The Annuity Imperative


February 6, 2013
Retirees and near-retirees often wonder whether they should purchase an annuity to provide sustainable lifetime income – in effect, a guaranteed retirement paycheck – that they cannot outlive. Many do not and that’s almost always a big mistake.
by CATHY MENDELL of Elevation Capital Strategies
Income annuities – whether an immediate annuity, the annuitization of a deferred annuity or utilizing the new hybrid lifetime-income benefit annuities – are incred­ibly powerful tools for providing sustainable lifetime income and are almost surely the most underutilized financial asset in the market today. As reported by The Wall Street Journal, “income annuities can assure retir­ees of an income stream for life at a cost as much as 40 percent less than a traditional stock, bond and cash mix.” In effect, this means that retirees who need a given amount of savings to provide for themselves through­out retirement can live the same lifestyle with as little as 60 percent of that amount through the use of an income annuity.
Proffessor David Babbel of the esteemed Whar­ton School at the University of Pennsylvania sets forth the value of annuities clearly and unequivocally, “Lifetime income annuities may not be the perfect financial instrument for retirement, but when com­pared under the rigorous analytical apparatus of economic science to other available choices for re­tirement income, where risks and returns are care­fully balanced, they dominate anything else for most situations. When supplemented with fixed income investments and equities, it is the best way we have now to provide for retirement. There is no other way to do this without spending much more money, or incurring a whole lot more risk coupled with some very good luck.”
The Retirement Crisis
We face a retirement crisis of epic proportions. Be­ginning in 2011, 77 million baby boomers will start turning 65 and begin what they expect will be a com­fortable retirement. For most retirees, their retirement plans have been built upon three major components.
Social Security: Most retirees rely heavily upon Social Security and related government programs. Social Security, which provides, on average, about 40 percent of retirement income, will face increasing financial pressure as the dynamics of funding are challenged.
Traditional pensions: With a traditional pension, the saving and investing is done by employers, and these employers bear the risk that retirement assets will fall short of promised benefits
Home equity:  For many people, their pri­mary residence is their big­gest retirement asset. In re­tirement, people can cash in on the value of their homes by selling them and then either buying less expensive houses, renting or mov­ing in with their children. More people are also using reverse mortgages to extract equity from their homes in retirement. But the recent real estate bubble and long-run housing data show why relying upon home equity for retirement is a risky endeavor.
Finding Solutions
for a Secure Retirement
A study prepared by Ernst & Young on behalf of the non-profit Ameri­cans for Secure Retirement entitled ‘Retirement Vulnerability of New Retirees’ has found that those with guaranteed retirement income beyond Social Security, such as income annuities, are much better prepared for and in retirement. It also found that middle-income Americans entering retirement with­out a guaranteed source of income beyond Social Se­curity, such as an annuity, will, on average, have to reduce their standard of living by 32 percent to minimize (but not guarantee) the likelihood of outliving their assets. The problem only gets worse with time. The study also found that the next wave of retirees (five-10 years from now) will have an even higher risk of outliving their fi­nancial assets than those currently at retirement age.  That’s why income annuities are so vital. As the report states:
“Without additional guaranteed lifetime income streams, such as income provided by an annuity, middle-income Americans are at high risk of outliving their financial assets and living their final years in poverty.”
Effective Retirement Planning
Effective planning requires meaningful risk management and, even more importantly, risk avoidance. That means it can’t be a “wish and hope” strategy. The plan actually has to work. Simply put, retirees and near-retirees must avoid the mistake of risking what they cannot lose. During the “retirement transition window” (five-10 years on either side of retirement), it is more impor­tant to avoid mistakes than to reach for the highest investment returns. The key risk during this period is a deviation from purpose. Like Odysseus passing the Sirens and hearing their enchanting songs, investors during this time need to be “tied to a mast” to protect them from giving in to the temptation to seek “just a little bit more” return. Put another way, retirement planning has two key objectives, which are often in competition: to maximize the rewards of success and to minimize the consequences of failure. During the retirement transition window, at least, the second must take priority over the first. Accordingly, during this time period, return of capital must trump return on capital.
If there could be doubt about the need for guaranteed income vehicles generally, the recent market turmoil has clearly established that there is much more to obtaining a secure retirement than merely accumu­lating a large retirement savings nest egg. True re­tirement security requires a sustainable strategy for preserving that nest egg and allocating it in such a way as to meet its owner’s goals, plans and dreams. Such a strategy demands the use of income annuities for nearly all retirees. Those approaching retirement with substantial retirement savings ought to consider preparing for retirement and preserving their prin­cipal through the use of a deferred annuity, which may be annuitized upon retirement to guarantee a sustainable income that cannot be outlived. The needs of the future suggest that greater risk, greater uncertainty and greater volatility are all likely.
Disclosure.  Securities offered through GF Investment Services, LLC, Member FINRA/SIPC. Investment Advisory Services offered on a fee basis through Global Financial Private Capital, LLC, an SEC Registered Investment Adviser
Cathy Mendell of Elevation Capital Strategies can be reached in Bend at 541-728-0321 or Securities offered through Pete Mendell and Dirk Wall through GF Investment Services, LLC, Member FINRA/SIPC. Investment Advisory Services offered on a fee basis through Global Financial Private Capital, LLC, and SEC Registered Investment Adviser.


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