Blessed Assurance Too Often Rejected

I spoke this afternoon at the Retirement Income Symposium here in Boston.  A theme I emphasized (and which was emphasized by others, including Bob Reynolds of Putnam) was the importance of assured (guaranteed) income.  There are few things scholars agree upon the way they agree on the importance of guaranteed income in retirement.  A few of those sources are linked below. 

Unfortunately, very few people actually avail themselves of those opportunities.  Academics call that disconnect between theory and practice the “annuity puzzle.”   And, to be fair, there are some understandable reasons why some people don’t take advantage of assured income options, the most prominent being concerns about the financial health of a provider out 30 years and the lack of control over the money allocated to such a solution. 

However, as I pointed out today, I suspect that the disconnect is also due in large part to the investment community’s unwillingness to promote guaranteed income options because it is not in the advisor’s financial interest to do so — because income annuities pay so little to advisors when they are sold and because the advisor loses control of the asset.  In short, when an advisor has a financial interest in a particular strategy over another, it is highly likely that the advisor will support the approach that is beneficial to the advisor.

Fortuitously for my argument, but unfortunately in terms of best practices, today’s news provided a great example of this problem.  Investment News highlighted some critics who don’t think the government is doing enough to promote guaranteed income.  One naysayer, however, was Scott Thoma, a member of the investment policy committee for Edward Jones, who wanted to be sure to assert that  “[a]nnuities are not appropriate for everyone.”

Particularly notice how Thoma frames the type of person who would benefit from an income annuity.  Guaranteed income makes sense for people, according to Thoma, ” if they aren’t worried about leaving a legacy (because of the cost of buying the annuity will cut into the estate) and if they are taking out more than 6% a year from their portfolios.”  That response is carefully crafted to try to stifle the use of guaranteed income (and presumably stay invested with Edward Jones) because people resist options — even options that are clearly in their best interest — that limit their flexibility, especially with respect to their children.  Moreover, since anyone advocating or using a 6% withdrawal rate would be acting in a highly irresponsible manner, Thoma is safe to use that as his cut-off point for annuity usage (the best evidence today is that withdrawal rates in excess of 2% are at high risk of failure — see below). 

Assured income solutions would be  of tremendous benefit to most retirees for a portion of their assets and as part of a comprehensive income solution.  Unfortunately, too many advisors conspire to prevent their use.


Academic sources worth examining:

Pfau, “Can We Predict the Sustainable Withdrawal Rate for New Retirees?” (May 2011)

“[A]nnuities provide more monthly income than other approaches, such as the ‘4-percent rule’ or living off the interest on assets.”  “The NRRI and Annuities,” Center for Retirement Research at Boston College (October 2010).

“To achieve a similar riskless guarantee of income throughout one’s uncertain lifetime without life annuities would cost between 25% and 40% more.” Babbel & Merrill, “Rational Decumulation,” Wharton Financial Institutions Center (May 2007).

“[T]he market for privately purchased individual [income] annuities in the United States is very small,” which represents a “remarkable disconnect between theory and practice” because income “annuities ought to play an important role in the portfolios of elderly households.” Brown, “Life Annuities and Uncertain Lifetimes” National Bureau of Economic Research, NBER Reporter (Spring 2004).

“For all time periods and for all portfolios, the addition of the annuity leads to a decline in the portfolio failure rates.” Ameriks, Veres & Warshawsky,, “Making Retirement Income Last a Lifetime,” Journal of Financial Planning  (December 2001).

“If…the Social Security program will not generate sufficient income to satisfy minimal consumption needs, then it should be supplemented with the purchase of high-grade private annuities.” Babbel & Merrill, “Rational Decumulation,” Wharton Financial Institutions Center (May 2007).

“Without additional guaranteed lifetime income streams…, middle-income Americans are at high risk of outliving their financial assets and living their final years in poverty.” Ernst & Young, “Retirement Vulnerability of New Retirees,” Americans for Secure Retirement (June 2009).

“Lifetime income [products] may not be the perfect financial instrument for retirement, but… they dominate anything else for most situations.” Babbel, “Lifetime Income for Women: A Financial Economist’s Perspective,” Wharton Financial Institutions Center (August 2008).


4 thoughts on “Blessed Assurance Too Often Rejected

  1. Bob, I really enjoy your posts. They are very erudite.

    Thank you for first tuning me in to this issue about how it is not in a financial advisor’s self-interest to advocate annuities. I attended the Retirement Income Industry Association conference earlier this month (also in Boston, and also headlined with a speech from Bob Reynolds), and there was some discussion about this. I can’t remember whether a presenter made this point, or if it was someone else I talked to, but it should be possible to investigate and show that it may actually be in an advisor’s self-interest to advocate partial annuitization. The idea being that this would allow for a riskier asset allocation with the remaining funds, which, if things work out positively as they have in the past — and I know it is a big if — would lead the remaining assets to grow larger than otherwise and offer more AUM fees over the entire lifetime of the client. This, of course, requires the advisor to have a long-term outlook for company revenues. It will depend on lots of assumptions, but it is something that I think will be worthwhile to investigate further.

  2. I agree, Wade. In his remarks about Target funds, Bob Reynolds argued that as retirement approaches (I believe he suggested within five years), Target funds should hold no more than a 20% equity allocation. In my presentation, I referred to Bob’s comment in the context of sequence risk in the early years of retirement and suggested that with assured income in place for true needs, a retiree could be much more flexible and aggressive with the remainder of the portfolio.

    Unfortunately, such an approach requires delayed gratification on the part of the investor as well as on the part of the advisor which means — no matter the merits of the idea — that it’s much easier said than done.

    As always, thanks for reading.

  3. Pingback: 2012 Investment Outlook (3) | Above the Market

  4. Pingback: 2012 Investment Outlook (3) | Above the Market |

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