Tag Archives: insurance products

Why Annuities are Good (yikes!) and Bad for Your Retirement

  By petillo | July 7, 2011 - 4:03 am | 401k, annuities, financial planning, insurance, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025, women and finances, women and retirement
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Nothing that is good for you can be considered bad and vice versa. Except perhaps when asking a five-year old about broccoli. But the vast majority of adults, fifty years hence wouldn’t even consider an annuity for their retirement and if they did, would almost certainly regret the decision at some point soon after. How can annuity be both regrettable and not, good and sometimes bad, bad and almost the best option?

First, a disclaimer: I am not a big fan of annuities – too complicated and too costly and too much insurance. Secondly, as if that weren’t enough of reason to dislike them, they are quickly becoming an idea with a certain allure, almost mystique. They have done little to reinvent what they are – aside from some product tweaks along the way, they are essentially exactly what they always were. So why the sudden interest? Okay, it’s not really sudden. The thought that is currently being bandied around by many of my cohorts is worth considering. After I tell you what they are.

If I were to offer you a “guaranteed income for life” that grew at 4%, you’d think to yourself that this was too good to be true. If it were free of fees and locked in penalties and all sorts of hidden costs, it would be too good. But this is an insurance product. And I’d be willing to wager you have never met, over the course of your lifetime, an insurance product that is free of some small print just waiting to rear its ugly head the moment you need it. Then they tack an investment portfolio into the mix and you have a recipe for problems. Kinda sorta.

First off, you need to buy the product. When you buy it has more to do with it than the actual need or desire. Annuities come with salespeople in tow and when they begin talking, most of the information you might need to know later gets pushed to later. What stands out is the fixed number, the income for life. Secondly, you will not be the same person ten-years from now and this makes this sort of purchase subject to those shifts in not only who you are but where you are financially.

MetLife explains the difference between the two most common types: the fixed and the variable. A fixed annuity “earn[s] a guaranteed rate of interest for a specific time period, such as one, three, or five years. Once the time period is over, a new guaranteed interest rate is set for the next period. A fixed annuity guarantee is subject to the financial strength and claims-paying ability of the insurance company that issues the annuity.”

In other words, you know exactly what it is your are getting into – if only it were that simple. The fixed rate often offered is just barely beating inflation and won’t beat taxes. Yes it will be fixed but this also depends on your age and your sex. If you are a woman, you will receive less compared to a man because you will live longer – the insurance side of the deal in the equation.

If you meet a retiree who regrets their decision once they have bought and annuity, it will be because the stock market is doing well. Studies have shown that if the markets are good in the months preceding retirement, the retiree will more than likely opt for investing on their own; if they are bad, they buy an annuity.

When MetLife describes variable annuities, they roll their eyes and shrug their shoulders, knowing that even as the markets are doing better, you still want safety. They describe these products: “Variable annuities typically offer a range of funding options from which you may choose. These funding options may include portfolios comprised of stocks, bonds, and money market instruments. The account value of variable annuities can go up or down based on market fluctuations. Your purchase payments and earnings are not guaranteed; they depend on the performance of the underlying investment options.”

But believe it or not, there is a place in your retirement plan where these products belong: inside your 401(k). When asked about them in 401(k) plans: “Eleanor Blaney, consumer advocate for the Certified Financial Planning Board, is blunt, “This is categorically a bad idea.”" Of all people, women benefit the most from annuities in these plans. They don’t discriminate based on sex. They give women the conservative approach many say they want – and the knowledge of knowing what they will have – and it gives them the opportunity to educate themselves about other potential investments available to them. Plus, it eliminates the choice at retirement that most people can’t make. Stuffing them in every 401(k) can help men make the right choice for their wives – who will live longer and benefit from them.

The Annuity Trap to Avoid: Retirement in a Down Market

  By petillo | February 28, 2011 - 9:08 am | Boomers, financial planning, insurance, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025
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It is a relatively well known phenomenon amongst the soon-to-be retired. You are jettisoned from your 401(k) with a large chunk of money, a lifetimes’ worth of hard earned cash. You are forced to make a decision about what to do with it. Kept in its present form would require you pay taxes on it as it is. Rolled into an IRA allows you to hold off on distributions, possibly until you are 70 or begin to take money out. But some folks fall into the annuity trap.

This choice, the annuity, in whatever flavor you are sold by the insurance company is often picked when the newly retired person does so in the midst of what would be a bear market. For those not versed in that term, this a period of lower stock prices; the reverse of which would be a bull market. Most folks fall back on the same logic, perhaps not fully tested or vetted, that retiring in a down market is hardest on your retirement account because you have far less than you might have has had you retired when the market was on the upswing.

On paper it might look bad. But the bear market might be your friend, especially if you are the counterintuitive type not prone to believe the conventional wisdom. What is the conventional wisdom? To be upfront, something I disagree with in most cases in large part, because I don’t think pat formulas work. We evolve and so does our thinking. Why, if that is true of us and we are the markets, do we insist on being harnessed by stringent parameters?

Because they provide comfort, a point of reference, a goal. No matter what name you assign them, they are prevalent and with so many personal finance and retirement “gurus” saying the same thing, you tend to fall lockstep into the same thinking. Withdraw 4% you chant and you will never run out of money.

I’ve disputed this notion in the past as not very wise or thoughtful. Two things helped me arrive at this conclusion. Long before Susan Jacoby wrote her new book about old age (Never Say Die: The Myth and Marketing of the New Old Age, Pantheon Books), which provides a no-hold-barred look at the distinct, perhaps inevitable slide the human body takes on its path to death, I was suggesting that we might live longer but what will living longer mean. Oh, we may live to 85, but our arrival signals the end of cognitive independence for more than half of us.

She blames the baby boomer, the reinventor of what life is as the culprit in this thinking. We may have changed the way our youth unfolded and we may have upset the norm throughout our working careers. But when it comes to old age, it doesn’t matter whether you have some sort of can-do attitude, you won’t be able to change what is going to happen to you. You may envision a life of vigor and vitality, volunteerism and travel. We all need something to keep us moving forward. But Jacoby says we are ignoring the hard facts of life. We’ll still get old. And with age comes the maladies of that time. Still there and still the same unsolvable mysteries.

So we will reach a point somewhere in the future – and the odds are in favor of this thinking – when you will no longer be the person you are right now. The years that you believed would be full and vital are now gone and you are collecting in the form of equal – possibly inflation adjusted – income that you can’t spend. You scrimped in the early years of your retirement, downsized, even counted every penny. And then later in life, it doesn’t matter. My suggestion was to start out big and taper back. Perhaps gradually easing back from a 6-7% withdrawal rate in the first ten years of retirement to a paltry 2-3% by the time you are 80 years old.

The result would be more or less the same with you using the money in the early years to do what you thought you could do and scaling back as your new sedentary lifestyle takes hold, an inevitability we can’t avoid. “Young old” is easy to imagine. “Old old”, not so much.

But the choices we make right at the moment of retirement may have a greater impact on how well that retirement is financed than we may have previously thought. Those bear market retirees, the ones who graviate towards annuities more so than their cohorts who retire in the midst of a bull market, may end up doing better over a longer period than their more optimistic cohorts.

I am of course referring to the studies done by Wade Pfau, an associate professor at the National Graduate Institute for Policy Studies in Tokyo who has suggested that retiring during a bear market is actually the best case scenario. His thinking is that a bear market provides more upside potential than a bull market would. On this point, he may be right. Our penchant to follow the herd during a bull market gives the impression that markets will always go up.

And there is some proof that for a time, they will. There is also proof that if you retire during a robust bull market, you will be more inclined to believe that you possess some sort of powerful ability to manage your money better. But bull markets fall and this causes confusion among those who may have deluded themselves into thinking they were more skilled than they were.

Professor Pfau thinks that a 60/40 stock split is optimal and if you invest over the course of 30 years at a rate that is close to 17% of your pre-tax income, you will be able to have 50% of your pre-retirement income, inflation adjusted, throughout your retirement. Staring earlier will mean less needed to get to the same mark. And of course this excludes any other money you might receive in retirement.

You are probably saying to yourself, ‘that’s a lot of income to sock away’ and you’d be right. But this is one thing that hasn’t changed: if you think you haven’t been putting enough away, you are probably right. If you think old age is something that will resemble the first day of retirement for the next 30 years, you would be wrong.

Baby Boomers should be thinking about spending more when they are healthiest. Because ‘old old’ doesn’t give you the chance to revise your planned ‘young old’ retirement.

 

The Value Neutral Retirement Plan

  By petillo | November 30, 2010 - 3:57 pm | 401k, bonds, financial planning, index funds, insurance, IRA, Repercussions: A Retirement Review, Retirement Planning Target 2025, women and retirement
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To see the word okay (the form I prefer over the simpler OK or the punctilious O.K.), without intonation or judgement doesn’t do the word justice. Hearing it adds meaning and nuance. You need to experience it roll off of someone’s lips lazily, dropped in an aggressive acquiescence or simply thrown out there for fun . It is a word, or phrase that simply is.

This is the prevailing feeling you get from hearing someone say ‘I’m okay’ when asked about their retirement plan, or their day at work, or their time spent in school. It becomes an answer ladled over falsehoods. Why is that? Okay is value-neutral. In fact, for it to have any real meaning, it must be spoken. What happens when okay is, well, okay?

For the last year, we have seen the markets kind of recover (I would not suggest watching the regular gyrations of the stock market these days for anyone but those strong of stomach) as they continued to deal with news from around the globe. True, the markets are notably higher than several years ago but the structure seems rickety, unstable. This applies to more than just equities; bonds are troublesome too. Commodities have weighed in with gold becoming bubble-like in the wake of low inflation, the opposite of what usually happens. And yet, if asked about your retirement plan, you would probably answer: “It’s okay.”

What is happening in your 401(k) has offered the a look at what okay is when it comes to investing. Some of this is your fault. Some of it the fault of those whose definition of fiduciary responsibility has shifted. Perhpas there is no better evidence than that offered by Prudential Retirement. They have introduced okay investing to its 3.7 million customers using 401(k)s the manage. By doing so, they extend the risk avoidance to a new level: an FDIC insured bank account in your 401(k).

There are basically three things wrong with this, two are obvious, the other is speculation based on years of experience ferreting out the moves most financial institutions make.

The first has to do with risk, or better yet, lack of it. The average investor is still recoiling from the meltdown now over two years old. In all my years, I have never seen a lingering fear last so long or an industry do what it can to enable it. By this time in usual times, what happened to your investments would have been long forgotten. A bull market somewhere would have been outed and it would start anew. This is a different era. Lingering unemployment, continued global financial strife, housing, and all the rest have made forgetfulness more difficult.

But this pendulum swing to conservative is a bit surprising.Risk is inherent in the investment world. Without it, as I have mentioned on numerous occasions, you have savings, vanilla and plain and safe.

You can get to retirement with savings. But you will have a greater opportunity to get there with more money if you invest. Trying to get folks to change this vernacular, from retirement savings to retirement investing has been a Sisyphean task. We want to think of it as savings so most personal finance and retirement writers and pundits continue to use the phrase. 401(k) plans have become the new bastion for low to no risk, offering target date funds and index funds as the go to investment for all of their participants.

I have many reservations about target date funds (from promoting set-it-and-forget-it investing, the inability of these funds to beat the market, a good target date index, and the fact that so many of these funds are simply a halfway house for orphan funds) and index funds (yes they are cheap but they are also too tax efficient for a 401(k)). Making them the default investment for new hires or advising older workers to use them and you have a recipe for an underfunded retirement – in part, because the vast majority of people who use them don’t fund them with enough money to make up the low risk sacrifice they are making.

I mentioned that you could get to retirement with savings. It’s possible but not within the purview of the average worker. You would need to save using a wide variety of stable vehicles like money market funds and CDs, all of which are offering so little in the way of interest that it hardly beats inflation. Bonds may seem like they offer a safe haven and in some instances they do. But that safety is accompanied by risk and one of those risks is beating inflation. Did I mention that you would probably never stop working in order to make the “savings-only” plan work?

What about annuities? This is where I am speculating. Prudential Retirement is an arm of Prudential Insurance which sells annuities. Although the vice president of Prudential Retirement Carlos Mello makes it known that his company doesn’t give investment advice, the seed will have been sown with the new product.

Billed as a place to ponder your next investment move or even an account whereby those close to retirement can have access to cash when they do, putting a savings account in a 401(k) will be used as a sales tool for annuities. Insurers know that most people look back on the performance of their 401(k) in the short-term (about six months) and base their decision on whether to buy annuities at retirement or not. A market that has done well turn newly minted retirees away from the product. While with a down market in the months leading up to retirement, the purchase of an annuity is much higher.

Now imagine someone close to retirement stockpiling cash in one of these FDIC insured offerings. They are already (or will be at least) accustomed to little or no return. The upsell to annuitize that cash upon retirement, and the pitch is rather charming, may be too hard to avoid. To hear retirement planners talk, you would think they are reinventing the pension. Which in some respects they are. Without the employer’s contribution.

If you were employ a three thronged approach, which is an okay way to go, you might use savings for emergencies, building up a six month reserve – a year would be even better. But do so knowing that you will need to fully fund your 401(k) in the process – not just a comfortable 10%. And you will need to hedge both of those bets with a Roth IRA held outside your 401(k) – this is where your index funds belong.

While etymologists tell us that the O and A long vowel sounds, separated by the hardness of the K is nearly universal and used in almost every language, it shouldn’t be used to describe the state of your retirement plan.