The following article discusses how some retirees are looking to integrate insurance products with their retirement portfolios to secure a guaranteed income stream that addresses longevity risk -- the risk of outliving one's money. PIMCO does not offer insurance products or products that offer investments containing both securities and insurance features. PIMCO offers investments that may complement insurance products.
As the waves of baby boomer money flow into retirement accounts and the importance of Social Security and defined benefit plans decline, the need for appropriate retirement income solutions and advice from the financial industry is growing. To illustrate the magnitude of the waves, we currently estimate there is $20 trillion in retirement plans or otherwise earmarked for retirement in the U.S. and $1 trillion of "money in motion" each year due to withdrawals, transfers, rollovers and conversions in retirement accounts, based on data from the Investment Company Institute, Department of Labor and our own internal estimates.
As a greater portion of the owners of this money enter retirement, especially in the years immediately ahead when baby boomers begin retiring, demand will increase for ways to convert these retirement assets into income.
However, a major challenge retirees face today is an unusually uncertain economic and market environment occurring precisely at the time they are expected to take more control of their financial future. Historically, retirees had fewer investment decisions to make, since they could rely on income from pension plans and Social Security. Now, with the increasing prevalence of defined contribution plans, people have more control than ever to choose their own investments and must face the consequences should these investments perform poorly and fail to support the desired income stream. This means finding tools specifically created for retirement income distribution.
More Responsibility, Less CertaintyRetirement planning should also take into account today's lower growth and potential for rising inflation. For instance, many retirees may need to allocate large portions of their wealth to living expenses, as opposed to spending just interest and gains from their investments. Therefore, retirement planning must focus on paying out principal from savings. Additionally, while investment growth may be lower than it has been in the past, retirees can still seek upside potential in the stock market "“ but only after necessary expenses are addressed with more traditional sources of income. Retirees also need to protect against three major risks that can lead to retirement disaster.
These risks should be viewed in the context of anticipated spending needs relative to size of savings. It would be incorrect to assume a retiree with a large amount of savings can't run out of money. Instead, what really matters is his or her spending relative to savings. Think of a frugal retiree who gets by on Social Security plus a small pension versus a wealthy retiree who take risks with, and spends more than justified by, the amount he or she saved. The wealthy retiree may actually need a supplemental source of income, such as a guaranteed lifetime income stream, more than the frugal retiree, to continue living the same lifestyle, especially if he or she is exceptionally healthy and therefore may outlive a normal life expectancy.
Addressing Longevity RiskWhile many retirees are in need of longevity protection, many do not get exposure to this type of protection in their current investment process. The preferred investment vehicle of U.S. investors is mutual funds. Yet the only commercial source of guaranteed longevity protection, apart from Social Security and pensions, is through annuities issued by insurance companies. The problem is less than 20% of advisors offer annuities and many advisors may not or prefer not to offer annuities in their current common form, according to Cerulli Associates.
Even if a retiree does not need guaranteed lifetime income, he or she could still likely use a distribution plan upon entering retirement. Currently, many advisors employ the same investing strategies used during the accumulation phase of their client's life. These approaches typically involve creating a diversified portfolio and withdrawing income for retirement as needed, typically on a monthly basis. But retirees need tools designed specifically for retirement income distribution rather than relying on accumulation strategies for income.
If a retiree wants guaranteed lifetime income "“ and also wants to continue using traditional investment products such as mutual funds typically used in accumulation strategies "“ one option is a type of annuity known as Stand Alone Living Benefits (SALB). A unique feature of a SALB is that the insurer provides a fixed withdrawal benefit guarantee on non-annuity assets, such as an investment account, instead of on annuity assets.
To illustrate the mechanics of a SALB, an insurance company may guarantee a 5% withdrawal payment for life based on the highest value of a retiree's investment account. Should the investment account become depleted while the retiree is still alive, the insurer would then begin making the annuity payments for the remainder of the insured's life. Retirees who live long or experience a bear market, may be glad they bought this extra protection on their investment account.
Another type of annuity that can guarantee lifetime income to a retirement portfolio is longevity insurance, which is issued exclusively by insurance companies. Longevity insurance essentially converts the sum of money paid to purchase the annuity into a lifetime income stream that begins at a set future date if the retiree is still alive. (Usually, there is little or no death benefit or cash value if the retiree dies before the date when income payments are scheduled to begin.) For example, a 65-year-old could buy longevity insurance that starts at age 85 (if he or she is still alive) and lasts for the rest of his or her life. The longer the delay before the income payments begin, the lower the initial investment will be for a given income payment amount. Therefore, longevity insurance may provide a relatively cost-efficient way to help provide a steady income stream for the later years of a long retirement.
Longevity insurance can be added to a retirement portfolio using the PIMCO Real Income strategy to create a truly unique approach to retirement income. The Real Income strategy uses U.S. Treasury Inflation-Protected Securities (TIPS) to provide retirees with a systematic, inflation-adjusted monthly income stream containing principal and interest, until a designated maturity date at which time all assets will have been distributed. TIPS are issued by the U.S. government, which guarantees their timely payment of interest and return of principal at maturity. Their face value is adjusted in step with changes in the rate of inflation, with interest paid on the adjusted amount. By maturity, a TIPS investor receives the original principal plus the sum of all the inflation adjustments since the bond was issued. Of course, the value of a TIPS investment is not guaranteed and can decline if inflation-adjusted interest rates rise. With the foundation of a monthly income stream for the term of the Real Income Strategy, a retiree can separately purchase longevity insurance to establish a lifetime income stream that begins (assuming the retiree is still alive) after the Real Income strategy distributions cease upon maturity. Note that the Real Income strategy's distributions are not guaranteed and are made until their stated maturity dates rather than for life.
Planning for the Golden YearsThis baby boomer generation has dutifully accepted more "“ and varied "“ types of insurance than any in history: they have insured their lives, their homes, titles to their homes, their cars, their reputations, their investments, their health, and even the health of their pets. It may be time that serious consideration be given to maintaining their most important remaining asset; their retirement income.
The annuity products discussed above "“ Stand Alone Living Benefits and longevity insurance "“ are available only from an authorized insurance producer. As insurance products they are not insured by the FDIC, the NCUSIF or any other government agency, nor are they guaranteed by, or the obligation of, the financial institution that sells them. All annuity product guarantees are made solely by the issuing insurance company. Income payments under an annuity, therefore, depend solely on the issuing insurance company's claims-paying ability and financial strength.
Past performance is not a guarantee or a reliable indicator of future results. All investments contain risk and may lose value. Investing in the bond market is subject to certain risks including market, interest-rate, issuer, credit, and inflation risk; investments may be worth more or less than the original cost when redeemed. Inflation-linked bonds (ILBs) issued by a government are fixed-income securities whose principal value is periodically adjusted according to the rate of inflation; ILBs decline in value when real interest rates rise. Treasury Inflation-Protected Securities (TIPS) are ILBs issued by the U.S. Government. Certain U.S. Government securities are backed by the full faith of the government, obligations of U.S. Government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the U.S. Government; portfolios that invest in such securities are not guaranteed and will fluctuate in value. The Real Income strategy is designed to be an efficient and systematic means to draw down investment capital during retirement. As the securities in these laddered portfolios mature, investors should receive monthly distributions of principal and interest so that all assets will be distributed upon maturity. The principal value invested is not guaranteed and an account may lose value.
During periods of rising inflation the amount of the Real Income strategy monthly distribution is expected to increase and during periods of deflation the amount of the monthly distribution is expected to decrease. The monthly distribution amount may be adjusted during the term of a portfolio to better enable the portfolio to provide regular monthly distributions through the final maturity date. These distributions are not guaranteed.
Hypothetical examples have many inherent limitations and are generally prepared with the benefit of hindsight. There are frequently sharp differences between simulated results and the actual results. There are numerous factors related to the markets in general or the implementation of any specific investment strategy, which cannot be fully accounted for in the preparation of simulated results and all of which can adversely affect actual results. No guarantee is being made that the stated results will be achieved. There is no guarantee that these investment strategies will work under all market conditions and each investor should evaluate their ability to invest for a long-term especially during periods of downturn in the market.
The Consumer Price Index (CPI) is an unmanaged index representing the rate of inflation of the U.S. consumer prices as determined by the U.S. Department of Labor Statistics. There can be no guarantee that the CPI or other indexes will reflect the exact level of inflation at any given time. It is not possible to invest directly in an unmanaged index.The views described may not be suitable for all investors. This material is not intended to provide, and should not be relied on for accounting, investment, legal or tax advice. You should consult your accountant, investment, tax or legal advisor regarding such matters. This material contains the current opinions of the manager and such opinions are subject to change without notice. This material has been distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2011, PIMCO.
No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. Pacific Investment Management Company LLC, 840 Newport Center Drive, Newport Beach, CA 92660, 800-387-4626. ©2011, PIMCO.
Are you sure you would like to leave?
You are currently running an old version of IE, please upgrade for better performance.
Read Full Article »