By Linda Koco
Contributing Editor, InsuranceNewsNet
The idea of using income annuities to generate retirement income took center stage in a new report just out from the United States Government Accountability Office (GAO).
The 79-page document says purchasing an income annuity from an insurance company is “an alternative to self-managing periodic distributions from savings.”
Although the report carefully avoids endorsing the products, it makes clear that the experts whom GAO has contacted are definitely recommending use of annuities in certain income scenarios. View the entire report here.
For example, the GAO researchers point out that their experts “tended to recommend that retirees draw down their savings strategically and systematically and that they convert a portion of their savings into an income annuity.”
Such conversion would be “to cover necessary expenses or opt for the annuity provided by an employer-sponsored defined benefit (DB) pension, rather than take a lump sum.”
GAO prepared the report in response to a 2010 Obama Administration request for information (RFI) about retirement income strategies. The Departments of Labor and Treasury had asked for a study on recommended strategies for retirees to use to ensure income throughout retirement, among other topics.
The RFI had followed President Obama’s Task Force on the Middle Class recommendation early last year that there be promotion of “the availability of annuities and other forms of guaranteed lifetime income.” The Obama push on annuities has caused a stir in annuity and income planning markets ever since, because is a sign that retirement income strategies are now on the national agenda. See related article here.
Those same professionals should be further buoyed by the new GAO report. Portions of it touch on points the annuity industry has been making about income needs and products for a long time. For instance, it cites today’s increasing life expectancy as one reason why the risk of outliving assets is a “growing challenge.”
Likewise, it says the ongoing shift away from DB plans toward defined contribution (DC) plans “may mean that increased retirement savings and other options for generating retirement income from savings, such as annuities, might become more important for retirees in the future.”
Perhaps not insignificantly, the report includes references to several sources often cited in insurance circles. These include National Association of Insurance Commissioners, American Academy of Actuaries, Insured Retirement Institute, Employee Benefit Research Institute, and the Securities and Exchange Commission. In one passage, the report cites an annuity offering from American General Life Companies.
These sources are in addition to the myriad of government sources, such as the Bureau of Labor Statistics and the Social Security Administration, that GAO often cites in its reports.
Pros and cons
The report gives ample airing to the pros and cons of using annuities for retirement income purposes, as gleaned from its research and interviews with unnamed experts.
On the pro side, it says income annuities can: help protect retirees against the risk of underperforming investments, the risk of outliving assets (longevity risk) and, in the case of inflation-adjusted annuities, the risk of inflation diminishing purchasing power. It also discusses how annuities provide risk pooling; can help deter over- or under-spending, and can help relieve retirees from the “burden” of managing their own investments.
On the con side, it says income annuities may be inappropriate or expensive for people who have predictably shorter-than normal life expectancies, and points out that funds used to purchase income annuities will no longer be available to cover large unplanned expenses. Also, it notes that immediate annuities that provide for bequests have higher costs, and that some experts are concerned about the risk that annuity insurers might default on making annuity payments.
As part of its research, GAO had asked experts to assess income strategies for five households that were near-retirement, based on 2008 data. The households were randomly selected from the lowest, middle, and highest net wealth quintiles and had varying types of pensions.
The experts saw places where annuities could work well and other places where they may not be useful.
For example, according to the report, the experts recommended that the two middle quintile households purchase annuities with a portion of their savings. However, the experts suggested that the lowest quintile household accumulate some precautionary cash savings before purchasing an annuity or investing in securities.
On the other hand, the experts suggested that the two households in the highest quintile had sufficient resources to go without annuities—“unless the individuals were very risk averse and felt the need for additional protection for longevity,” the researchers write.
One of the two middle quintile households did not have a DB plan. What to do then? According to GAO, the experts suggested this household should consider using a portion, such as half, of financial assets to purchase an inflation-adjusted annuity.
Another part of the report discusses five proposals that have been circulating in Washington about how to facilitate employee access to lifetime retirement income products — such as annuities — in DC plans.
The DC proposals came from industry, consumer, academic, and other groups, according to GAO. The ideas include not only a suggestion to revise the Safe Harbor Provision for selecting annuity providers but also one to “require” plan sponsors to offer an annuity as a choice.
The discussion of proposals includes some terminology that has not yet seeped into annuity circles, but about which annuity professionals may wish to be conversant.
One of the terms is “default annuity.” It shows up in a discussion of a proposal to encourage DC plan sponsors to offer a default annuity. According to the GAO, the annuity would serve as the participant’s election by default. Or, the proposal might “require an annuity as the default way to take pension benefits, as with DB plans.”
The concept is similar to the default option in 401(k)s which enroll employees automatically in the company 401(k) plan.
Another proposal calls for modifying the tax law regarding minimum distributions for what GAO calls “deeply deferred annuities.” Most advisors will stop scratching their heads about his term, once they realize that deeply deferred annuity products are none other than longevity annuities.
The fifth proposal is to modify spousal protection provisions in DC plans.
The GAO report includes a number of data points that may be useful for annuity professionals and income planners. Here are a few:
- Social Security benefits in 2008 were on average the source of 64.8 percent of total income for recipient households with someone aged 65 or older.
- Among those eligible to take benefits within one month after their 62nd birthday from 1997 through 2005, 43.1 percent did so. An estimated 72.8 percent took benefits before age 65.
- For households with someone aged 65 or older with income from assets, such as interest and dividends, the estimated median amount of asset income for households in the third (middle) income quintile was $1,022 in 2008. For those in the highest income quintile, the median was $8,050.
- In 2010, 29.1 percent of people aged 65 to 69 worked at least part-time and 6.9 percent of people aged 75 or older were employed.
- In 2008, among households with someone aged 55 to 60, the median net wealth for the middle quintile of net wealth was $339,000.
- In 2009, 94.4 percent of annuity sales were deferred annuities ($225 billion of the $239 billion), while sales of traditional fixed immediate annuities purchased to provide lifetime retirement income totaled about $7.5 billion (3.1 percent of total sales).
Titled “RETIREMENT INCOME: Ensuring Income throughout Retirement Requires Difficult Choices,” the report has been delivered to Sen. Herb Kohl (D-Wisc.) who is chairman of the Senate’s Special Committee on Aging.
Linda Koco, MBA, is a contributing editor to InsuranceNewsNet, specializing in life insurance, annuities and income planning. Linda can be reached at firstname.lastname@example.org.
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