What are the risks everyone will face in retirement? We recently received a list of retirement risks prepared by the financial planning team at Global Financial Private Capital. This list comes as close to encompassing all the risks that retirees face as we have seen. Annuities do not answer or alleviate all of these risks, but they can control a significant number of the risks retirees have to consider.
This week Dick and Eric discuss the first 14 risks and how an annuity can be utilized to address some of these potential concerns.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
- Longevity Risk – Outliving retirement resources by living longer than planned.
- Excess Withdrawal Risk, also known as Portfolio Failure Risk – The depletion of retirement assets through poorly planned systematic withdrawals that lead to the premature exhaustion of retirement resources.
- Inflation Risk, also known as Purchasing Power Risk – When the price of goods and services increases in such a way as to impede the client’s ability to maintain his/her desired standard of living.
- Long-term Care Risk – When dementia and/or physical impediments restrict a person from performing the activities of daily living and may require him/her to outlay significant resources for custodial or medical care.
- Incapacity Risk – As a result of deteriorating mental or physical health, a retiree may not be able to execute sound judgment in managing his/her financial affairs and/or may become unable to conduct his/her financial affairs.
- Health Care Expense Risk – Not having adequate medical insurance.
- Investment Risk – Losing money in the financial markets.
- Asset Allocation Risk – Losing money in the financial markets due to inadequate diversification.
- Market Risk – Events cause all stock market prices to fall.
- Sequence of Returns Risk – Receiving low or negative returns in the early years of retirement which will lead to a long-term negative effect on the ability of the retirement portfolio to provide the needed income.
- Reinvestment Risk – As higher-yielding fixed income investments mature, the client may be forced to reinvest that principal in a lower-yield fixed income investment.
- Forced Retirement Risk – Work ends prematurely because of poor health, care giving responsibilities, dismissal by the employer, lack of job satisfaction, or other reasons.
- Business Continuity Risk – The employing business closes and the client is unable to amass the appropriate amount of retirement resources.
- Public Policy Change Risk – An unanticipated transition in government programs such as Medicare and/or Social Security that were embedded in the retirement planning process to the point where they will not provide sufficient protection during retirement.
Annuity Guys® Video Transcript:
Come back next week to see the next 14 risks people with face in retirement.
DICK: Eric, there’s so many risks that we face in retirement and I know that you’ve put this list together. You didn’t actually put it together.
ERIC: With the help of some certified financial planners.
DICK: Right, that’s right; and amazingly, and we’re not saying this is exhaustive but it would appear exhaustive; 28 reasons– 28 ways that retirees are at risk.
DICK: And I don’t think that there’s any way we can actually get through this in one session, so let’s call this part one.
DICK: Hopefully, we’ll get it done in part two but these, folks these are important. We’ll go through these one at a time. Annuities do not answer or solve each one of these.
ERIC: Not all of them.
DICK: But there are several that an annuity can…
ERIC: Impact an end player. Yeah, there are at least 11 of them, by my count. Basically annuities have the ability to negate or assist with and there’s a few more that there are options that you can add to an annuity that would help take care of some of these things.
DICK: Right. Let’s start off with number one here, Eric, longevity risk.
ERIC: Okay, and longevity risk is the first and foremost one that annuities take care of, because when you purchase an annuity you’re looking for lifetime income, typically.
DICK: So when we talk about longevity risk we’re talking about living too long.
ERIC: Too long. Yeah, living longer than you planned. Oops, I’m still here, right?
DICK: You’d have had enough money if you would have just died on time.
ERIC: Right, yeah. So that number one risk that longevity risk is really the one that fits hand and glove with annuities, because you don’t have to worry about outliving your money.
DICK: Right, which can be accomplished through immediate annuities, hybrid annuities even a variable annuity# can be annuitized.
So really virtually any form of annuity can solve longevity risk, if you have enough money and you’ve positioned it in the right way.
DICK: And we would contend that this is like a pension plan.
ERIC: Exactly, you’re self-directed pension, basically. So, all right, should we move on to number two?
DICK: Let’s go.
ERIC: Okay, excessive withdrawal risk, also known as portfolio failure risk.
DICK: Can you say that again?
ERIC: No, I have to read that.
ERIC: Portfolio risk.
DICK: Okay, so what we’re really talking about here is actually not having enough money, for the amount of money that you’re pulling out.
ERIC: It’s very similar to longevity risk in the sense of you think that you put yourself on the clock, you have five years-worth of income.
DICK: I’ve got a half a million dollars, Eric.
ERIC: I can spend, I can spend; I can spend. And you’re just basically outspending what you’ve saved. Right. Your expectations…
DICK: So you really don’t have a plan. You’re just spending, because you feel that you’ve got quite a bit of money. And so that’s—you know, there’s some other things we need to talk about on that, but we’ll be coming up to that in a little bit. Now we look at number three here, this is one that I think everyone is concerned about in general terms and that is inflation risk.
DICK: Losing our purchasing power and let’s talk about that, and how annuities might make a difference.
ERIC: Well, obviously, there are ways to structure annuities to give yourself an increase in income. Some of them have a staged series, where you can take a 3.0% increasing income across your life.
ERIC: Others have options that tie to an index, and there are even options now to tie it to the CPI or a version of the CPI, consumer price index. So those are ways to help guard against inflation with an annuity.
DICK: Right. So let’s just say, maybe in a simplified way, when it comes to using annuities for inflation that there are probably a couple of variations. One is an immediate annuity that will give you– or annuitization of a deferred annuity that will allow you to have some kind of a **guaranteed increasing income or there is another way to offset inflation and that is, you don’t need the income now so you can defer it and you can get a very high rollup rate, maybe in the 7.0% range that will allow your money to grow for future income needs
ERIC: Yeah, we call it, laddering is basically laddering annuities, so that you’re saving some out there. You may hope you never have to turn them on, but they’re there, in case the cost of living grows so much that you’ve outlived your income, so you need more.
DICK: Right. Okay, long term care.
ERIC: Oh, it’s only number four. Yeah, so long term care risk. I mean and people I mean none of us want to think about losing, the kind of the physical…
DICK: Sure. Going into some institution…
ERIC: And we talk about the activities of daily living, you know?
ERIC: Being able to button your shirt, being able to do the small things. There are things that if you all of the sudden you can’t do all those things on your own, how do you adapt so that your ability, and bring those resources in to take care of that situation so you can still have a comfortable, you know.
DICK: Well, I’ve seen these situations with clients where—I mean the first thing that we think of is being institutionalized, nobody wants to be institutionalized. And yet, many times that’s not the even the bigger concern, sometimes it’s just home health care. How do we get someone to come into our home and be able to afford them? Because that can actually be, sometimes even be more cost prohibitive, because it’s 24/7 care in your home.
DICK: Sometimes or it could just be a supplement. You’re right.
ERIC: Right, but it’s paying for that resource. Did you anticipate having to take care of that need?
DICK: And long term care with annuities there are different ways that we can provide some long term care benefits, supplement or maybe even, a full long term care plan with an annuity.
ERIC: Right, so there are pieces, riders typically, that you can utilize in annuity to basically make those kinds of contingency plans if you need them, but that’s one of those risks that’s out there that really needs to be addressed quite often.
ERIC: The next one, incapacity risk, now that sounds really deadly when you, but it’s– I have a family with a history of Alzheimer’s so it’s the mental, losing that physical, the ability to make the decision. We don’t say that the annuity takes care of this but what happens, if you can’t make those financial decisions?
DICK: You have to have planned in advance, because if you can’t make the decision, a decision’s going to be made for you and it may not be the person you want making it or the decisions you want made, so a little advanced planning can make a big difference.
ERIC: Right, so the financial matters, it’s not having the physical mental capacity, to take care of your own financial matters.
DICK: Health care, number six, health care expense.
ERIC: I think this is becoming more and more of an issue that’s coming into the forefront, with everything that’s going on. It’s what medical insurance going to cost? How much are we going to have to expend out of our pockets, especially as an aging community?
DICK: And this is one of the things that I have frequently discussed with clients and that is that they will inevitably say, “You know, I’m going to need more money in the beginning, because I’m going to be traveling and I’m going to be doing this, that and the other thing. So as I age, I won’t need as much.” But what they’re not counting into it many times is the cost of health care, and that’s the wild card. There are more and more things that are becoming electives that you have to pay for out of your pocket, so if you want a high quality of life, you’re going to pay for some of these things yourself in the future.
ERIC: Yeah, you don’t think about—yeah, you may be on an 80/20 plan, which seems like a great thing well, all of the sudden your portion of that 20% is getting to be a lot more expensive as you age.
DICK: Right, so I think that health care expense is a big risk that retirees face.
ERIC: Yes. So our next one here is investment risk which is obviously, if you’ve got money in the markets, the risk there of losing money in the financial markets. So a lot of people will put a portion of their money out there, still leave it in the equities. Well and there’s a chance that the market’s going to go up and the market’s going to go down.
DICK: Well, in a very general sense, Eric, the way that we like to discuss this with our clients in general, is if you have discretionary income, money that you can afford to lose. Then you may want to have it in the market or some in the market. But when it comes to that portion of your money that you want it to be secure and safe, annuities can be very effective in this area.
ERIC: And we talked about foundational income, protecting, having your covering your basic needs and basic necessities, with the foundational level of income. You know stuff that’s in the market you don’t have the time, sometimes to recover. It’s a risk-reward aspect, you have to realize those are higher risk, higher reward settings. You may not have the ability to recover as a retiree.
DICK: Yeah, these next couple here, Eric. Number eight and number nine are somewhat tied into the same risk area. One is asset allocation risk, having inadequate diversification.
ERIC: Yeah, and when we talk about asset allocation usually most people in the equities think, small cap, large cap, bonds, exposure. There are really more safe money positions, in addition to that, but it’s allocating across multiple places and making sure that you’re not having all your eggs in one basket. It’s simple. Don’t use that silver bullet. It may work very effectively for a big growth, but then all of the sudden it comes crashing down.
DICK: Right. You know when we look at annuities, there’s a lot of talk about non-market correlated assets, and annuities are very much non-market correlated, and you’ve also got an additional level of security and protection because annuities are basically secured, many times with very high grade investments and bonds, even government treasuries. So you’ve got the claims paying ability of the insurance company, actually even **guaranteeing another level above those bonds, which you don’t have if you buy the bonds directly.
ERIC: And here we’re talking about fixed annuities.
DICK: Fixed annuities, right.
ERIC: We should always be, the caveat there, if you’re in a variable annuity#, you’re going to have…
DICK: You’re going to have the investment risk.
ERIC: Exactly, and then market risks, which is of course…
DICK: Stocks fall.
ERIC: Yeah, it’s events that we’re looking at things right now. You look at what’s going on in Europe. It’s causing our market to fluctuate both up and down.
DICK: A lot of things that are out of our control. In the sequence of returns risk, this kind of ties back into one of the early ones that we had talked about and that was excess withdrawal risk and that’s when you’re…
ERIC: But it is tied into the market, as well.
DICK: Yes it is.
ERIC: We talk about a dollar cost averaging. Well, this is the reverse of that. When you’re putting in you’re going to buy more at the low times than at the high. Well, the same happens when you’re pulling out, by odds you’re going to pull out more at the low times. Well, you’re reducing your principal more quickly then, and so it’s that sequence of returns.
If you actually get negative returns while you’re pulling money out, you don’t get the advantage of compounding. So it really does become a much bigger impact when you’re using equities, as that safe storage place for your retirement plan, and so you have to be careful about sequence of it, and you can’t control it.
DICK: You cannot control it and there’s unfortunately, long periods of time where the market does go in a negative or in a flat position and you can really get yourself in a bad situation, especially when you’re in or near retirement. When you’ve got a lot of time ahead of you, and you can wait things out, it’s completely different then when you’re in retirement, and you’re very vulnerable.
ERIC: The next one’s kind of an interesting aspect, and its reinvestment risk. And we’ve had a lot of it lately especially with the people we’re talking to, and it’s basically, when your investments mature.
DICK: Like CDs?
ERIC: Like CDs right now. I don’t know how many people I’ve talked to that said “Hey, my CD was at 5.0%, it’s coming up due, and they’re offering me 0.8% for five years.
DICK: They’re in shock.
ERIC: Yeah. So, you thought you were getting a good deal when you did it, and by today’s series you did, and then, all of the sudden, it’s at maturity. Well, if you were living off that interest, that 5.0%, you were just pulling that interest to live off. Now it’s matured, what do you do?
DICK: Well, and this is where an annuity properly positioned, the right strategy, could even be a pre-issued annuity with a high yield, so there’s a lot of things that annuities can solve in this area, especially really when there’s no yield to be found in the banking instruments.
ERIC: Yeah, you usually think of things—you always hope will be higher when you come out. In this case, what happens if they’re lower?
DICK: You know this number 12 here, forced retirement risk, now you run into this quite a bit where someone maybe is relying on a younger spouse that’s working or maybe the two of them are healthy, and they believe that they have this many more years to work and then they’re forced into retirement.
ERIC: Right. Well and it can be their own doing. It could be the business’s doing. Something happens to them, that they have poor health. One of them gets injured on the job, all of the sudden, having 15 more years of anticipated work, turns into 2 or zero and now you don’t have that income or that level of income, to basically continue planning or preparing for retirement.
ERIC: It’s become a lot more prevalent with how companies are kind of moving and downsizing.
DICK: Well and this is where with the flexibility of a deferred annuity, you can actually have your money earning and preparing for that day, even though, you don’t know what day that’s going to be. There’s enough flexibility, if it’s set up right that you can turn that income on when it’s needed.
ERIC: The business continuity risk is really what I was kind of alluding to in that, what if the business closes? What if you work for a small business and it doesn’t have to be a small business. You can look at what just happened with GM, we were on the verge of hundreds of thousands of people being out of work.
DICK: And then there’s been, is it Ford or GM that’s just recently done the…?
ERIC: Well, they both did. The pension change…
DICK: The pension changes, right. They forced people into choosing new options and foregoing what they thought they had.
ERIC: Right, so you think you’ve got your retirement taken care of and in this case, it’s still stable but your options change. How they’re funded it changes. What you expect to happen from the business being able to fund your retirement.
DICK: Hey, Eric. We’re kind of about halfway through here. Maybe we’ll call this our part one, but let’s take on number 14. I think this is a big deal. I think we’re in a lot of flux right now and that’s public policy change risk.
ERIC: Yeah, what do you do if the government changes the rules on you or basically, it could be the insurance companies, I guess too, but in this case we’re usually talking about the government?
DICK: Or forcing insurance company rules, you know to change, so we’re got, right now we’ve got our health care.
ERIC: Health care. Social security is in flux.
DICK: Medicare. State Medicaid programs.
ERIC: That’s right.
DICK: And then just all of the tax, which I think we’re going to get to that in part two, but all of the public stands that are being taken in what’s going to be taxed, what isn’t going to be taxed. How investments are going to be handled, capital gains, how insurance will be treated.
DICK: Roth’s everything’s on the line.
ERIC: I mean here in Illinois we’re having problems with public employees. Their pensions are basically going to go away.
ERIC: And that’s the threat anywhere, of what’s going on here.
DICK: Exactly, and throughout the United States to various degrees.
ERIC: Exactly, so what happens if a public institution changes the rules, on how things are going to have to happen?
DICK: So again, all we can work with is what we have in the present, and know that in many instances especially going back, those that have entered into something in good faith, such as certain life insurance policies, and that type of thing that had tax benefits, they typically were grandfathered in, and then those new ones trying to get in were disallowed.
ERIC: Right, you have to plan based off the rules for today and you hope that the game doesn’t change.
DICK: Folks, this has been more of a little bit serious time of reflecting, on the various risks that retirees face. These are very real risks and Eric and I, deal with these on a regular basis with our clients and so we really wanted to take this in, kind of a serious sense, and take our time on them to some degree. So these first 14, call it part one?
ERIC: I think that’s probably, this is probably a good stopping point, but we’ll continue to go through this list next week.
DICK: Yes, talk about them individually.
ERIC: Because these are things, I think as you’re planning your retirement, these are questions you have to ask, ask yourself. I mean hopefully, your financial adviser that you’re working with, is asking you these questions as well, but you have to have a plan, or at least the ability to say “What are we going to do if this happens?” And so it’s a good strategy for us to, kind of go through all these pieces, lay them out there for you and give you some options to prepare your own answers.
DICK: Right, very important exercise. So thank you for taking your time with us and look for us next week and we’ll go over some other details on risks to retirees.
ERIC: That’s right, 14 more coming next week.