Five client profiles to consider for annuities
|Retirement "mis-timers"||Ultra-conservative investors|
|Retirement de-riskers||Good saver/bad spenders|
|Long lifer/inadequate savers|
Because annuities can meaningfully improve retirement outcomes, they often make sense as a part of a household's overall post-retirement strategy. The following profiles are based on findings from new research from J.P. Morgan Asset Management, and they illustrate five client situations in which annuities could potentially improve the retirement experience.
Households have some control over when they retire, but not what type of market they retire into. This can be described as “retirement timing risk.” The Retirement mis-timer is a household that experiences below average or negative returns either five years before or after retirement. This is typically when the household wealth is greatest, and therefore when it is at greatest risk.
For Retirement Mis-timers, the addition of an annuity improves the likelihood of success from 56% to:
- 66% with a 20% annuity allocation
- 78% with a 40% annuity allocation
Exhibit 1: Likelihood of success: $1M fully invested vs. partial variable annuity (VA) allocation (-5%) returns in first three years of retirement, $50k inflation-adjusted annual spending
Individuals have a declining risk appetite as they get older. For more conservative individuals, the transition from work to retirement can magnify their risk aversion, resulting in a desire to have little if any market exposure in retirement. Over a 30- to 40-year retirement, this decision can result in significant erosion of purchasing power and increasing longevity risk.
For this profile, the variable annuity can improve outcomes by offering greater market exposure with guaranteed step ups and/or income protection. Our research finds that the annuity provides greater upside opportunity, and benefits from annual guaranteed roll ups as well as step ups for 10 years prior to income being drawn at a 5% withdrawal rate beginning at age 65.
Exhibit 2: Likelihood of success: $1M fully invested vs. partial variable annuity (VA) allocation $50k inflation-adjusted annual spending
As households approach retirement, "de-risking" by allocating a higher percentage of the retirement portfolio to safer assets such as fixed income is generally recommended to protect wealth when it is at greatest risk. But if fixed income is challenged at that time, an annuity could be a more attractive alternative for the percentage of equity assets that needs to be reallocated.
For this profile, we assume that the pre-retiree currently owns a 60% equity and 40% bond portfolio. The advisor and client have established a 40% equity risk target at retirement, so the question is what to do with the 20% in equities that needs to be reallocated. In the chart below, we compare the reallocation of that 20% to fixed income versus a variable annuity with a 60% equity/40% bonds investment strategy. The reallocation to the variable annuity improves outcomes by almost 10% (77% versus 84% respectively) and provides an estimated $17,500 in protected lifetime income.
Exhibit 3: Likelihood of success: reallocating from equities to fixed income vs. 60/40 variable annuity (VA) $1M initial 60/40 portfolio, 20% in equities reallocated to bonds or annuity, $50k inflation-adjusted spending
Long lifers, inadequate savers
The long-lifer/inadequate saver profile is likely the most ideal candidate for an annuity – a household that enjoys relatively good health, has not saved enough and has a high likelihood of running out of money. They would benefit especially from an annuity that enables them to capitalize on mortality credits to maximize their income at an appropriate level of cost.
Longevity risk is the risk of running out of assets before running out of time – and is a primary concern for most Americans. Individuals approaching retirement who have a family history of longevity and who are in excellent health as the result of making good lifestyle decisions are likely to experience above-average life expectancy. If they haven’t saved enough to achieve their desired retirement spending goal with a high level of confidence, they need to maximize the amount of income their wealth can provide for life—however long that may be.
Good savers, bad spenders
The good saver/bad spender household has successfully accumulated more than enough wealth to cover their spending needs and then some – yet has a difficult time spending any principal out of fear of longevity risk.
The best savers are very good at allocating monthly income between current spending needs and future savings goals, and generally have experienced growing wealth over time. As those households shift into retirement, the idea of depleting their wealth to support their retirement lifestyle can feel daunting. In this situation, an annuity can translate a portion of a portfolio into a consistent level of lifetime income that can be used to enhance the household’s retirement lifestyle.
Our research concludes that annuities can:
- Protect the long-lifers/inadequate savers from running out of money with protected lifetime income.
- Provide a periodic payment that can supplement other sources of income like Social Security to enhance the retirement lifestyle with greater confidence.
Exhibit 4: Spending based on level of retirement income Median annual spending ages 70-75