Rethinking Retirement Income Risks in a Lower-Yield World

In a diversified portfolio, fixed income investments have long been a relatively safe and stable choice for the conservative portion of a client’s retirement nest egg. In recent years, however, interest rates have reached levels where this asset class may not generate enough income for retirees because inflation is outpacing low returns. As a result, many retirees are turning to equities and lower-grade bonds to produce retirement income, which in turn increases their overall risk.

What’s another option for providing sustainable retirement income in a low-yield environment?

The role of fixed index annuities

When included in a diversified portfolio strategy alongside fixed income, today’s fixed index annuities (FIAs) offer a combination of growth-oriented features — such as first-year premium bonuses, competitive roll up rates, and index linked crediting strategies with the ability to lock-in interest credits. These are all designed to help build retirement income during the accumulation phase.

At the same time, FIAs offer guaranteed principal protection whereas the value of fixed income investments can shift with interest rates. The risk has been transferred from the individual to the insurance company. This helps shield a portion of client assets from market volatility, whether from fluctuations in bond funds or the need to sell individual bonds prior to maturity.

Importantly, these solutions can also provide a reliable “paycheck” for a client’s lifetime. As an insurance product, FIAs are designed to pool risk and utilize mortality credits, which can allow for higher lifetime payouts than a bond ladder alone. Simply put, this may require less upfront capital to generate the same level of income when an FIA is incorporated into a client’s plan.

“Retirees who shift assets from savings to lifetime income can provide a retiree with the psychological benefit of being given ‘license to spend’ accumulated savings. We find strong evidence that households holding a greater share of their wealth in guaranteed income spend more each year than retirees who hold more of their wealth in investments.”

— "Guaranteed Income: A License to Spend," a study from the Retirement Income Institute at the Alliance for Lifetime Income

Balancing retirement income risks

Financial professionals tout the importance of taking a diversified approach to retirement planning for good reason: A single financial vehicle isn’t equipped to take on all the risks that come with trying to generate income that needs to last 30 years or more. There are simply too many factors at play: longevity risk, market volatility, inflation, and more.

The key is finding the right approach to managing income risk for each client. The ART methodology can be helpful for this, identifying where clients are best suited to:

• Avoid risk by keeping assets in certificates of deposit or bonds held to maturity,
• Retain risk by allocating a portion of their accounts to a diversified investment portfolio with a sustainable withdrawal strategy, or
• Transfer risk by purchasing an annuity and moving risk to a third-party insurance carrier.

For clients who favor the strategy of avoiding risk, using long-term bonds has been a popular strategy, allowing for a certain amount of comfort where clients feel good that their retirement funds are secured in a safe harbor of sorts. However, in a lower-yield environment, as we’ve had more recently, relying solely on avoiding risk can increase the possibility a client will not generate enough from fixed income investments to provide a sustainable retirement income. But incorporating transferal of risk can give clients the protection they seek by placing a portion of their retirement savings in an annuity, while also allowing for potential growth in the rest of their portfolio.

A study from the Alliance for Lifetime Income’s Retirement Income Institute found that when households place a portion of their retirement assets in an annuity and invest the remainder in a diversified portfolio, they felt more confident about having enough to last through retirement and were more comfortable spending money during their retirement years. Activities such as travel that make many retirees’ bucket lists feel more realistic when they know that a portion of their income is secure.

Explore more here.

An option to do more with less

Financial professionals are always looking for ways to help clients do more with their retirement assets.

For example, a client seeking $15,000 in annual income beginning at age 65 would need to invest $333,333 in a 10-Year Treasury bond earning 4.5%. By comparison, a client using an FIA after a 1-year deferral period may require $210,000 to support that same level of income.

Using less capital to generate income creates additional flexibility — in this scenario, approximately $123,000 less compared to a 10-Year Treasury bond. By transferring risk through allocating a portion of a client’s retirement savings to an annuity, the difference can remain invested in a diversified portfolio for long-term growth potential.

In a low-yield environment, clients may need alternatives to bonds and other fixed income assets for managing the retirement income risk in their portfolio. Annuities can provide the necessary protection, growth potential and income stability that clients are looking for.

It's important to note that FIAs are long-term products designed for retirement. Optional benefits may include fees, withdrawals above the free withdrawal amount may be subject to charges, and surrender charges, caps, participation rates, and other limitations may apply.

Help your clients prepare for a secure retirement. Download our e-book "The ART of Managing Income Risk" to learn more about the framework for managing retirement income risk to help improve your clients retirement outcomes.

This content was provided by American Equity. Kiplinger is not affiliated with and does not endorse the company or products mentioned above.

^{For Financial Professional use only. Not for solicitation or advertising to the public. This material is for informational purposes only, and is not a recommendation to buy, sell, hold or rollover any asset. It does not take into account the specific financial circumstances, investment objectives, risk tolerance, or need of any specific person. In providing this information American Equity Investment Life Insurance Company® is not acting as a fiduciary as defined by the Department of Labor. American Equity does not offer legal, investment or tax advice or make recommendations regarding insurance or investment products. Each client has specific needs that should be discussed with a qualified legal or tax advisor.}

^{Under current tax law, the Internal Revenue Code already provides tax deferral to qualified money, so there is no additional tax benefit obtained by funding a qualified contract, such as an IRA or Roth IRA, with an annuity; consider the other benefits provided by an annuity such as lifetime income and a death benefit.}

^{Possible interest credits for money allocated to an index-linked crediting strategy are based upon performance of the specific index; however, fixed index annuities are not an investment, but an insurance product, and do not directly invest in the stock market or the index itself.}

^{Annuity products offered by American Equity. Other retirement options may also support similar goals.}

^{Any information regarding taxation contained herein is based on our understanding of current tax law which is subject to change and differing interpretations. This information should not be relied on as tax or legal advice and cannot be used by any taxpayer for the purposes of avoiding penalties under the internal revenue code.}

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