You hear a lot of talk about the retirement crisis - In reality, American retirement savers face two big, but different, retirement challenges. Conflating them risks misdiagnosis and missing out on a potentially valuable solution that could help some retirement savers overcome both challenges. In this post, I will explain those challenges and how “growth annuities” may help.
One challenge is inadequate retirement savings. Simply, too many Americans have too little saved for retirement. The decline in the number of Americans with pensions is a big part of this story. There was a time when a sizable percentage of American workers could rely on their employers to fund their retirement. The employer would put their employees’ retirement money into a defined-benefit pension plan and invest that money with the help of financial experts. The employer also would withhold its own and its employees’ Social Security payroll taxes so employees would be eligible for benefits, and benefit levels could increase as wages rose. As a result, retirees could count on receiving two regular and reliable “retirement checks” - a pension check and a Social Security check - for the rest of their lives.
Without pensions, American retirement savers must accumulate a sum of money, and then figure out how to make it last. This planning task requires navigating a complex obstacle course of known knowns, known unknowns, and unknown unknowns. For ordinary retirement savers, these questions are difficult, if not intractable. It is not surprising that so many retirees underspend in retirement, according to EBRI and BlackRock. Unsure about how much they will have or need, many retirees resort to stockpiling their money.
Pensions give visibility into our financial situations by providing a predictable and regular amount of income. This makes financial planning possible. If you add up your monthly expenses and subtract the amount you receive from Social Security and your pension, you know if you will have enough money each month to support yourself and your family. This visibility allows you to make choices: spend less, save more, continue working, move to a place with a lower cost of living, and so forth. Retirement savings do not provide the same visibility and ability to plan. Except for the wealthiest savers, planning becomes possible only when your savings capability is translated into income that can be compared to your expected spending. Otherwise, you may be left with the nagging worry you are spending too much (or too little).
How These Retirement Challenges Interact
Many Americans face both retirement challenges. We do not have adequate savings to provide sufficient income to fund our retirement lifestyle, we do not have visibility into the amount of income we will have in retirement, and so we risk running out of money.
Wealthy people do not have these worries and, therefore, prove this point. The average net worth of households in the top 10% of American wealth tops $4.5 Million.1 Absent lavish spending, a gambling addiction, catastrophic health care costs, or irresponsible investments, this amount should be more than enough in retirement if these families spend at a reasonable pace. But the vast majority of us who have much less net worth can overcome our retirement challenges in these three ways:
- Growth: First, we need to grow our savings. In other words, we need a larger pot of money for retirement, typically without sufficient help from an employer or anyone else.
- Protection: Second, we need a way to protect the income produced by our retirement savings so that it lasts as long as we do
- Visibility: Third, we need to know how much regular and reliable income we will have to supplement our Social Security benefits so that we can plan for retirement
Growth annuities satisfy all three needs: growth, protection, and visibility. They do it by combining some of the best elements of pensions, annuities, and higher yield investments.
Annuities* can deliver protected income for the rest of your life—that is, you can include a benefit that ensures your income continues throughout retirement. Some annuities have time limits, but you can usually elect a “living benefit” that generates lifetime income that might be compared to a pension or Social Security. These and similar benefits may have different names depending on the particular annuity product.†
Lifetime income is a feature of many annuities. For example, a single premium immediate annuity (SPIA) allows you to translate some or all of your retirement savings into a pre-determined amount of protected income that starts soon after you buy the SPIA. A deferred annuity does something similar, but the income begins years later. These products provide income protection and visibility. But what if they won’t produce enough income for you and your family? What if you also need growth?
That’s where growth annuities can be valuable. They usually provide income benefits like SPIAs or deferred annuities, while also allowing you to put your retirement savings into higher yield investments, such as equity markets or other markets, either directly (e.g., variable annuities) or through indexes that mirror their performance (e.g., fixed index annuities). Over time, these kinds of investments are likely to grow your savings more than investments tied to interest rates or inflation adjustments, like SPIAs or deferred annuities. In 2018, for example, savings accounts, certificates of deposit, and government bonds yielded roughly - 1% to 3% returns. Over the last 90 years, the S&P 500® Index—one stock market benchmark—has averaged 7% annual growth. That’s a potentially significant difference in the value of your retirement savings.
Higher returns typically come with greater risks. High-return investments may increase in value, but their value also may fall, sometimes precipitously and at the worst times. In the U.S., markets have always recovered from declines. Yet, it is impossible to know whether they will recover in time for you to retire as planned. Some individual investments never recover. By contrast, savings accounts, certificates of deposit, and government bonds are very low-risk investments while providing small returns. For many retirement savers, they are a safe choice, especially for those worried their savings will not last for the rest of their lives.
Some growth annuities offer the option of a guarantee against market declines, allowing potentially higher returns without the risk.‡ Similar to other kinds of insurance, you will pay an additional fee, but the guarantee ensuresthat the income you receive from your annuity will not decline (some offer loss limits instead) even if the value of your investments drops. Equally important, with insurance against losing money in the markets, you can put your retirement savings into higher risk/higher return investments and grow your savings more aggressively. The result: more retirement income and a shifting of market risks to your annuity company.
These added protection and growth features of growth annuities add costs. So, you will need to calculate whether your retirement savings may grow more in lower risk/lower return investments, or in higher risk/higher return investments after subtracting the higher costs. That’s the question you should sort out with your financial professional. Start the conversation by asking how your retirement savings can be used to secure growth, protected lifetime income, and visibility into your retirement income. You might even mention growth annuities as a place to start.
Think of it as a positive way to overcome your own personal retirement savings income challenges.
1. Federal Reserve Bulletin, "Changes in U.S. Family Finances from 2013 to 2016: Evidence from the Survey of Consumer Finances", Vol. 103, No. 3, Table 2, September 2017.
*What is an annuity?
Annuities are long-term, tax-deferred investments designed for retirement. Variable annuities involve risks and may lose value. Earnings are taxable as ordinary income when distributed and may be subject to a 10% additional tax if withdrawn before age 59½.
Annuities are not for everyone. And, it’s important to remember that these products are meant to be long-term investments designed for retirement, so there are restrictions in place to discourage you from withdrawing all of your money at once or taking withdrawals before age 59½. However, most annuities do allow for exceptions based on specific circumstances such as a terminal illness or other emergencies.
† Optional benefits are available for an extra charge in addition to the ongoing fees and expenses of the variable annuity. Guarantees are backed by the claims paying ability of the issuing insurance company.
‡ Guarantees are backed by the claims paying ability of the issuing insurance company.
The opinions and forecasts expressed are those of the author and individuals quoted and should not be construed as a recommendation or as complete.