO Consulting Group in Parsippany, N.J.
