MASTERCLASS: Retirement Income - October 2021
- 57 mins 14 secs
Financial challenges, rising healthcare costs, demographic trends, and the low interest rate environment are changing the way people think about retirement.Channel: MASTERCLASS
Four experts look at the role of alternatives, annuities, and other income strategies for financial planning.
Four experts look at the role of alternatives, annuities, and other income strategies for financial planning.
- Michael Raymond, Assistant Vice President, Competitive Market Solutions - Lincoln Financial Group
- David Blanchett, PhD, CFA® , CFP®, Head of Retirement Research - PGIM DC Solutions
- Lauren Drapeau, National Sales Director, Annuity Advisory Solutions - Protective Life Insurance Company
- Brad Crawford, Divisional Sales Manager - Transamerica
Jenna Dagenhart: Welcome to Asset TV's Retirement Income Masterclass. Rising healthcare costs, demographic trends and the low interest rate environment are really changing the way that people think about retirement. Joining us now to share strategies for finding income, we have Brad Crawford, divisional sales manager at Transamerica, Lauren Drapeau, national sales director, annuity advisor solutions at Protective Life, David Blanchett, head of retirement research at PGIM DC solutions at Prudential and Mike Raymond, assistant vice president, competitive market solutions at Lincoln Financial Group. Everyone, great to have you with us. And kicking us off here, Brad, could you talk about the income gap and how it helps simplify the income planning process for advisors and their clients?
Brad Crawford: Definitely Jenna, and thank you once again for having me on the show. The income gap is a simplified version of how advisors as well as clients should be looking at planning for retirement. And at its most basic form, the income gap is really essentially what your income is coming in from social security, pensions, deferred comp, and then what are your expenses? And we usually divide those expenses off into essentialist expenses, which are going to be your housing, your food, your electricity, things that you absolutely just have to have to get by in life and then discretionary expenses, or let's call them the bucket list items, the things you'd like to do, the vacations, the new cars, the eating out at night.
Brad Crawford: So once we tally up the essential and discretionary income and then compare it against what are our guaranteed sources of income, the social security, the pensions, the preferred comps, that's going to leave us a number which we refer to as the income gap. So if we have, let's say $5,000 of guaranteed income coming in and $10,000 of discretionary and essential income going out, that leaves a basic $5,000 gap per month for the advisor as well as the clients to look at for planning for.
Brad Crawford: Then we take a look at what assets we have and how do we turn those assets into a guaranteed $5,000 worth of income to get the client through the rest of the retirement without any risk of them running out of money. So Jenna, at it's most basic that's what the income gap is, and that's how it simplifies the approach for both advisor and client when it comes to planning for retirement. But then we get into some of the more creative things of where are the spending accelerators, where are the hiccups that take place and we can get a lot more complicated at that, but we'll get into that a little bit further as we go along.
Jenna Dagenhart: Lauren, could you give us an overview of some alternative strategies to providing income in retirement?
Lauren Drapeau: Yeah. Thank you, Jenna. It's such an extremely important topic to talk about and admittedly, I kind of nerd out over it a little bit. I feel like our industry as a whole has done a great job of teaching people how to accumulate their assets, but de cumulation or income distribution is a whole nother piece of the puzzle and it's one we just can't get wrong. So recently Protective just completed the 2021 RIA retirement income survey with RetireOne. The study revealed that 91% of financial advisors surveyed prioritized retirement income planning as one of the most important services they can offer their clients.
Lauren Drapeau: Now, this planning also takes on added significance as the US hits peak 65 and in three years, we'll have more 65 year olds than any of our time in our history. This will test our nation's retirement system like never before. Couple that with the fact that 70% of Americans fear running out of money in retirement more than death itself and we have a real opportunity to help clients with their retirement needs. When planning for retirement, there's a variety of strategies available to create really unique retirement plans that aligns with the client's income and emotional needs.
Lauren Drapeau: By using strategies that include a guaranteed lifetime income component, you can create a customized investment strategy that can help your client prepare for retirement more confidently. For today's retirees, traditional sources of retirement income such as employee sponsored pension plans or social security will only fund a portion of the client's retirement. And in fact, over reliance of social security as part of the strategy could compromise your client's ability to meet the retirement needs.
Lauren Drapeau: So you'll be able to bridge this gap that Brad was just talking about to live a more comfortable retirement. There was a recent study done by the Alliance for Lifetime Income and CANNEX to reveal that 9 out of 10 investors said it was important that income plans provide a guaranteed income payment or principle protection. So a variable annuity can really fill this gap by providing protection for your retirement savings as well as that reliable stream of income.
Jenna Dagenhart: Mike, how would you define an annuity and how has that definition changed over time?
Michael Raymond: Well, Jenna, first off, thank you so much for having me on today's call, I'm truly grateful for the opportunity. Boy, the definition has changed so much over time. I mean, one of the analogies I tend to think about is we've all seen the movie Wall Street and you think of Gordon Gekko walking on the beach with a cell phone that looked like a brick. And when cell phones first came out, it was literally built to call people, I know it's crazy.
Michael Raymond: But you think of the evolution of your cell phone and the devices that we use today, I mean, I literally have my cell phone on my watch right now. You can use your cell phone for social media and GPS and flashlight and all these various things. The same parallel exists within the annuities world because in many ways when... well, let's start with, when you look at the Webster dictionary of an annuity, right? It's essentially a sum of money payable yearly or at some regular interval over time. It's a contract between an insurance company and an investor.
Michael Raymond: Now, certainly that has changed a lot over time, right? You think about where variable annuities for example came out in the market in the 1950s and tax deferral was really its primary objective in non-qualified accounts. That has changed a lot, right? If you go now fast forward into the mid to late 1990s, we started to see Americans shift their retirement savings to self-funded investments like 401ks and 403(b) and IRAs et cetera. And so the annuities industry adapted heavily to that by offering a lot of new features that were appealing for qualified investors.
Michael Raymond: And even through today, qualified assets can constitute the bulk of annuity sales. Over the last five or 10 years, now we've seen even more evolution of the term annuity. We've seen a lot of carriers in this market offer products that are diversifying away from simply lifetime income. It's about wealth protection, it's about legacy or estate planning. It's about unique and innovative investment solutions. It's downside protection. It's a lot of these variables that ultimately help meet a lot of different needs that clients have today. And whether that's tax deferral, whether it's legacy planning, wealth protection, lifetime income, the term annuity means a lot of different things just like our cell phones as well.
Jenna Dagenhart: Yeah, a lot of innovation all the way around, whether it's retirement income or your cell phone. I also have a cell phone on my watch just like you. Now, David, what are some of the innovations that we're seeing in the annuity space today with a specific focus on guaranteed income?
David Blanchett: Sure. So low interest rates are really tough for all investors, insurers included, right? And I think that low rates make it really hard for investors to lock in what I would call an irrevocable contract like even annuity, even where rates are. And so I think that what we're seeing is that while there are kind of existing products like GWBs that exist that allow someone access to those funds, they're kind of losing favor among insurers that don't necessarily have great prospects for increases in income either.
David Blanchett: And so from my perspective, what I'm seeing is this kind of rise of this product that we can call it a protected lifetime income strategy kind of similar to how the Alliance for Lifetime Income refers to it, where the guaranteed income component evolves each year based on the performance of the underlying account versus that kind of benefit based structure with the GWB. And these are somewhat new and I think they have a lot of promise because they allow a lot more personalization with respect to the underlying risk levels and they have a lot more potential for income.
David Blanchett: Now when I talk about these before people will say, "Well, David what does it mean to have guaranteed income that isn't truly guaranteed?" And there is some more risk there, right? So it is possible the income could evolve over time, but again, that's a personalized choice. You have this income that is on top of other sources like social security or pensions which are guaranteed so it allows someone the opportunity to possibly take on more risk based upon their unique facts and circumstances.
Jenna Dagenhart: What about innovations in the annuity space in general, David?
David Blanchett: So, I mean, I guess to follow up, right? Low interest rates really create a dynamic environment for everyone out there today, right? And I think the one example of a product that has been very popular like fixed index annuities is really challenging an environment where you've got low interest rates and low cap rates. And so what we're seeing this massive explosion in products that offer these things called floors and buffers. And these have a whole host of names or different products out there, but kind of super simple, a floor is a product that has a maximum possible loss.
David Blanchett: So if there's a 10% floor, you're not going to lose more than 10% of the product. A 10% buffer product would absorb the first 10% of losses in that contract. So for example, in a 10% floor in the underlying index goes down 5%, the investor or the annuitant wouldn't lose anything. Now I mentioned these products have lots of names. They're called registered index annuities, or RILA, they're called index variable annuities, or IVAs, they're called structured annuities. It's a little bit confusing.
David Blanchett: But I think it's good that a lot of companies are focused on creating products in this space, because I mean, when I've researched these products, there's benefits to them, I think that are both behavioral and economic. Behavioral perspective, it helps to nudge people to take on risk, right? Stocks have outperformed bonds over the long term and I think these products allow people that wouldn't otherwise be comfortable taking on risk to do so in a way that they're comfortable.
David Blanchett: From an economic perspective, there's actually some benefits to buffer like strategies what I see here is an opportunity for advisors and for investors, for everyone to kind of have access to a new type of product that really can help them better accomplish their goals.
Jenna Dagenhart: And I'm glad you bring up interest rates. Brad, how has the current interest rate changed the view and utilization of traditional and newer income related products in the industry?
Brad Crawford: Oh, it's definitely changed over the years. I've been in the annuity space for 20 plus years. And I remember when I first started we were charging 25 basis points to give people 6% income for life. And you couldn't give it away. People thought, "Why would you give up 25 basis points to get 6% for life?" That was crazy. And then it seems like almost every single year that I've been in this space, the benefits have gotten a little bit more expensive as well as coming down a little bit.
Brad Crawford: We're starting to see lifetime incomes in the 4 1/2 space that people are willing to pay 1 1/2% percent for at this point. So definitely the utilization has changed quite a bit where people start to really see the value of what we're offering right now. But obviously as the low interest rates have come down, the products have started to have to come down to match the current environment. And couple of trends that I've been noticing at least here at Transamerica.
Brad Crawford: The first is we've definitely seen a big utilization of people adding to those old contracts. If you did purchase a contract five years ago, 10 years ago, that's a great contract and it's probably a good time to reevaluate, maybe it's time to put a little bit more money into those products because you're not going to find the current equivalent in today's space if you're looking for pure income needs. Now, if your needs have changed, obviously the client's side, I might look for a different style product like David was mentioning the RILAs and the buffers that are starting to come out now.
Brad Crawford: But the second trend that I'm starting to see is that as the interest rates have come down, we have, as an industry started to go towards more simplification of the products. Historically the GMWBs had all sorts of moving parts, roll up, step up, stacking, not stacking. And what we're starting to see is that while those were great in a high interest rate environment, in this lower environment, a more simplified approach of focusing on what is the income going to be as well as maybe trying to just focus in on locking on the market returns.
Brad Crawford: So I know that's a trend that I've seen come for bear over the years, is people don't like the confusing products, they don't like the moving parts. They want to see really a simplified product that's going to allow them to participate in the market without a lot of the managed volatility out there. So that's just a couple of the things that I've been seeing as the interest rates been coming down, is the fully taken advantage of products that are in the market that people have already purchased as well as trying to focus a little bit more on a simplified approach to providing that income in today's environment.
Jenna Dagenhart: I see a lot of heads nodding but Lauren, I'm going to come to you next. During low interest rate environments, it's important for advisors to manage investors' behaviors to ensure that they have enough income for retirement. Can you explain why this is so critical and what advisors can do to help clients stay on track and what tools they can leverage to support clients?
Lauren Drapeau: Yeah, so like I tell my children, you have to have patience, right? It's important for clients to realize they're playing the long game and that time in the market will only result in hurting their overall returns. So usually we see investors who are emotionally motivated make illogical moves. During low interest rate environments or bear markets, instead of keeping the money invested, they lack in their losses by pulling that money out of the market and therefore really miss out on the rebound.
Lauren Drapeau: This is especially important when taking income because there's no time to allow the portfolio to grow back up and clients must continue to take withdrawals from an already decreasing asset. So what an annuity can do is it can kind of take that emotional aspect out because there's a true sense of that protected income and an insurance that the income will always be there. There was a recent DALBAR study actually that showed that investors who utilized variable annuity fixed sub accounts outperformed their mutual fund counterparts by 291 basis points in 2020.
Lauren Drapeau: So these sub accounts averaged about 6% where the mutual fund was only about 3%. But the study and the thing that's really important is that the study found that the major factor was the difference between the number of investors that pulled out of the market during the March 2020 crash and panic. So looking at the variable annuity sub account holders in the same funds and same environment, you don't see that same panic. And this is largely due to the way that variable annuities are built, right? By providing that risk pooling and reducing the portfolio risk through these guarantees.
Jenna Dagenhart: Mike, what kind of strategies can investors leverage to help them in a low yield to environment?
Michael Raymond: Well, Jenna, there's so much. I mean, I recall when I entered the industry 20 plus years ago as well and there weren't really that many options. And I think one of the things that's so exciting about 2021 with the annuities world is that we have so many options that can help meet consumer need. If you look sort of across the spectrum, there are so many new annuity solutions out there for many purposes. So where we start, for example, is fixed index annuities.
Michael Raymond: I mean, this is a product that is uniquely built to provide essentially full downside protection with upside potential. So many investors are using these type of product solutions almost as a bond alternative to say, "I'm not generating really enough yield in my traditional bonds." I mean, again, the 10 year treasury right now is roughly at 1.3%. So this is a great product solution with no implicit fees, for the most part, to be able to capture a little bit greater upside potential and unlike a bond investment, have 100% downside protection.
Michael Raymond: I like to use the sort of baseball analogy as well when I look at all these products and I think of fixed index annuity as almost like a singles hitter. Someone that's going to get on base a lot that's not going to strike out. You're not going to have a lot of risk in either direction, you're going to have an opportunity to consistently get on base and that's what fixed index annuities are really built for. Now, if you want a little bit more riff, now there's products out there, for example, as David and Lauren and Brad had all pointed out, that you have these index variable annuity products, these IVAs, or RILA products that give greater upside potential perhaps than a fixed index annuity, but with a little bit more risk where you can potentially lose money on the downside.
Michael Raymond: So maybe now you're hitting some more doubles and an occasional triple, to use the baseball analogy, but on the other side, you're maybe striking out once every so often as opposed to never striking up. And then if you kind of go along the risk spectrum even further, you've got now these products in the investment only variable annuity world. For example, Lincoln has a product that we're currently offering which has defined outcome funds, which again, is helping to meet that growing demand that exponential growing demand that Americans have for wealth protection, particularly the boomers that are in or near retirement that really don't want to lose their money.
Michael Raymond: And so these types of products are really built with that in mind. If you go even further, you've got now variable annuities that you can have with living benefits as Lauren had mentioned that provide that lifetime income solution as well. And this is something that we're seeing a lot of advisors use in a way almost like a bond laddering alternative to look for that guaranteed income stream.
Michael Raymond: And then the most aggressive, and this is again to keep that baseball analogy like that home run hitter that is going to come up and hit a three run home run to win a game but he probably struck out three times before he got up to the plate or before that happened, and that's essentially a variable annuity so high risk high reward. My point with this is that there's so many solutions and ideally the most exciting part of this innovation is that it's meeting a lot of individual client needs, not just one specific need, and that's been unlike a time ever in the annuities industry.
Jenna Dagenhart: Bonus points, if anyone can keep the baseball analogy going here. But I think you raised some really important points there Mike. So, I mean, you mentioned boomers, how are different demographics thinking about these types of products?
Michael Raymond: Yeah, this is a tremendous opportunity and one I think that our industry can really try and capitalize more on. I think as you look across the spectrum, I think we as an industry have focused in many ways of course, on wealth, but I think as you look at the demographics, there is so much more opportunity there as well. Right now, for example if you look at just women as a demographic, they're currently at least as of 2020 based on the most recent study I saw, over half of the labor force, roughly 57%.
Michael Raymond: If you look at millennials, which is about a quarter of the labor force, which is another tremendous opportunity. And one of the things that we're seeing through various studies with millennials is they want to save more, they want to look for products that offer these type of solutions. Another tremendous area of opportunity is the minority consumer group where I saw just a study this morning and that talked about how by 2032 people of color will constitute over half of the labor force. So there is a tremendous amount of opportunity that the annuity carriers can really try and work hard to attract their benefits, their value proposition to by demographics for sure.
Jenna Dagenhart: Anything you wanted to add there, Lauren?
Lauren Drapeau: Oh, sorry. So it's not a baseball analogy, I apologize, but I've got a different one for you. So if you kind of think about the different strategies that you can go into for long term care needs, so again, nerding out, was kind of watching this on Mount Everest and the trek to Mount Everest. So if you think about the climbing to the top of Mount Everest, the planning, the physical and emotional training and money it takes to climb to the top is extraordinary and I can't even begin to imagine what it's like to get to the summit and really just looking out and admiring everything you just accomplished, but now you still have to end from the top, right?
Lauren Drapeau: And there are more casualties that occur on the way down because of fatigue and lack of planning. So if we take that Mount Everest and think about that as your retirement planning journey, what a feeling it must be to retire at that summit and look down over everything you've accomplished over your career. But there's still that descend, right? There's still more energy... there's still more injuries coming down from Mount Everest. And there's also more issues with the income phase, again, for kind of lack of planning or understanding and lack of time.
Lauren Drapeau: So to carry this just a little bit further, 2019 was one of the most challenging years to climb Mount Everest. The contributing reasons why were climate changes to the mountain were unpredictable and volatile, similar to the stock market, right? Number two, the climbers faced a number of life threatening health risks. Again, when you're in retirement, you've got health risk that increase during retirement age and health insurance is more costly.
Lauren Drapeau: And finally, the psychological factors impair the climbers' judgment because of lack of oxygen just as our emotional factors impair our ability to stay in the market during downturns like we've talked about. So this is again where variable annuities can help. And yes, we hear a lot of noise. Like variable annuities are illiquid, they're complicated, they're expensive, you give up control. We hear it all. And really what we're on a quest to do is to help advisors understand that the industry has made huge strides to make annuities more straightforward, flexible and cost effective, and more importantly, that they provide that guaranteed income without that giving up of control.
Lauren Drapeau: At Protective, we're making sure guaranteed income is an option for everyone by offering both the commission and the fee based annuities to really look at everyone in this marketplace. So an annuity can help minimize the risk of retirement. What are those? Right? Longevity risk, health risk, sequence of return risk, really any risk that causes the need to take a higher withdrawal out of your portfolio than expected. Let's look at sequence of return risk, right? The market goes up and down, investments win or lose but one thing that always remains constant is that the devastating impact that a poorly timed downturn can have at a seemingly solid income strategy.
Lauren Drapeau: When clients are relying too much on their portfolio for income and they're hit with a major loss, it could result in running out of money in retirement. The National Retirement Risk Index found that 50% of pre pandemic households were in danger of lacking sufficient funds to continue their standard of living in retirement and that number rose to 55% after the pandemic. So the probability of running out of money increases with your portfolio reliance rate.
Lauren Drapeau: What's a portfolio reliance rate? It's the percentage of which you need to withdraw so that your needs are met. We talked earlier about there's vacations and fun things you want to buy, but this is just so your needs are met. But there's a market downturn that withdrawal percentage increases and may not be sustainable. This may deplete the portfolio before it has a chance to recover. So what the annuity really does is it offers optional benefits such as that guaranteed income that can lower the reliance rate on the other portfolios but still protect the portfolio in a down market and be able to let you participate in any market returns.
Jenna Dagenhart: You bring up sequence of returns, Brad, what is sequence of returns and how does that play a role in planning for income generation? What kind of tools can you use to combat that risk?
Brad Crawford: Now sequence of returns risk is probably the number one reason that people run out of money in retirement. Everybody thinks that it's... So I invested poorly, I got the bad mutual fund or I got the bad stock. At the end of the day, when you look at some of the Monte Carlo simulations, and again, they've been changing given the low end straight environment, but let's just say if I want to live 30 years in retirement and pull out 5% for life, that's going to give me historically around a 30, 35% chance of running out of money.
Brad Crawford: Where does most of that risk come from? It's really when you got into the market that's going to determine if your assets last for that entire payout. And a great example I always love is if you're one of the lucky ones that retired in 2002 right after the dot-com blow up and you started pulling out income, at this point almost 20 years later, your portfolio's probably significantly higher than where it was when it started. On the flip side, if you're one of the unlucky ones that maybe retired in 2000 and you started to pull... had a million dollar portfolio and you were pulling out 50,000 a year, as that portfolio went down in value almost 40%, 50%, in some cases, you're still pulling out 5% of that top line, you're going to deplete those assets before they have a chance to fully recover.
Brad Crawford: Now there's a lot of different strategies that I've seen that can help avoid or alleviate some of this draw down or sequence returns risk, and a simple one is a buckets approach. Basically all your assets that are susceptible to market fluctuations, you want to make sure that you have 5 and maybe 10 years long of safe money to pull from so that if those assets do get deplete or go down in value significantly, you have enough time for them to fully recover before you have to tap them as an asset. That's a bucket's approach of doing it.
Brad Crawford: Quite honestly, it's a good approach, but it's overly complicated for most individuals. Most people don't want to constantly have to dabble with which bucket they're pulling income from. The simpler approach is look at just implementing an annuity strategy as part of the portfolio. And if you're trying to cover maybe those essential income needs as 30% of the portfolio, it makes sense to maybe put 30% of the assets into an annuity that's going to cover those essential income needs so that if we do have a draw down risk where we have a severe downturn and you have to keep pulling income, then you're not ever worried about running out of income.
Brad Crawford: And I always love a fact I tell to a lot of people is, during the 08, 09, 2010 housing market crash, I remember I was in a room with my mother and a bunch of her friends at a birthday party and they were all teachers. And all the guys were over in one room complaining about how bad the market had gotten and how their portfolios are crashed. And all of my mom's friends were sitting in an another room just could care less the market had gone down 40%. And the reason behind it was because all the teachers had a pension.
Brad Crawford: When they knew that those guaranteed income streams were going to pay out no matter what the market did 40% down, half the time we're worried about the actual market returns but a lot of what we forget about is investing in annuities given that emotional return as well and watching all those happy faces on my mother's friends knowing that their pensions are going to pay out definitely reassured me that annuities need to be part of the strategy.
Brad Crawford: And again, I can't speak for where the market's going to go, but I can tell you, I was looking at some of the numbers and right now the Shiller PE index is at one of its all time high at 37.5. And for those that aren't familiar, it's kind of an indicator of what the future returns are going to look like over the coming years with a historic average at about 25.7%. We're sitting at one of the most highly valuations in the market since almost the dot-com era.
Brad Crawford: So if I'm a client that's looking at retiring today and I'm worried about some of that sequence of returns risk, I would definitely be considering purchasing an annuity given where we are in the markets because again, if you're buying at the low and all you got is upside, that might be a great strategy. But knowing that we're so high evaluations in the market right now, I'd definitely be putting some protected strategies in at this point.
Michael Raymond: Jenna, if I could just chime in here to Brad's points, this is something that we've been following quite a bit here at Lincoln as well. I think historically, at least, particularly for your average, let's say mutual fund managed money type investor during accumulation as Lauren pointed out earlier, you typically would see investors that would be a little bit more over weighted towards equities, so an 80, 20 or 70, 30, et cetera.
Michael Raymond: And then over time as the client's age and they get in or near retirement, what typically would happen is that they would just dial down equity risk and they would simply increase the fixed income or bond percentage of the allocation and just limit the amount of equities. What's been happening more recently though, is because of the annuity innovation that we've seen and because of the way these products are now built, we're now seeing annuities not just simply being considered a product that you sell in a non-qualified or qualified in account, you're seeing annuities as their own independent asset class altogether.
Michael Raymond: And they're used literally either in non-qualified or qualified assets and why? Well, because in many ways, again, there's a lot of these products, no implicit cost and potentially greater upside potential with limited downside risk in the way these products are built. And I know Lincoln has a ton of great information that we track as well that say, look for those investors, like Brad pointed out, that own these products, they are consistently more satisfied.
Michael Raymond: And let's be honest, as a financial professional, if you have more satisfied investors and through the pandemic and the market correction, the volatility we've seen over the last several years, those conversations are generally probably more pleasant. And so if you have more satisfied investors, you're likelier to retain your clients, to get referrals from clients, it's a win-win for everyone. And so I think again, Brad brings up a lot of great points here, but it's something that can't go without saying.
Brad Crawford: And Jenna, one great study that one of the independent broker dealers did out there during the last downturn is they looked at the accounts that had annuities in them and the accounts that didn't and they were just managed money and they found almost, and again, I'm going to be wrong on this number, but it's pretty close, I think it's about a 50% retention rate was better for the accounts that had an annuity in it versus that were directly exposed to the market. So given where we're at today, that's a great fact for a lot of people to consider.
Jenna Dagenhart: David, turning to you, how well do you think financial advisors do when it comes to using reasonable inputs in a financial plan?
David Blanchett: So honestly, not great. And I think that there's two things that planners often get wrong. And it might sound trivial, but it is actually essential for giving an investor or a client good advice. So I think that too often advisors use long term historical averages. I mean, this has already been relatively depressing talking about... Brad was talking about valuations. I agree. I think that right now is a tough time to retire, right? The average yield on tenure government bonds back to 1870 based upon Shiller's data set is 4.5%, right? It's about 1.3% as of today, that's 300 plus basis point different from the long term historical averages.
David Blanchett: If you're using long term historical averages in your projections, in your financial plans, you are implicitly assuming that you can go out and buy a government bond including 4 1/2% today. That's just not realistic, right? I think that there's also issues with the retirement periods. I actually got a data set about 30,000 financial plans and published some research last month, the Journal of Financial Planning looking at these. And financial planners do not, at least based upon this data set, personalize how long retirement lasts.
David Blanchett: They're not thinking about the implications of joint life expectancy, about the fact that a lot of their clients are a lot healthier and wealthier than average and they're going to have really long life expectancies. If you combine the combination of assumptions of returns I think are too optimistic and a retirement period that's too short, it can dramatically impact this definition of how much you have to save for retirement, how much you can spend and perhaps most importantly, what is the role of guaranteed income? I think that if we can get planners to use better assumptions, more realistic assumptions, they're going to really understand the value of guaranteed income in terms of improving the outcome or the success rate for financial gain.
Jenna Dagenhart: I mean, it is a scary time to retire when stock market valuations are at record highs or on your record highs and you're not really getting that yield on bonds. Mike, in what ways can annuities help offer solutions for some of these challenges that many Americans face today? And I mean, also add to that the rising healthcare cost that Lauren mentioned.
Michael Raymond: I mean, I'll start there in itself. I mean, that is in itself a tremendous opportunity whether it's people that are underinsured, people that just don't anticipate the rising costs and how much that they are. There's estimates out there that roughly 70% of people over age 65 will need some type of long term care. In 2018, healthcare costs were about 3.6 trillion which is about 18% of the GDP. So these costs are just going up exponentially and there are absolutely annuity solutions that are out there that can help address those needs in particular, for those perhaps that are uninsurable otherwise, or perhaps whether it's being in a facility or the home through ADL requirements. So there are absolutely solutions that can help meet that need.
Michael Raymond: When you look at a lot of the other needs that are out there, I mean, one of the most fundamental needs that we've seen over the last decade plus has been the need for guaranteed lifetime income, as David just mentioned. And I think to the conversations that I have with a lot of financial professionals who say, "Well, these products, they were richer. They cost less or they had a higher roll up rate, payout rate, et cetera." But I think what's more relevant and more appropriate to compare these products to is other investments outside the annuity world at that time.
Michael Raymond: I mean, for example, if you went back to 2007, which was arguably the peak of these lifetime income benefits where they were paying out 5% for life or 6% for life, the 10 year treasury was north of 4% consistently that year. You had equity markets were booming, investor confidence was much higher. You had a lot of people that said, "Well, look, I don't need these guarantees because I could take my chances in a diversified portfolio."
Michael Raymond: Well, then we weathered 2008 and people shortly realized that that might not necessarily be the case. So as we fast forward to today, yeah relative to these products years ago, they might be slightly less attractive, but relative to other investments that are available today, they're significantly far more superior. You have again, the 10 year treasury at 1.3%. You have a lot of uncertainty in the equity markets and volatility. So all of these things are able... these products are available for clients today that again, the value proposition has never been great arguably.
Michael Raymond: You have products out there that meet the need for estate planning or legacy protection, whether an enhanced death benefit rider on a variable annuity, for example, or a fixed index annuity even that pay out a certain percentage to offset the tax liability for a surviving beneficiary or that guaranteed growth on the investment. There are so many different solutions there as well. We talked about wealth preservation today, that's been a big topic. And these new index variable annuities or RILA products really have been the main driver of annuity sales momentum over the last few years. Why? Simply because they're meeting the huge demand that Americans have for wealth protection.
Michael Raymond: The boomers are in retirement. They don't want to lose their assets, but they don't want to just simply put their money under their mattress and not earn anything either. So this is a product to help meet that need, which is why you're going to continue to see sales in these types products continuously rise. So there are a lot of great solutions out there.
Jenna Dagenhart: Lauren, coming back to you, what type of clients would consider these products?
Lauren Drapeau: There's such a wide array of clients I think that could be considered. I mean, if you just, what Michael was just saying, think about people who think they're going to self-insure, right, their retirement. So selfishly being a woman, my husband's a little bit older than me so let's say I'm going to outlive him. He's 63. If he needs nursing care, I'm not the one who's going to pick him up and help him around unfortunately.
Lauren Drapeau: So if you think about it that way, just trying to self-insure, if he needs nursing care help, and I'm unable to help him, I mean, he could go through a lot of our savings, right? So then where does that kind of lead me? So in general, I think it's important to help clients define their needs versus their wants, right? We talked about that a little bit earlier. But needs should be covered by a protected guaranteed income source. And so this frees up the rest of the money for their wants because a want could be foregone where obviously a need can't.
Lauren Drapeau: So designating the annuity as the guaranteed income bucket helps them see more of that full financial picture and really allows people to be more of a holistic planner by being able to better model all of the portfolios. And this is especially important when it comes time for income, right? So they can be designed for many types of clients that financial advisors work with with different goals, including tax planning, wealth management, asset protection, estate planning. But really in terms of retirement income planning, which is the focus of what we're talking about, I think there's really three personas you can fit into.
Lauren Drapeau: One is the asset protector, right? This is the client that has a low risk tolerance and really needs the principle protection and possible tax deferral benefits. They tend to be practical and focused on generating income for their everyday needs. They say, "As long as I can keep my principal safe, I'm fine." So that's the first one. The second one is that income seeker. This client has to maximize their income and cannot afford the market risk, which may put their income in jeopardy but still needs to participate in the market.
Lauren Drapeau: So their top retirement concerns are things like running out of money, making sure they have enough to meet their needs, keeping up with rising expenses, especially the healthcare we just talked about. And I would really say the third client is that guarantee seeker, right? The client understands they need to grow their assets, but they have some fear of the market. These clients still need the help of the market to increase their portfolio, but at the same time, they can't tolerate the downturn. So although the annuity can be options for lots of different type of investors, these are kind of the three income investors that I would say.
Jenna Dagenhart: And Still a lot of hesitation out there. David, what would you say to an advisor who's waiting for interest rates to rise before considering annuities?
David Blanchett: I want to win those bonus points for the baseball now. And I think that... so we keep talking about annuities and for the folks that have paid attention, right? It is such a broad term, right? I feel that too often when an advisor hesitates to buy annuity, they assume that they're all just pitchers or they just view them as one role, but in reality, right? The role of an annuity as part of a baseball team, it can be the designated hitter, the catcher, the pitcher. I mean, they all serve a very different role.
David Blanchett: So I think the problem is that too often advisors don't understand how broad and deep the category is in terms of providing benefits to clients. And there's always an excuse, right? So the excuse today is well, I don't want an annuity because interest rates are low. Well, let's talk about that in terms of both accumulation and de cumulation. So it's true that from an accumulation perspective interest rates are low, but that affects all investors, right?
David Blanchett: Insurance companies are going to buy similar bonds as a portfolio. So yes, the pay out rates for products like MYGAs for example are lower than they may have been historically, but so are bonds you buy as an investor. Annuities have things like tax deferral that you don't get in regular accounts. I think that de cumulation is actually even more interesting. Some will say, "David, I don't want to buy an annuity because interest rates are low." Well, here's the thing. When it comes to guaranteed lifetime income, there's kind of two key drivers of payments, right?
David Blanchett: One is the investment component, what you're going to earn in the general account of [inaudible 00:42:25]. And then there's the mortality piece. It's true that the investment piece is going to be lower because rates are lower today. But you get that everywhere. What you will get in a guaranteed income product is that mortality pulling, which actually makes it more valuable. So an advisor that says, "David, I don't want to think about annuities because interest rates are low," the first question is, well, what type? Because they mean lots of different things.
David Blanchett: But my second point would be, do you realize that relatively speaking, annuities are more valuable and interest rates are down? And so I think that it's true that rates could rise, a lot could happen, but unless you're learning about these products and where they fit, you're not going to really do your clients justice figuring out how they want to accomplish their strategy.
Jenna Dagenhart: That yield is even more attractive in a low interest rate environment. Now, I think another hesitation is fees. Lauren, if someone hasn't used annuities in the past because of fees, why wouldn't they just invest in mutual funds to grow their wealth and avoid the fees of the annuity?
Lauren Drapeau: So I mean, as we talk about annuities can help protect against that negative sequence of returns, that emotional I'm going to pull out of the market, the importance of the lifetime income we talked about and David just kind of touched on it, we can't underestimate that power too of tax deferral. So as opposed to a mutual fund where you pay the taxes annually on your earnings, in annuities, you receive earnings on your money, earnings on the interest and earnings on the money you otherwise would've paid in taxes.
Lauren Drapeau: So as your time horizon increases, so does this affect of the compounding. I think there's a great example from AllianceBernstein. So simple math and a lot of numbers, but if you invested $100,000 for 30 years and at 8% growth and a 33% tax bracket, your taxable account would be almost $500,000. Now your tax deferred account would be almost a million. So even if you took that million and paid the taxes, you would still net around 700,000 or 48% higher than the taxable account. Especially when you're trying to generate income, this is huge. It really shows the power of that tax deferral.
Lauren Drapeau: Also as part of that full financial plan, the annuity preserves the other part of the portfolio that have been earmarked for other goals, right? There's that emotional attachment to money that people have saved. It represents hard work, vacations that were foregone, bigger houses that could have been bought, cars that could have been purchased but instead you save that dollar. So clients have a really hard time spending that money down. If that money is invested in an annuity, they know that that money is set aside for income, it's doing what it's supposed to do. And it really eases that emotional attachment as that other money is earmarked for other goals.
Jenna Dagenhart: And Brad you've been sprinkling in some fun research throughout as well, but could you speak to the spending pattern research and how variance and cash flows throughout retirement impacts planning?
Brad Crawford: Jenna, one of the things that is absolutely wrong is for advisors and clients to assume their spending pattern's going to be nice and level and maybe grow with inflation every single year. Because in reality, when somebody does get to the age of retirement, those first 10 years, and again 10, 15, 20, it depends, 5 are usually those go go years. Those are the years that they want to travel. They want to go out and have dinner parties. They want to go out and enjoy all the things that they've been saving for.
Brad Crawford: And then they start to hit the mid seventies and eighties and their bodies start to get a little bit worn down and kind of a more of the slow go years where they're not doing as much traveling, they're not doing as much eating out and their spending starts to dip from the high point of those first 10 years and kind of starts to really hit a low between maybe 75 years old to 85 years old. And then we see this astronomical spike in those final couple years of their life expectancy.
Brad Crawford: Historically the most money is spent in those finals year or two because of healthcare costs. So we typically see this pattern of high spike followed by the slow go years and then just a vertical line up depending on what kind of medical issues that they have. So assuming for a nice steady inflation adjusted income stream over that entire retirement would be an absolute mistake. What it is nice is to have the essential cost covered by the guaranteed income stream and then have those buckets of money set aside to candle all the spikes that take place as well as the maybe end of year planning with long term care, things like that.
Jenna Dagenhart: And David, you touched on some financial advisors who might be trying to time interest rates, but on the whole, what are you seeing in terms of financial advisor interest and annuities?
David Blanchett: So maybe I'm an optimist, but I think it's definitely increasing. Lauren kind of made this point that, I mean, people save money to retire, right? You don't save money because it's fun, you save money to do stuff with it, right? You save it to vacation, to buy that vote, to do stuff. And it's hard to do that from a portfolio when you don't know how much you can spend. I mean, Brad's talking about how spending evolves, there's sequence versus all these things that scare people, right?
David Blanchett: And annuities provide something, especially when it comes to [inaudible 00:47:45], you can't get anywhere else. And so I'd like to think that more advisors are starting to understand this point, right? They're starting to see that if you want to really help a client accomplish a better retirement, you're having a conversation about, do you have your needs, for example, covered? How are you actually covering your liability? I mean, again, it's all about... retirement is a liability, it's the most expensive purchase you're ever going to make. And if I'm a financial advisor giving good holistic advice, I'm not doing a very good job if I'm not incorporating the impact or the benefit of guaranteed income into a financial plan.
Jenna Dagenhart: Looking forward, Mike, what types of innovation and, or opportunity exist for annuity carriers now and in the future? I mean, what do you think that the industry will see in the coming years?
Michael Raymond: Well, I think that's a million dollar question, Jenna. A lot of-
Jenna Dagenhart: I'm asking you to look into the crystal ball there, so no pressure.
Michael Raymond: I'll try my best. I think a lot of it's going to certainly depend on where things are headed in terms of the regulatory environment that seems to change on a daily basis whether it's department of labor, fiduciary standard or SECURE Act, REG BI and all these different regulations, it's causing annuity manufacturers to adjust almost on the daily basis. And then as a result of that, you've got broker dealers and, or financial professionals who have to adjust accordingly as well. So that's going to change a lot.
Michael Raymond: Now overall though, I think one of the biggest areas of opportunity is going to continue to focus around education. We've brought up a lot of good points today in terms of what these products are built for, how this evolution has only helped investors in terms of offering product solutions that meet client need. But I think that this education focus is going to continue to be big and let's call it what it is. Generally speaking, annuities are not really bought by investors, they typically are sold to investors by financial professionals.
Michael Raymond: So I think there's obviously education that can be done to financial professionals. The Alliance for Lifetime Income as Lauren pointed out has been a great advocate to do that. I mean, for example, if you were to Google the term annuity, we're kind of sick and tired of all the negativity. I mean, we want to see positive things and be proud of the different features that these products offer. So that's a tremendous opportunity there I think also again, from a client's perspective. There's also a tremendous amount of opportunity as well within the managed money/mutual fund world.
Michael Raymond: Combined, that's like over $30 trillion market. And I think when you look holistically at that market, those are assets that don't have protection, they don't have guarantees. And so what percentage of those assets are held by investors that are in or near retirement that are really in desperate need for those type of protection or guarantees. And I think that's another area that we continue to tap into more. We talked earlier about the demographics and specific areas demographic wise that we can target to whether it's women, millennials, et cetera.
Michael Raymond: And I think also I believe David pointed out on the simplification of these products. I think that's one of the things clearly that we hear regularly from clients and certainly advisors around a lot of moving parts, a lot of variables to consider, really trying to simplify these products and make them easy for not just financial professionals, but certainly clients to understand as well. So there's a lot of areas to look at, but those are, I think some of the major ones.
Jenna Dagenhart: And if we know anything, we know that the market can and will throw us curve balls playing into that baseball analogy and some speed balls too, fast and furious movements in the market, which is why that protection can be so important. Moving forward, anyone want to weigh in on just the role in general of annuities in a portfolio?
David Blanchett: So, I mean, I'll take a quick stab at it. I mean, I think again... so my problem... It's an excellent question, right? But my problem is that I have no idea how to answer it because I think as we pointed out, annuities can mean so many different things, right? They can be a incredibly valuable accumulation vehicle. There's all these different flavors of annuities. There's fixed rate annuities or MYGAs, and you can go all the way to Vas.
David Blanchett: When it comes to retirement, there's this kind of equal spectrum of kind of risk on risk off. And so from my perspective, it's like if you're... I made this point earlier, but if you're an advisor who is not actively thinking about annuities and you're not doing a very good job, because you're missing this huge spectrum of possibilities to help a client improve their outcomes, and it's really important. Not every client's going to need one, I'm not suggesting every client has to have one, what I am suggesting if you're not kind of considering that question itself, how could an annuity help a client accomplish their goal better, then you're not accomplishing the best possible outcome for all your clients.
Jenna Dagenhart: Any final thoughts on your end, Brad?
Brad Crawford: One of things that nobody had touched on on the evolution though, is one of the reasons that a lot of advisors choose not to use annuities is just the complications of the paperwork and trying to get them through the back office. So one of the innovations that I'm probably most excited about is some of these fintechs that are starting up now that are linking in to the back offices and try to simplify the process of getting annuity applications pushed through.
Brad Crawford: I mean, it makes absolutely no sense to me that a broker can basically hit couple buttons and buy a double inverse index fund but he has to fill out 20 pages of paperwork and 10 signatures and go back to the client twice to buy in a protected strategy like annuity. So one of the things that I'm really excited about is the simplification of the back office. Because the more we can get it as an easy product to purchase, then we're going to start seeing it utilized in the correct places a lot more instead of the hesitancy that we see from some advisors to just say, "It's too difficult, I'll just stick to what I know."
Jenna Dagenhart: And I think we're in the bottom of the ninth here, but Mike, I want to give you one more chance to weigh in and then Lauren, if you want to follow up as well, it'd be great to hear your final thoughts.
Michael Raymond: I would just say, I guess one of the areas that I could have probably expanded upon earlier in my discussion too, is something that's been coming up quite a bit, which is regardless of political affiliation or anything like that, I mean, the current administration has made it abundantly clear that they're looking to increase tax rates and raising the highest marginal tax rate up to 39.6% and cap gains and all these different things.
Michael Raymond: I mean, so taxes have become a major issue and something that I think we can do a better job as an industry continuing to educate advisors on the value proposition. Again, we focused so many years in a row on qualified assets and all these different guarantees that exist and they've been tremendous and they offer great value, but the kind of that old school tax deferral component of the annuity is also something that not just as important, but will continue to be more important as we look forward particularly again in the short term with the current administration. So we'll see how that works, but I think that's another major trend too.
Lauren Drapeau: Yeah, I think it's also... there's the power of words. Do you want to buy an annuity? Heck no. Do you want guaranteed income for the rest of your life? Absolutely. Well guess what? They're the same thing, right? And shame on us as an industry, it's because we've made them complex or illiquid or forced annuitization. So there's definitely that education component to it. And then if you kind of look where advisors are going, right? There's more of those hybrid advisors, RIAs, there's a lot of interesting things around that, having the ability to have some of these insurance products for people who don't necessarily have an insurance license, right? Working with OIDs or back offices, I think is absolutely tremendous.
Lauren Drapeau: And then think about what the SECURE Act, right? So every year now we're going to get a statement from our 401k that says you're on track, or you're not. That's an annual constant reminder now that's going to say, "Oh, shoot," or, "good job." Right? So there's a lot of education that needs to be done. It's easy enough to say if you build it, they will come and we'll all have an annuity and have a big party when we retire but I think the education component of what the dreaded A word really means is going to mean a lot to our industry.
Jenna Dagenhart: And unfortunately, a lot of Americans are not on track to retire when they want and how they want so that report card will be crucial. Everyone, thank you very much for joining us, great to have you.
Lauren Drapeau: Thank you.
David Blanchett: Thank you Jenna.
Jenna Dagenhart: And thank you for watching this Retirement Income Masterclass. I was joined by Brad Crawford, divisional sales manager at Transamerica, Lauren Drapeau, national sales director, annuity advisor solutions at Protective Life, David Blanchett, head of retirement research at PGIM DC solutions at Prudential and Mike Raymond, assistant vice president, competitive market solutions at Lincoln Financial Group. And I'm Jenna Dagenhart with Asset TV.