Annuities suffer from a branding problem

Against a backdrop of low interest rates on savings and a volatile stock market, near and current retirees are hungry for predictable, guaranteed income for life.

But many clients and, in some cases, their financial advisers generally reject annuities as a way of removing some of the uncertainties of an increasingly do-it-yourself retirement model.

“There's not enough understanding of what these products are and why protections against living so long are important,” said James Poterba, a professor of economics at the Massachusetts Institute of Technology and president of the National Bureau of Economic Research.

He was one of a star-studded cast of financial experts who participated in a recent symposium on Capitol Hill about how to develop better lifetime-income options to improve retirement security.

Although other distribution strategies can provide income, annuitization is the only means to guarantee a consistent income stream that can't be outlived. Despite the logic, the private-annuity market is quite small.

BEHAVIORAL FINANCE

There are the usual stumbling blocks: Individuals worry about losing control over their money or not having enough liquid assets in case of an emergency. And there is the nagging fear of getting hit by a bus shortly after signing an annuity contract that turns over a wad of cash to an insurance company in exchange for lifetime payments.

But annuities can provide peace of mind and impose financial discipline, and they don't have to be an all-or-nothing decision. A recent AARP survey of more than 2,300 older workers and retirees between 50 and 75 suggests that there is more potential in the private-annuity market than many observers have assumed.

Underscoring that conclusion, a recent survey by Cerulli Associates Inc. shows that annuities were at the top of a list of topics that clients wanted to discuss with their advisers this year. Of course, record-low rates make immediate-payout annuities relatively unattractive. But overall, I think it is more of a branding problem.

Maybe it is time to ditch the Scarlet Letter A-word that lumps simple payout contracts with more-complicated deferred-investment products that share the same name.

Lifetime income, lifelong income, personal pension or paycheck-for-life all have a nice ring to them. Pick a favorite and run with it.

It isn't just what the income products are called that creates a perception problem. It is also how advisers frame the discussion.

Comparing the cost of buying a lifetime annuity with investing the money elsewhere is going to look like a losing bet for about half the people who die before their life expectancy, said Joe Tomlinson, head of Tomlinson Financial Planning.

But a payout annuity isn't an investment. It's a promise of income for life. And guarantees cost money.

“Financial advisers need to fairly present the options to their clients,” said Anna Rappaport, a nationally recognized expert and chairman of the Society of Actuaries' Committee on Post Retirement Needs.

She recommends that advisers don't “just think about what you make money on,” even if allocating a portion of a client's portfolio to buy an annuity means sacrificing a portion of the assets-under-management fee.

Advice matters, and clients tend to follow their advisers' recommendations, Ms. Rappaport said.

She pointed to a 2010 TIAA-CREF Institute study showing that 19% of a group of individuals who retired with significant accumulations in defined-contribution plans and individual retirement accounts, but with little pension income, annuitized at least some of their retirement savings.

More than 20% of those who bought annuities said they were following an adviser's recommendation.

But advisers should first make sure clients are getting the most out of the best annuity deal of all: Social Security. Knowing when and how to claim benefits can increase an individual's lifetime-income payout by tens of thousands of dollars, and for married couples, a coordinated claiming strategy can boost lifetime income by at least $100,000.

Mr. Tomlinson crunched some examples for a recent Society of Actuaries conference.

Assume that a man eligible for $20,000 of Social Security retirement benefits at his normal retirement age of 66 decides to delay collecting benefits until 70. At that point, his annual benefits increase by 32% to $26,400. If he dies first, his spouse continues to receive that amount.

To delay collecting his benefits for four years, Mr. Tomlinson estimated that the man would have to withdraw $109,000 from his savings on an inflation-adjusted basis to replace the deferred benefits.

If he claims the $20,000 in benefits at 66, it costs him $136,000 to buy an immediate payout annuity to supply the additional $6,400 of inflation-adjusted annual income.

For a 66-year old woman, it would cost $148,000 to top off similar Social Security benefits. And to replicate the additional income and survivor benefit that Social Security would provide by delaying benefits until 70, a husband, 66, and wife, 64, would need to spend $180,000 from other savings.

“The message is to get Social Security right first,” Mr. Tomlinson said.

Mary Beth Franklin (mbfranklin @investmentnews.com) welcomes your comments and suggestions for column topics. Twitter: @mbfretirepro