Annuities

Why Product Allocation Matters More Than Asset Allocation


Annuities

Several years ago, I attended a continuing education seminar from an insurance carrier. And recently, one of my co-workers gave a webinar about tax efficiency using life insurance. Both reminded me of how quickly we drift back to our old habits of asset allocation.  

 

So, I went through my continuing education files and found the case study from the seminar several years ago. Surprisingly, even with the drop in interest rates, the example still provides value to many retirees and their portfolios. Let me share it with you. 

 

The Situation

A husband and wife are both age 65 and getting ready to retire. Like many Americans, they have no pension plan but have managed to create a nest egg of $750,000. They have $20,000 of Social Security income between the two of them, starting at age 65. The difference in income, $30,000, needs to come from the assets under management using a systematic withdrawal strategy. That withdrawal equates to a 4 percent distribution. 

 

You may be thinking this sounds like a lot of your middle-American clients. And, you would be right. As I travel around the country, I see a lot of clients taking income off their assets through a more conservative asset allocation. But here are the problems with this set up:

  • There is no guaranteed income for life outside of Social Security
  • Research indicates that the 4 percent withdrawal rate may be aggressive, regardless of asset allocation modeling
  • 60 percent of their income would stop if they run out of money, which puts pressure on the management of the assets and the allocation strategy. Essentially, the clients may be forced to take on more risk (assume more return) later in life when volatility might not be appropriate.  

 

The Solution

Now, let’s look alternatively at product allocation and how beneficial it can be to our sample client. The client places $100,000 in a fixed indexed annuity with a guaranteed income rider that generates $5,000 annually. Next, they purchase a $160,000 single premium income annuity that pays $9,000 per year. Both are guaranteed for both the lives of the husband and wife, no matter how long they live. Finally, $490,000 remains in the asset allocation strategy, where they take $16,000 of annual income from the account.  

 

Here are the improvements with this strategy that generates the same $30,000 of income:

  • $34,000, or 68 percent, of the total income will never stop, regardless of how long they live, even if they run out of money in their assets under management. Social Security may adjust after the first death, but income will continue. 
  • Only $16,000 of their income is at risk if their account balance draws down to zero.
  • The systematic withdrawal is now just 3.3 percent. It’s still not at the recommended 2.85 percent, but it is half of the 4 percent strategy before the product allocation. 

 

The Takeaway

Product allocation is more important than asset allocation. The use of guaranteed income can provide the needed leverage to lower withdrawal rates and increase the stability ratio of the entire income portfolio.  

 

Winning Strategy

Product allocation should be the first thing you look at when constructing an income portfolio. Think about the location of products and income assets before assigning an asset allocation strategy.  

 

About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”

Retirement Income Planning Annuities

How to Flip Your Strategy from Accumulation to Income


Annuities

Winning sometimes requires looking at alternatives. That doesn’t mean you win with illegal actions or without integrity. Instead, it means attacking a challenge differently than you normally would. You do so because your opponent is unique and the consequences of losing are high.  

 

On the Offense

In 1984, I had the privilege of seeing one of the greatest minds in basketball, Coach Bob Knight, prepare for a regional semi-final game against the No. 1 team in the country and the defending national champions. The opponent, the University of North Carolina, played with a half-court trapping defense that had been a staple of their legendary coach, Dean Smith. Their team consisted of players that many college basketball fans recognize: Brad Daugherty, Matt Doherty, Sam Perkins and a guard by the name of Michael Jordan. (He was a great player in college as much as he was in the NBA.) 

 

Losing this game would mean Indiana’s season would come to an end and there would be no chance at a regional or national title. So, we had to look at this mighty opponent differently in order to have success. 

 

As a student manager, during the week of preparation, I took several messages to Coach Knight. He sought out the advice from basketball icons like Henry Iba and Pete Newell. We played a motion offense and typically had our guards bring the ball up the court. We started four freshmen that year and, with Carolina’s press so disruptive, our young team might have folded under the pressure. So, we needed to look at alternatives.  

 

Coach Knight practiced with our guards positioned in the corner so we had an outlet to relieve ourselves of the pressure. Additionally, we experimented with having our big men bring the ball up the court while having our smaller guards in the low post. Essentially, we flipped the court on the opposing team and took our biggest risk – their half court trapping defense – off the table.  

 

An Alternate Defense

In retirement, our clients face several risks, and the consequences are just as devastating – you don’t get a second chance at planning a retirement. Therefore, you need to take risks off the table by thinking alternatively. Today’s economic environment presents several ways to look at alternatives to improve the client’s retirement.  

 

  • We have historically low interest rates, making it more difficult to retire through capital preservation
  • Most people believe over the next three to five years we will see increasing interest rates that might depreciate the bond values that some many look to for safety
  • Our government continues to manipulate monetary policy, making it uncertain how bond markets will react to “uncensored” interest rate movements
  • We continue to be part of an extended bull run following the financial crisis that many believe is running out of steam

 

So, it’s more important than ever to look at alternatives, especially for those invested in bonds. Fixed indexed annuities can provide alternative income streams, protection from markets risks, and tax deferral. I encourage everyone to look at alternatives and share them with your clients. 

 

Winning Strategy

Retirement is the most complex problem your clients will ask you to solve. You can’t win the game with the same strategy you used during accumulation. Instead, you have to consider alternatives to better your client’s probability of success during retirement.  

 

About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”

Retirement Annuities Financial Planning

Take Advantage of Today’s Tax Laws


Annuities

Looks can be deceiving. Nowhere is that more true than in retirement planning. The client who drives a modest car, wears jeans and eats at Bob Evans ends up being the millionaire next door, while the flashy dresser with the fancy watch has a pile of debt and little to no nest egg to fall back on.  

 

Looks can also be deceiving when it comes to investments. All too often, clients get caught up in seeking the highest rate of return they can find in an investment. Unfortunately, many don’t always walk away with the best net return because of what’s hidden underneath: taxes and fees.  

 

Just like a fancy watch, those attractive, high interest rates do not tell the whole story. Within many typical, non-annuity-type investments, there are certain pieces of drag embedded in the total return. 

  • There are sales charges with the purchase or redemption of the asset
  • There may be annual fees for overall investment and planning 
  • Perhaps the most harmful are capital gains and ordinary income taxes – those can cost clients more than a third of return on an annual basis

 

So the initial high interest rate that enticed the client ends up being irrelevant after taxes and charges eat into it.    

 

Don’t Miss Out by Misunderstanding

Like I said, sometimes you will find the modest, jeans-wearing client ends up having the highest net worth. In the same vein, annuities are plain and simple but offer surprisingly essential benefits. One of the strongest reasons to position part of a portfolio with annuities is to take advantage of the tax-deferred growth. During the accumulation phase, the asset grows without the drag of either capital gain or ordinary income tax. 

 

Now, some will argue that the deferral creates a larger tax bill at distribution. But, that’s only true if you completely liquidate the annuity. If the goal is to live off the annuity with just interest and systematic withdrawals during retirement, you will have created a much larger nest egg during accumulation rather than paying taxes annually. After all, “It’s not what you earn – it’s what you keep,” and annuities are instrumental in helping the client do just that.

 

Build a Bridge

Additionally, the low interest rate and favorable tax treatment of annuities creates a unique planning opportunity to help maximize Social Security benefits. By bridging early income at age 62 with a non-qualified single premium immediate annuity (SPIA) rather than starting Social Security, as much as 96 percent of the client’s income is tax-free. This bridge allows the client to minimize tax drag on their income and wait to maximize their Social Security benefits at age 70.  

 

The difference in Social Security income at age 62 versus age 70 might be as high as a 50 percent. That increase might translate to more travel, more time with family, or a larger cushion for necessities like medication. More importantly, this strategy affords the client to have more of their money linked to income that keeps pace with inflation. And, inflation might be the cruelest tax of all. 

 

Today, the average younger baby boomer (aged 50-59) has only saved $130,1001, so it’s critical to create as much asset value as possible in the future. Tax laws are always changing – in fact, there have been 31 changes in U.S. tax rates in the 34 years between 1979 and 2013.2 So you have to take advantage of what's available now. It’s important to help your clients remove their “interest rate blinders” and see the many benefits of annuities – benefits they might miss on first glance. 

 

Winning Strategy

Many people do not realize the powerful tax advantages of annuities. Plan how you can help your clients seize the opportunity of the current tax laws governing annuities. The disparity between annuities and other investments may not last long.  

 

Learn More

1LIMRA, “Fact Book on Retirement Income 2016”: https://www.limra.com/bookstore/item_details.aspx?sku=23518-001

 

2Tax Policy Center, Statistics: http://www.taxpolicycenter.org/statistics/historical-average-federal-tax-rates-all-household

 

 

About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”

Retirement Taxes Tax Efficiency Financial Planning

The 4 Key Advantages of HECMs in Income Planning


Annuities

I spend a lot of time on the road. Not just for my job, but also because my wife and I both have families who live within four hours driving distance of my house. Making sure everyone’s favorite Uncle Mike makes it to the latest family event requires some flexibility. On many of those long drives through Indiana, I have found the GPS route that delivers me to my destination changes from one day to the next. Because of traffic, weather or construction, I end up taking alternate routes on roads I’m not familiar with. But sometimes the alternate route is best.

 

Helping clients navigate the ever-changing retirement income market means you have to be innovative. Maybe you’ve never heard of using Home Equity Conversion Mortgages (HECMs) as part of an income planning strategy. But, with almost $31 trillion dollars of unused housing wealth available right now, it’s time to talk to clients about this alternative vehicle.  

 

There are unique advantages to using housing wealth as part of the income planning process. This tool does not work in every situation, but it can provide added income and flexibility for many clients. Here are some key advantages:

 

  • Income from HECMs is received tax-free. I talk a lot about the importance of what you keep verses what you earn. The use of tax-free income can be beneficial in many ways. First, it reduces combined income for Social Security taxation, which can provide relief for many middle Americans. With means testing on Medicare, a slight reduction under a tax threshold can create as much as a $1,800 difference in medical premiums. Paying attention to client incomes and potential thresholds will become an important planning criteria as health care becomes more difficult to predict. 

 

  • HECM lines of credit grow annually. If set up properly, a HECM credit line grows between 4 percent and 6 percent annually under current interest rate environments. If you qualify for a $200,000 credit line at age 62, it will grow to more than $525,000 at age 82. That pool of money is available for any purpose, at any time, with no taxation, regardless of the value of the home. Because the newer HECM products are non-recourse loans, the client does not risk losing their home if the local real estate market doesn’t grow accordingly.  

 

 

  • HECM for Purchase strategies can allow retirees to move to a more appropriate home without increasing their mortgage payments. One of the most neglected client conversations is the discussion around where they will live in retirement. With longevity increasing, many of our clients will not want to live in the same multi-story home where they raised their kids. At the same time, they are not willing to add more expense to an already compressed income after their working years. So, a HECM for Purchase allows a new home to be purchased without a traditional amortization schedule. 

 

 

As our clients age and navigate multiple longevity-related issues, it’s important to maintain flexibility in their plans. Home Equity Conversion Mortgages can provide liquidity when they need it most. And, these tools can take pressure off existing assets under management during the income distribution phase.  

 

Winning Strategy

There’s more than one path to a successful retirement plan. Look at alternatives to relieve pressure from assets under management – tools like HECMs can provide flexibility and put your clients in suitable housing. You can help your clients be in the driver’s seat as they retire and face longevity risks. 

 

Learn More

The marketplace is demanding financial professionals to work in our clients' best interest, which will not only need to address retirement income, but also the risk of longevity.

Download the e-Book Here!

 

*The American College RICP® Retirement Income Literacy Survey, September 2014, p. 88: http://retirement.theamericancollege.edu/sites/retirement/files/Retirement_Income_Literacy_Survey_Full_Report_0.pdf 

About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”

HECM Retirement Housing Wealth

Why Now is the Time to Talk About Pension Risk Transfers


Annuities

When it comes to corporate decisions, tax considerations are always in play. Given the current and potential tax laws, now is a good time to talk to your corporate clients about taking their pension obligations off the table. Aside from the tax impact, there are several good reasons, to have the conversation with your clients. 

 

Pension plans continue to lose their status in retirement planning for a lot of small to mid-size corporations. While defined benefit plans can make sense for a lot of single-employer plans, they largely are not helping recruit talent for many businesses in America. Small pension contributions don’t seem to entice younger workers or recent college graduates as much as profit sharing or stock option incentives. That’s because the value of guaranteed income is lost on many of workers younger than 45 years old. 

 

The cost of administering a defined plan continues to escalate as well. Even for fully funded plans, the cost of Pension Benefit Guaranty Corporation (PBGC) premiums will increase 25 percent by 2019.1  So, even if your corporate client makes no changes in their plan, it will cost more to simply have the plan – even if it is not being offered to new employees. 

 

One solution could be a Pension Risk Transfer (PRT). A PRT gives a corporation multiple benefits:

  • Transfers the risk of longevity from the plan to an insurer
  • Eliminates future administration and shifts the service to a third party
  • Frees up existing corporate resources dedicated to the plan
  • Provides a potential current deduction to make plan assets whole
  • Guarantees the commitment made to employees is honored, without leveraging company cash flow

 

By transferring plan assets to an insurer, the corporation shifts many of its pension obligation risks. And, as many believe that tax reform might happen in the next 18-24 months, corporate assets can be used to bring plan obligations to 100 percent funding levels. In doing so, those contributions receive a tax deduction in today’s higher corporate tax brackets. 

 

For too long, corporations have ignored their defined benefit plan obligations. Now, we find that many employers have underfunded plans, which is putting many retirees’ guaranteed income plans at risk. With today’s tax rates, it’s a prime time to engage corporate clients in using stale and underperforming assets to complete the obligations that were made to so many current and past employees. 

 

Honor the Intent

When talking about pensions, it is rarely about interest rates or performance of the plan assets. Without a doubt, the valuation of the assets comes into play. But, in reality, executives want to honor the commitment they made to the employees that helped build the company. For decades, pensions have been the way to reward employees. Now, it’s time to make sure that actually happens. 

 

Tax rates, interest rate risk, and longevity risks all play into managing pension assets. Our tax policy favors contributing to plan assets now. There is considerable uncertainty in the world today, and the potential rise or fall of interest rates will affect bond values. Bonds continue to make up large portions of corporate pension plans, so our retirees are truly at risk.  

 

Even with plans that are wholly funded, the assumptions from two decades ago do not account for today’s longer life expectancies. We increase our life span by 2.5 years for every decade in America.2 Therefore, with a normal, 20-year retirement, pension plans really need to have 25 percent more assets than they do today. It’s time to pay attention to this retirement risk and make it an opportunity to help corporations meet the obligations they promised. 

 

Winning Strategy

Even with a fully funded pension plan, increased longevity has likely not been accounted for. With changes in tax policy and asset performance, transferring pension risk from a corporate balance sheet to an insurer makes perfect sense today. Take the chance to talk with employers about how they can benefit from PRT. 

 

Learn More

The marketplace is demanding financial professionals to work in our clients' best interest, which will not only need to address retirement income, but also the risk of longevity.

Download the Whitepaper Here!

 

1Society for Human Resource Management, “Study: Pension Plans Overpay PBGC Premiums by Millions,” April 12, 2017: https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/pensions-overpay-pbgc-premiums.aspx

 

2Population Health Metrics, “Changes in Life Expectancy 1950–2010: Contributions from Age- and Disease-Specific Mortality in Selected Countries,” 2016: https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4877984/

 

 

About the Author

Mike McGlothlin is a tireless advocate for the retirement planning industry. As executive vice president of retirement at Ash Brokerage, he heads a team providing income planning solutions focused on longevity and efficiency. He’s also a thought leader who provides guidance and assistance for advisors and broker-dealers navigating marketplace and regulatory changes. You can find a collection of his blog posts in his book, “Above the Clouds … Winning Strategies from 30,000 Feet.”

 

Pension Funds Pension Risk Transfer Retirement