A client recently wrote in and said he'd attended a viewing of the film "The Baby Boomer Dilemma." He said he came away with a sharpened awareness of stock market risk. And since he's planning on retiring soon, he was interested in securing risk-free, guaranteed income. He said the film led him to consider annuities as solutions for his concerns. What do you think?
OK. Let’s unpack this.
“The Baby Boomer Dilemma” is a well-crafted infomercial. It’s designed for annuity and insurance salespeople to use as a lead generation tool. Regardless, the film actually does a good job of describing the dilemma. At face value, its conclusion that annuities can secure risk-free, guaranteed income is also true. But, like many things, the devil is in the details.
The rest of this post lays out our thinking on the topic.
First, we are financial planners, not annuity or insurance agents. So, we don’t have a product axe to grind. If an annuity makes sense for a plan, fine, we’ll help you find one that meets your needs. This avoids the conflicts of interest that permeate the industry, and highlights our role as true fiduciaries.
So, when would an annuity be a useful solution for income generation? A few questions need to be answered first.
1. When is the income needed? How much is needed? Is it a present need or a future need? Or both? This is the “problem” or “goal” that has to be defined before any product solution is advanced. Like we don’t talk about whether to drive or fly until we know where and when we want to go somewhere.
2. What solutions are or will be available to meet the income goal? Here are the common ones:
Defined benefit (DB) pensions. This is where a company or agency pays you a monthly retirement benefit for life. However, DB plans peaked in 1983. Now, only about 3% of private company employees have one. You’re probably not among them. These days, most DB plans are found in government or public agencies like education. If you’re in one of those, great. If not, there’s no way for you to create one.
Defined contribution (DC) pensions. This is where you’ve contributed to a workplace retirement savings plan. This is the world of 401k, 403b, 457, Deferred Comp, IRA, SEP, and so on. Fidelity reports that the average retirement account balance for people who have been in a plan for at least 10 years is $412,000.
Social Security. Social Security benefits are based on your earnings, the number of years you’ve worked, and the age you start benefits. This year, the average monthly Social Security benefit is $1,656. That’s about half the maximum possible benefit. A planning note to keep in mind is that Social Security is designed to replace about 40% of pre-retirement income.
The Third Leg. Back in our parents and grandparents day, personal savings were one of the three legs of a household’s platform of financial resources. The other two were DB pensions and Social Security. For various reasons, that discipline has gone out of style.
Bottom Line: Many people struggle with matching income and savings with
their spending. So, they must downsize, cut back, relocate, work longer, divorce,
rely on family or the kindness of strangers. Not a pretty picture. That’s the
gist of “the baby boomer dilemma.”
The Annuity Solution.
Annuity or insurance salespeople may offer products that could resolve two important issues:
- Pay a guaranteed monthly income for life. Longevity risk is eliminated.
- Have no stock market risk. There are no stock market investments.
Social Security actually does both
of those things. But as mentioned earlier, it was never intended to fully
replace pre-retirement income. The best annuity can be thought of as a Social Security-like supplement to retirement income.
The Devilish Details.
- Any annuity selection must have an inflation-indexed feature, often called a COLA rider. With only a 3% inflation rate, what costs $50,000 to buy today will cost about $120,000 in 30 years. Sadly, many annuity purchasers forego this feature because they want more money now. Bad decision.
- Costs matter. Annuities typically have annual costs of 2-3% of their value. However, annuities bought through Fidelity, Vanguard, and Schwab are priced well under 1%. That cost difference is the fee of the agent and the company who sold you the annuity.
- There’s no hurry. Annuities are kind of like mutual funds. There are a vast number of choices. They can be bought at any age. Investigate before you invest.
- Once an annuity is purchased, that’s it. They are insurance contracts. There are no do-overs. Other uses for that capital no longer exist. If your situation changes, there’s no way to change the annuity you’ve bought. You’ll have to buy another different annuity to meet the new circumstances.
If you think an annuity might be a solution for you, let’s talk. Together, we can explore the idea and see if it makes sense for you.
James
Cosgrove, CFP, Plano, TX jim.cosgrove@verizon.net 972-489-0262
Jim Cosgrove, Partner, San Jose, CA jimcos42@gmail.com 408-674-6315 Twitter@JimCos542
Evidence-based. Rules-driven. Policy-focused.
