2015 The Self-Made Pension

Transcription

1 2015 The Self-Made Pension Using guaranteed income to help secure the retirement you deserve Many workers in decades past relied on company pension plans to provide them with steady income through retirement. Today, you may be on your own, investing part of your paycheck in a 401(k) or other retirement plan that can experience significant losses, as we saw during the financial collapse of While traditional pensions are fading, annuities can allow you to build pension-like income that s designed to keep paying you, no matter what the markets bring, while protecting you from some of the biggest threats to your financial wellbeing in retirement. When used as part of a balanced retirement plan, this self-made pension, with a guaranteed minimum withdrawal benefit, can help you protect your hardearned money so that you can get closer to achieving the retirement you deserve. Inside: Understand the risks to your retirement Learn a new approach to protecting your retirement income Discover how a selfmade pension with a guaranteed minimum withdrawal benefit can strengthen your retirement portfolio All guarantees, including optional benefits, are backed by the claims-paying ability of the issuing insurance company. Annuities issued in all states except New York by Transamerica Life Insurance Company, Cedar Rapids, IA and in New York by Transamerica Financial Life Insurance Company, Harrison, NY. Annuities are underwritten and distributed by Transamerica Capital, Inc. References to Transamerica may pertain to one or all of these companies. Annuities may lose value and are not insured by the FDIC or any federal government agency. They are not a deposit of or guaranteed by any bank, bank affiliate, or credit union.

2 Are your goals still within reach? Are you comfortable that your financial plan will provide enough income to last you through retirement? Is your answer today different than it was only a few years ago? You re not alone. Only 18% of American workers say they are very confident they will have enough money to live comfortably in retirement. 1 The financial crisis of 2008 created a shift in the psychology of investors from greed to fear. Years later, this fear cycle still drives investing decisions. Most investors still seek vehicles designed to protect their assets, and many have turned their backs on equity markets. In fact recent research suggests Americans, on average, are leaving well more than half their portfolios in cash. 2 This fear cycle isn t an altogether bad thing. It has motivated many workers to save more, decrease debt, and build emergency funds. But an approach completely fueled by fear may hinder your ability to reach the finish line. Take control What do you think of when you imagine your financial future? Maybe you are traveling more or pursuing your passions full-time. Or maybe you want to be able to afford to live the lifestyle you want, with enough left over to give an inheritance to charity or to your family. Market declines have the potential to derail your retirement dreams. But there are strategies that you can use today that can help protect your portfolio from market downturns and other prominent risks, such as the inevitable effect of inflation, the certainty of taxes, the rising cost of health care, and the likelihood you ll live longer than you expected. With professional planning, these new strategies can make the difference in helping you achieve your retirement goals. 1 Employee Benefit Research Institute, The 2014 Retirement Confidence Survey, March U.S. Investor Pulse Survey 2014, BlackRock Time for a new strategy 18% Only 18% of American workers are very confident they will have enough money to live comfortably in retirement. 2 Self-Made Pension

3 Product allocation: A three-part retirement income strategy Traditional investments Stocks, bonds, mutual funds, and other conventional accumulationbased instruments Pensions and immediate annuities Pensions and immediate and deferred income annuities that offer lifetime income Guaranteed living income benefits Financially engineered products that offer guaranteed lifetime income, such as a variable annuity with a GMWB, often referred to as a living benefit A new approach to retirement planning There are many old rules of thumb designed to predict whether one s savings will be enough to provide income throughout retirement, but they might not work today. Remember the 4% rule? It said that withdrawing 4% of assets from a portfolio each year would provide a steady stream of income while maintaining a sufficient account balance. We re finding out it s not that simple. The 4% rule is under heavy scrutiny today due to low interest rates, longer life expectancies, and the possibility of a prolonged market downturn in the first few years after retirement. In fact, a prominent 2013 study concluded that the 4% rule is more like the 2.8% rule. 3 A new strategy to consider? Product allocation. Faisal Habib, president of the Quantitative Wealth Management Analytics (QWeMA) division of CANNEX that provides consulting and product services in the income and wealth management fields, points to three main categories of financial tools that can help imitigate risks in retirement: traditional investments pensions and immediate and deferred income annuities guaranteed income living benefits It s now up to individuals to build or pensionize part of their nest egg to create a guaranteed stream of income in retirement, Habib said in a nod to industry academic and author Moshe Milevsky, who has written about pensionizing your nest egg. Our discussion in this paper focuses on an option falling within the third category of financial tools: a variable annuity with a guaranteed minimum withdrawal benefit (GMWB). The value of a variable annuity with a guaranteed minimum withdrawal benefit can rise if the market performs well but will never fall below an established minimum as long as withdrawals do not exceed the allowed amount. Variable annuities allow you to choose from a variety of investment options that are subject to market fluctuation, investment risk, and possible loss of principal. Variable annuity fees and charges include mortality and expense risk fee and administrative charge (M&E&A), surrender charges, and investment option management fees. Additional fees may apply to optional benefits. No matter what happens with the markets, this income option provides genuine security that you will have a guaranteed income stream for as long as you live, backed by the issuing insurance company. This is why a variable annuity with a guaranteed minimum withdrawal benefit can be considered one type of self-made pension. 3 Michael Finke, Wade Pfau, David Blanchett, Low Bond Yields and Safe Portfolio Withdrawal Rates, 2013 Self-Made Pension 3

4 Risks to retirement income We can boil down all of the major risks to your retirement lifestyle to one culprit the unknown. But to be more specific, it s a matter of your health, your purchasing power, how long you live, how much you will pay in taxes, and what happens in the market. Before discussing how to protect against these risks, we ll explore each of them in a little more detail. Health care the uncertain risk Health care is top of mind for nearly every person approaching retirement, but many do not realize it is one of the primary reasons people run out of money in retirement. Further complicating this issue is the broad spectrum in which your health care expenses can vary and how often the rules followed by thirdparty insurance providers can change. According to the Employee Benefit Research Institute, the average Medicare-eligible woman who has a good chance of outliving her husband has a 50% chance that $83K will be enough to cover health care in retirement. If you want 90% assurance, plan on setting aside $131K. 4 Inflation the silent risk Humorist Sam Ewing explained the relentless march of inflation as paying $15 for the $10 haircut you used to get for $5 when you had hair. What appears to be sufficient savings today may end up not being sufficient at all. The average woman eligible for Medicare would have to set aside $131,000 to have a 90% assurance of having enough to cover health care in retirement. 50% chance this will be enough 90% assurance this will be enough $83,000 $131,000 4 Employee Benefit Research Institute, October Self-Made Pension

5 Inflation s impact on your purchasing power The chart here shows how inflation can erode your purchasing power over time. Considering a 3.5% inflation rate, a $1 million retirement portfolio would purchase less than $300,000 of the same goods and services in 35 years. In this scenario, imagine how quickly your buying power would decline once you start making regular withdrawals. $1,000,000 $600,000 $200, Years 20 Years 30 Years 35 Years Based on 3.5% annual inflation rate Projected price of items in 2048* $6.49 $9.63 $5.31 $16.49 $28.29 Loaf of Bread Gallon of Milk Dozen Eggs Pound of Ground Beef Single Movie Ticket * Totals based on average prices for 2012 as reported by thepeoplehistory.com, adjusted using a 3.5% annual inflation rate. Self-Made Pension 5

6 Longevity the unexpected risk One of the most understated aspects of retirement planning is that most people can t wrap their heads around how long they are expected to live after retirement. The average American believes he or she will retire from all paid employment at age 65 and die, 20 years later, at age Those expectations far underestimate the data. According to actuarial projections, males who reach the age of 65 have a 20% chance of reaching age 89. For women, it s age Failing to factor longevity into your retirement income plan accurately could leave you short of income at a vulnerable time in your life. Taxes the inevitable risk If you retire and remain in today s top income tax bracket, you could wind up losing more than one-third of your income to taxes each year. Even more daunting is the thought of future tax increases. There are many strategies for managing the impact of taxes, especially as you withdraw funds during retirement. Consider these strategies carefully, and consult a tax professional to determine what effect taxes will have on your retirement income. Market performance the sequential risk You have no way of knowing how the market will perform shortly before and 5 The Changing Face of Retirement: Aegon Retirement Readiness Survey Source: American Society of Actuaries; data based on non-smoking individuals and couples The estimated chances of an individual or a couple who is 65 living to certain ages... 50% chance of living to 20% chance of living to Male Age % chance of living to 20% chance of living to Female Age % chance of living to 30% chance of living to Couple Age Self-Made Pension

7 shortly after you retire. This seems like an obvious thing to say, but it alludes to perhaps the biggest threat to your retirement income plan. Sequence of returns, or sequence risk, is the possibility that market downturns will occur around the time you start withdrawing your retirement savings. A series of illtimed downturns could force investors to recoup losses while drawing down assets. Combined with the possibility that many Americans are living longer, this could cause investors to significantly decrease their standard of living in retirement. Sequence risk is most prominent during the years immediately before and immediately after withdrawals begin. Let s look at a hypothetical example in the chart below. In this example, two investors each start retirement with $100,000 and take the same withdrawals of $5,000 per year, but they have very different results. Why? Because each experiences a very different market. By taking a deeper look, you can see the average returns for each investor over a 15-year period are the same. What s different is the order of the returns, which has been reversed. Despite having the same average annual return, Investor A earns $70,055 more than Investor B due to their sequence of returns. How sequence of returns can affect a portfolio Investor A retires at the beginning of an up market 103, , , , , , , , , , , , , , ,944 year start $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 8% 5% 11% -6% 18% -15% 14% -8% 12% -4% 9% 5% 5% 7% -4% 9% 11% -8% Average return: 4.0% -15% -6% -5% 7% 9% 11% 9% 12% 14% 18% 11% 8% Average return: 4.0% Investor A has $105,944 in year 15 GAP $70,055 Investor B has $35,889 in year 15 $0 year start ,000 79,600 62,660 52,647 45,541 42,818 40,816 39,489 38,833 37,328 36,807 36,960 38,613 37,860 35,889 Investor B retires at the beginning of a down market This is a hypothetical illustration and does not represent the results of an actual investment. It does not reflect any investment fees, expenses or taxes associated with investments. An average annual return of 4% is reflected for both investors over a 15-year period. Annual withdrawals of $5,000 are taken at the end of each year. Self-Made Pension 7

8 Protecting your portfolio So now we know the risks. Let s discuss, step by step, our strategies to address them. Product allocation Traditional asset allocation strategies that divide portfolio assets into stocks, bonds, and cash can help cushion a portfolio from market risk, making them valuable tools for accumulating wealth. However, they cannot ensure a dependable income stream once you begin to take withdrawals. With a product allocation strategy, you can incorporate traditional investment strategies with guaranteed income tools. This can be accomplished using three categories of retirement income strategies: Traditional investments These include separately managed accounts, exchange-traded funds (ETFs), mutual funds, and other conventional accumulation-based instruments. Throughout retirement, you systematically withdraw these assets, attempting to make them last as long as possible. You use asset allocation in an effort to achieve a desired return with an acceptable degree of risk. Pensions and immediate annuities These include defined benefit plans and fixed income annuities (payout annuities). In exchange for fixed income payments, you give up liquidity, investment control, and, in some cases, the ability to leave any of these assets to heirs. Guaranteed living income benefits These include deferred variable annuities with living benefits such as a guaranteed minimum withdrawal benefit (GMWB). These offer income for life, exposure to market gains and losses, and a little more flexibility in investment choices. They are also designed to leave remaining assets as an inheritance. Because these instruments can provide income for life, tools in this category can provide protection against sequence risk. Think of these as a pendulum swinging between the pure investment and pure pension categories depending on market conditions. When times are good, the account potentially increases in value, like a stock or mutual fund. When markets fall, the pendulum swings in the other direction by providing steady income, like an income annuity or a pension. How much money you should allocate to each category depends on many factors, including your expected retirement age, health status, desired withdrawal rate, inflation assumptions, financial goals, and more. A three-part retirement income strategy Traditional investments Pensions and immediate annuities Guaranteed living income benefits 8 Self-Made Pension

9 How the GMWB works Guaranteed living income benefits, pensions, and immediate annuities all focus on offering guaranteed income for life. However, there are important differences. With immediate annuities, you purchase an annuity contract with a lump-sum payment. In return, the insurance company promises to pay you an income stream for as long as you live. On the other hand, the GMWB is a rider to a variable annuity contract. This means you get ongoing access to your money, and you can control how your assets are invested if you stay within your withdrawal limits. In fact, most providers offer a number of investment options, including stocks, bonds, asset allocation portfolios, international investments, and cash. While GMWBs have limitations that vary with some providers, they generally provide a wide range of choices that allow market participation. Provided you don t take more than the guaranteed withdrawal amount in any year, the GMWB guarantees you will receive income for as long as you live even if your policy value goes to zero. If the market performs well, the benefit base (the basis for calculating your guaranteed withdrawal amount) may be stepped up, increasing your guaranteed amount. With some GMWBs, you may earn a bonus to be added to the benefit base, which increases your future guaranteed income if you wait until a specific time has passed before making withdrawals. Income from a variable annuity with a GMWB The chart below shows how the benefit base and guaranteed withdrawal amount of a variable annuity with a GMWB is protected during different market cycles. The guaranteed income never decreases during flat or down markets and steps up when the contract value exceeds the current benefit base. Note that the benefit base is not a cash value and does not guarantee a return on the investment. What about fees? GMWB riders assess a fee in addition to variable annuity charges. This may be calculated as a percentage of the policy value or the benefit base. Variable annuities with GMWBs can be more expensive than other investments, but it s important to remember these expenses are critical to supporting the guarantees that ensure you will not outlive your retirement income. You could instead purchase an immediate or deferred income annuity at a lower cost, but it would come at the expense of liquidity. A financial advisor can help you determine which type of annuity might be right for you. Growing your guaranteed income Bonuses and step-ups are designed to help grow your guaranteed withdrawal amount. During down or flat markets, you may earn a bonus to grow your benefit base, providing no withdrawals are taken. If your contract value increases, your benefit base can step up, locking in your gains. % Benefit Base* % Initial Investment % Contract Value Policy Year *Your benefit base is the basis for calculating your guaranteed withdrawal amount. Withdrawals of taxable amounts are subject to ordinary income tax and may be subject to a 10% additional federal tax if withdrawn before age 59½. All guarantees, including optional benefits, are backed by the claims-paying ability of the issuing insurance company. Self-Made Pension 9

10 The GMWB at a glance Guaranteed minimum withdrawal benefits allow you to... Retain access to your money Give your assets a chance to keep pace with inflation by staying invested in the market throughout retirement Withdraw the guaranteed amount each year, even if your policy value reaches zero* Earn automatic step-ups to your guaranteed amount when the market performs well *Certain conditions may apply. What to look for Like all insurance, guarantees are only as good as the company making them. When choosing an insurance company to provide lifetime income benefits, consider choosing a company with a long track record of weathering up and down markets and one with strong ratings from various agencies. In addition, you should make sure you feel confident in what you are buying. One has to be mindful of exactly what is under the hood, Habib said. He suggests evaluating factors including fees that you will be charged, withdrawal rates, bonus or step-up terms that could boost a policy s withdrawal base, when you are eligible to start receiving income, and how much exposure your account has to investments with high risks but also potentially high rewards. While ratings can be objective indicators of an insurance company s financial strength and can provide a relative measure to help select among insurance companies, they are not guarantees of the future financial strength and/or claims-paying ability of the company. The broker-dealer from which an annuity is purchased, the insurance agency from which an annuity is purchased, and affiliates of those entities make no representations regarding the quality of the analysis conducted by the rating agencies. The rating agencies are not affiliated with the above-mentioned entities nor are they involved in any rating agency s analysis of the insurance companies. Ratings reflect the current opinion of the relative financial strength and operating performance of the company and do not apply to variable annuity subaccounts. All contract and rider guarantees, including optional benefits and any fixed subaccount crediting rates or annuity payout rates, are backed by the claims-paying ability of the issuing insurance company. 10 Self-Made Pension

11 Conclusion The financial crisis created an unprecedented demand for a way to guarantee lifetime income during retirement. While traditional asset allocation approaches may help you build wealth during your accumulation phase, a product allocation approach can more adequately address the risks that threaten your financial security and independence once you begin taking withdrawals. A variable annuity with a guaranteed lifetime withdrawal benefit can be a key component of a self-made pension. This is because it s the one aspect of the product allocation picture that gives you the security of guaranteed income, while providing the opportunity to benefit from market gains. It also provides ongoing access to your money and the potential to leave an inheritance to future generations. This option can give you the confidence to invest even when you re uncomfortable with the markets, enabling you to make financial decisions based on your goals instead of your emotions. Talk to your financial advisor to learn more. Self-Made Pension 11

12 Before investing, consider a variable annuity s investment objectives, risks, charges, and expenses. Call for a contract and fund prospectus containing this and other information. Please read it carefully. Variable annuities are long-term financial products designed for retirement purposes. They offer three main features: tax-deferred treatment of earnings, guaranteed lifetime payment options, and guaranteed death benefit options available prior to annuitization. They contain investment options that are subject to market fluctuation, investment risk, and possible loss of principal. All contract and rider guarantees, including optional benefits and any fixed subaccount crediting rates or annuity payout rates, are backed by the claims-paying ability of the issuing insurance company. They are not backed by the broker-dealer from which this annuity is purchased, by the insurance agency from which this annuity is purchased, or any affiliates of those entities, and none makes any representations or guarantees regarding the claims-paying ability of the issuing insurance company. AWPSMP Transamerica Capital, Inc.