Q: What strategies can retirees and financial professionals employ to successfully navigate the shift to retirement and create the opportunity for more security around retirement income and spending?
Dr: Pfau: We’ve experienced a transition in the U.S. from a pension-driven, defined benefit world to one in which people increasingly have to find a way to manage market risks and longevity risks on their own through defined contribution plans, like 401(k)s. Protected lifetime income in the form of annuities really provides an avenue by which a retiree can create a pension-like model, which helps avoid concentrating all that risk in one investment portfolio.
Dr. Finke: Between 1970 and 1990, the average dividend yield on the S&P 500 stock index was 4.2% and 5-year government bond yields averaged 8.5%. Today’s retirees and their financial professionals have to deal with income yields on stocks and bonds that are less than half that amount. That means it takes even more capital to generate retirement income from traditional retirement investments such as bonds or dividend-paying stocks.
Q: How can funding essential expenses with guaranteed income help mitigate retirees’ fears of running out of money?
Dr. Pfau: You can give yourself a better quality of life if you have a higher level of confidence that you’re not going to run out of money. That’s the danger of an investment portfolio only approach—you’re keeping that longevity risk and market risk on yourself, and people are too afraid to spend the money on the things that truly make them happy.
You might want to think about not having stock market investments responsible for supporting essential expenses. Instead, look at Social Security benefits, and if there’s still a gap and you would like to have additional reliable, guaranteed income to help cover the basics, that’s a great opportunity to look into some form of an annuity that offers protected lifetime income—whether that’s an immediate annuity or a fixed, index or variable annuity with a guaranteed lifetime withdrawal benefit.*
Q: What are the benefits of including guaranteed income, such as protected lifetime income from an annuity, in an investment portfolio to generate income?
Dr. Pfau: Simulations demonstrate that a strategy that offers a contractual guarantee for income supports spending goals more efficiently—and with less capital—than traditional retirement investments. This, in turn, creates more liquidity for other potential surprises and, in the long run, might support more robust legacy goals.
Dr. Finke: An annuity can help pool key retirement income risks such as longevity risk and market risk.
To learn more about enhancing retirement security with guaranteed income, download the complete Q&A.
*Annuity guaranteed lifetime withdrawal benefit features may be standard or optional. Additional fees, withdrawal parameters, age restrictions, and other limitations apply. With certain variable annuities, investment requirements may also apply. Guarantees are backed by the claims-paying ability of the issuing insurance company.
Annuities are long-term insurance products designed for retirement. Earnings are taxed as income upon withdrawal. Early withdrawals may be subject to withdrawal charges. Partial withdrawals may reduce benefits available under the contract as well as the amount available upon a full surrender. Withdrawals of taxable amounts are subject to ordinary income tax and, if taken prior to age 59½, an additional 10% federal tax may apply. If you fund your IRA with an annuity, you should realize that these types of retirement accounts are already tax-deferred. An annuity provides no additional tax deferred benefit beyond that provided by the retirement account itself. You should only use an annuity in a retirement account if you want to benefit from features other than tax deferral. Please consult with your financial professional and tax advisor regarding your individual situation.