Jim Lorenzen, CFP®, AIF®
More and more boomers are beginning to approach retirement.
No news there; but something’s been happening – and continues to happen – that can negatively impact people who waited hoping to get a better deal regarding their retirement income. It’s little wonder that so many retirement plans are in jeopardy.
You see, immediate income annuity sales totaled $9.7 billion last year – a 17% spike. My guess is, as the boomer retirement bubble really begins to hit, that number will be much higher.
It’s Economics 101: Supply and Demand. As more and more boomers purchase annuities to cover their basic expenses in retirement, this demand coupled with increasing life expectancies, will likely have a dramatic effect on payout rates for future purchasers.
According to an excellent article by Tom Henga, writing in the June issue of Retirement Advisor, a Society of Actuaries (SOA) committee released the final report of RP-2014 mortality tables in October and those tables reveal a consistent trend, which if it continues for the next 14 years, means in 2028 life expectancy might rise to 88.6 years for males aged 65, and 91.2 years for females the same age.
According to Mr. Henga, these updated mortality tables will require insurance companies to lower their payout rates in order to properly reflect longer life spans. His logic is easy to understand and the math isn’t hard to do.
The trend increasing life expectancies – along with the consumer demand for guaranteed income solutions – could very well result in annuity payout rates going from 14 percent to 10 percent, from 9 percent to 7 percent, and from 7 percent to 5 percent. It’s about longevity credits. As demand increases, something has to give.
People who’ve been avoiding annuities now because of today’s low interest rates may find themselves wishing later that they had understood the situation. As Mr. Henga points out, income annuities are not an interest-rate play; they’re a longevity credit play.
Most people have no idea how annuities work or why the insurance companies can provide such high cash flows in a low interest rate environment. The key is longevity credits, i.e., mortality credits. It’s what separates annuities from investments.
When new mortality tables reflect increased aging, chances are better than good that insurance company payout rates will be reduced because of the adjustment in mortality credits. And, chances are, due to the factors cited above, we may be seeing the highest longevity credits we may ever see the rest of our lives…. And many of these adjustments may very well occur in the next 12 months!
Longevity credits aren’t unlimited. It’s the life insurance on the books that provides the built-in hedge to lifetime annuity sales. As people live longer and the demand for credits increases, the pool of available credits decreases. Econ. 101: This will affect pricing of annuity products in the future.
Boomers, of course, are becoming more preoccupied with covering 100% of their non-discretionary, basic retirement needs, and using other investments to address inflation and discretionary spending. Those who secure their annuities earlier in their planning can lock-in these longevity credits early.
Tom Henga likens it to fishing in a fully-stocked pond, as opposed to a pond with a limited supply of fish.
Income annuities come in all shapes and sizes, of course, and the long list of insurance carriers selling them each offer a variety of designs, each with their own bells and whistles. They can be complex products; but, they can also have simple, easy to understand designs. It’s important, however, to avoid the tendency of grabbing the best-looking shiny thing that may have other problems embedded.
Annuities, as mentioned earlier, are gaining in importance however; and they may be worth a look now, more than ever, because of the Econ. 101 issues cited above.
Retirement planning can be a little tricky. In fact, I believe – and many experts agree with me – that most retirement plans will probably fail. I’ve even created a special report that explains why. I think you may find it interesting. You can access it here.
Hope it helps!