Currently Browsing All Posts In 401(k) Plans

Friday September 8, 2017

Annuities, Bonds, and Bad Advice

Recently I was working with a client on analyzing and reallocating his IRA investment portfolio. The portfolio was substantial (over $3M) and was 40% Equities, 40% Bond, and 20% Cash. I really liked this allocation for someone his age (70) and told him that the only real improvements would be using a responsive, tactical investment management platform and to improve his Bond Allocation. The fees on the products and funds he held were already low at an average cost of 1.14%.

In assessing the Bond Allocation, using Morningstar’s X-ray Analysis, we found that over half the total was held in High-Yield or junk bonds. While there is nothing inherently wrong with holding a portion of one’s Fixed Income allocation in High Yield Bonds as a means of diversification and improving the overall yield, a 60% allocation seemed a bit high. Moreover, the total yield on his Fixed Income/Bond allocation was only 3.4%.

I came back to this client with the suggestion of replacing his Fixed Income/Bond Allocation with a combination of Fixed Index Annuities. The criteria I used for my recommendations were that any fees associated with these FIA’s should be comparable to his current annual cost of the Bond Allocation, which was .96%., that any annuity carriers we considered should have a credit rating of A+ or better, and that we could reasonably expect to exceed the current yield of his Bond Portfolio.

Many leading advisors (myself included) view a fixed indexed annuity (FIA) as another fixed income asset and allocate them accordingly:
• An alternative to low yielding bond allocations.
• Allows the investment professional to be as “active” as necessary in other areas of
the wealth management process.
• Provides a range of interest crediting methods with both capped and uncapped
strategies managed by leading investment banks.
• Provides for an ongoing guaranteed income stream for the client and spouse if desired.

The two FIA’s I recommended for this client had internal fees of .95% and .4% respectively, for an average cost of ownership of .675% annually, lower than the current cost of his Bond Funds. The performance of these annuities were tied to underlying diversified stock indices that were managed with volatility controls and had the ability to shift allocations monthly. Disclaimer: Index Annuities are never meant to be a competitor for true equity investments and are not direct investments in the underlying market indices. A reasonable return expectation for this type of product would be between 3½% – 5% over time, with negative index periods earning a 0% return. That’s why they are a viable substitute for bond positions.

This would remove the Market Risk, Credit Risk and Interest Rate Risk associated with his current Bond Allocation, lower the overall annual cost and potentially improve the annual returns. In addition, there is the option of a guaranteed lifetime income that would protect the client (and his spouse) from the risk of extreme longevity. While there are substantial surrender charges in the early years to withdraw more than the annual free amount, Required Distributions from IRA’s are never penalized and that’s all the client anticipated ever withdrawing. Seemed like a no-brainer. Except that it wasn’t.

When we finished with the analysis of the FIA’s, their performance data, reasonable projections, and the financial data on the carriers that offer the products, we scheduled our next meeting for the following week to begin the transfers and implementation of this strategy.

This next meeting is where the process fell apart. Why? Because his (adult) kid heard somewhere that annuities weren’t a good thing to do. While I’m sure that this child is smart, expertise as an elementary school teacher doesn’t qualify one to render complex investment advice. But that’s sometimes how it goes; blood is thicker than 25 years of experience and numerous advanced planning designations. In these situations I just have to let it go or run the risk of insulting the client by impugning the intelligence of their oh- so-smart progeny.

In my opinion, Index Annuities are actually over-hyped and oversold by agents (often posing as fiduciary advisors) as the silver bullet for everything investment related. Cable stations and weekend radio shows are filled with agents dispensing advice about how Index Annuities are the answer to whatever ails you. Market-like returns? Index Annuities! High Growth, No Risk? Index Annuities! Erectile dysfunction? Index Annuities! The only thing more annoying is former TV stars telling people to stockpile gold for the coming financial apocalypse.

Why are annuities so over-hyped? Because they pay commissions. Earning commissions on these products is not inherently wrong or against the best interest of the client, unless the product is not properly positioned and/or sold for the wrong reason – strictly for earning a commission.

But there’s no doubt that annuities can and do solve many of the challenges faced by retirees. The puzzle has been that consumers, and advisors to a large extent, don’t understand where annuities fit or how to use them effectively.

For me there are three primary uses for annuities in my practice – replacing Bonds or Bond Funds with a more efficient alternative in a client’s comprehensive financial plan, filling a defined need for current or future income, or for that client that just can’t stomach any real market risk.

A Wall Street Journal article once referred to income annuities as “super bonds,” which is not the most accurate term. A more appropriate term would be “actuarial bonds.” Extensive research in the field of Retirement Income Planning concludes that income annuities significantly improve retirement outcomes over what is possible with bonds or bond funds.

Unless of course your clients’ kids heard something from somewhere and doesn’t like them.

But for actual research, I suggest the following blogs:
https://retirementresearcher.com/
http://www.theretirementcafe.com/
http://squaredawayblog.bc.edu/

Thursday January 26, 2017

The Late-1950s Boomers Are The Least Prepared for Retirement

The following is a re-post of Boston College – Center For Retirement Research’s January 24, 2017, “Squared Away Blog”:

It’s old news that the many Baby Boomers who did not get married and stay married are worse off financially than those who did. Unfortunately, the financial damage to one segment of this generation has broken new ground.

Only 44 percent of “middle boomers” – those born in the late 1950s – have remained married to their original spouses, down from 52 percent of their parents’ generation. Middle boomers are also far more likely to have lived with partners without marrying, remained single all their lives, or even to have divorced twice.

The heart of a study is determining which of middle boomers’ choices were most likely to have led to financial distress when they reached their pre-retirement years.

About 11 percent of middle boomers had negative net worth by the time they were in their early 50s – more than double the share for the generation born during the Great Depression when they reached this age. Negative net worth means that middle boomers’ mortgages and other debts exceed the value of their assets; in this study, assets included everything from retirement plans and taxable bank accounts to primary and vacation homes.

To understand why, the researchers culled marital histories from a survey of older Americans. They found that four lifestyles are most strongly linked to middle boomers’ negative net worth: never marrying, going through one divorce and becoming single again, separating from a second marriage, and divorcing from a second marriage.

In all of these situations, the individuals were about three times more likely to have negative net worth than were the continually married middle boomers. The study controlled for age, gender, race, education, health, household income, and the number of offspring.

Middle boomers are the “least prepared for retirement” out of four groups studied, the researchers concluded, and their choices around marriage have been important contributing factors.

Marital Histories, Gender, and Financial Security in Late Mid-Life: Evidence from Four Cohorts in the Health and Retirement Study

The Late-1950s Boomers: Hit by Divorce

The research reported herein was performed pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium. The opinions and conclusions expressed are solely those of the author(s) and do not represent the opinions or policy of SSA or any agency of the federal government. Neither the United States Government nor any agency thereof, nor any of their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of the contents of this report. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply endorsement, recommendation or favoring by the United States Government or any agency thereof.

Thursday August 20, 2015

The Future of Retirement Is Now

The following is reprinted from the Center for Retirement Research’s August 18, 2015, Squared Away blog:

Gray, small, and distinctly female.

This is what the director of MIT’s AgeLab, Joseph Coughlin, sees when he peers into the future of retirement.

“The context and definition of retirement is changing,” Coughlin said earlier this month at the Retirement Research Consortium meeting, where nearly two dozen researchers also presented their Consortium-funded work on a range of retirement topics. Their research summaries can be found at this link to the Center for Retirement Research, which supports this blog and is a consortium member.

Coughlin spooled out a list of stunning facts to impress on his audience the dramatic impact of rising longevity and graying populations in the developed world, and he urged them to think in fresh ways about retirement. In Japan, for example, adult diapers are outselling baby diapers. China already faces a looming worker shortage, and Germany’s population is in sharp decline. In 2047, there will be more Americans over age 60 than children under 15.

“The country will have the demographics of Florida,” Coughlin said.

The attitudes and comportment of the ballooning population of U.S. retirees – baby boomers – will be more confident and less polite than their parents’ generation, he predicted.

The U.S. labor force is also graying with the aging population. The average age of physicians in this country is already 53, and it’s 49 for nurses, 51 for truck drivers, 56 for financial advisers, and 50 for engineers. In five years, more than one-quarter of the U.S. labor force will be over 55, according to the Stanford Center on Longevity. And an AARP study finds that 40 percent of boomers say they plan to work “until they drop.” But to assume you can keep working, because “you have a master’s or PhD is a joke,” Coughlin warned. “If you don’t stay aggressive about your learning, you’ll fall behind.”

When he says the future is “small,” he means family size is shrinking, with implications for retirees and the elderly. More Americans today than in the 1970s live in a household of one, especially women. In the 1970s, nine out of 10 women had children, but today just eight out of 10 do, he said. This points to a future in which there will be fewer children to care for aging parents. And fewer caregiving spouses: divorce among people over age 50 has also increased dramatically in recent decades.

As the population ages, he sees women, who tend to live longer, becoming more influential, because they already make decisions about retirement and child care. Women, particularly oldest daughters, also do the heavy lifting for parental care.

Older people today are “old but not sick,” but they have multiple chronic conditions, often managed with multiple medications. Aging in the home will be a prime location for the kind of technological innovations Coughlin’s AgeLab specializes in.

He predicted that seniors increasingly will rely on gadgets like implantable sensors to monitor their blood pressure or smart mirrors that detect worrisome changes in their health or gait. He even talked about a $100,000 pop-up house, so mothers-in-law can live (alone?) in their children’s back yard.

The future is here, and Coughlin suggests that everyone “really rethink the contract around what retirement is.”