Eric and Dick tackle the question of how much you should allocate to annuities when developing a sound retirement income and estate plan.

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**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.

GAO Report Tells Americans: Buy More Annuities!

The U.S. Government Accountability Office (GAO), a non-partisan federal agency focused on reducing wasteful government spending, has released a report entitled Ensuring Income throughout Retirement Requires Difficult Choices. The two most important choices involve:

• Delaying the age when you elect to start receiving Social Security payments; and
• Converting your cash-balance defined benefit pension into a lifetime income annuity rather than take a lump-sum payment upon retirement.

Social Security is Not Enough for Retirement

For those of you that think Social Security will meet your retirement needs, wake up! Given the massive debt overhanging the U.S. economy, the current generous benefits being paid out to retirees is not sustainable. As the GAO report states:

The cost of Social Security benefits is projected to exceed sources of funding, and the program is projected to be unable to pay a portion of scheduled benefits by 2036. In 2010, for the first time since 1983, the Social Security trust funds began paying out more in benefits than they received through payroll tax revenue.

Due to the long-term fiscal challenges facing Social Security, options for reform may result in lower benefits and reduced replacement rates from Social Security. As a result, reforms to the Social Security system may increase the need for retirement income from other sources such as private pensions.

Even under the current generous benefit schedule, social security cannot be relied on to fully replace a person’s pre-retirement salary. According to the GAO report, for low-wage earners (i.e., 45% of national average) social security replaces only 55.2% of pre-retirement income and for high-wage earners (i.e., 160% of national average) the replacement rate is only 33.9%.

by Jim Fink on April 19, 2012 at Investing Daily

Annuity Guys® Video Transcript:

Eric: Today we’re going to talk about what percentage of your portfolio should be allocated to annuities, and the magic number is, get right to the point.

Dick: Exactly 50%.

Eric: There you go, thank you very much for.

Dick: Video over. Wouldn’t that be nice?

Eric: Unfortunately, it doesn’t work that way. Everybody wants the magic answer of what exactly needs to go into an annuity?

Dick: Well, even the GAO which we’re going to talk about here, the Government Office of Accountability did a report last year in June that pretty much hit in July, and actually it’s even on the cover of our book that the GAO is recommending that everyone has more annuities and less securities, so that was the overall assumption that they were making.

Eric: I think it’s looking at the dependence people have on other; when you’re getting to retirement what percentage can you count on Social Security to cover, of your retirement income? The funny thing is you look at low income people in the article we utilized, it’s 55% of low income people, they’re income need is met by Social Security.

Medium wage earners is about a third of their expected income is met by the Social Security income, so how are you then going to supplement; what sources are you going to use to supplement your income and retirement after Social Security? Social Security is not going to do it.

Dick: Right. It won’t cover everything that folks need, so if we take—it’s hard to stereotype, because everybody’s situation is obviously different, but if we take what the GAO report is saying in a summary sense, and say that those folks that are somewhere in that median asset range, where they’re relying more on their Social Security that they would have a tendency to need to put a lot more of their portfolio into a safety and security, that will **guarantee their income throughout their life.

Eric: Right and we talk about this a lot with our clients in talking about the foundational portion of your income, so you take your building blocks. You know you’ve got Social Security, as much as we can count on it to be there. We always like to think of what the COLAs and the things, the increases are going to be.

Dick: Cost of living adjustments.

Eric: Yes, but are we certain that those are going to continue with the way that things are right now? You never know, so if you’ve got Social Security as the base, what do you need to add on top of that each month, to meet your monthly income need? That’s your foundation, a minimum amount, not your trips, not your fancy expenditures, but what’s your basic necessity expenditure need to be? Do we build that with– we always say build it with conservative CDs, annuities.

Dick: If you’re going to do investments, you may have it in bonds.

Eric: Look at the most conservative options out there and utilize those to build that income stream.

Dick: Right and this is where annuities do come in and they work so well, because the one thing that the CDs and the bonds and different things don’t address is longevity and that is outliving our money or another way to say it is, Eric just not dying on time.

Eric: That’s right. When we look at people that utilize CDs, they typically just pull the interest, but if you’re having to utilize the principal to meet those basic necessities that’s really where an annuity comes into play, because it gives you that added layer of insurance that you’re not going to outlive your income.

Dick: Exactly, and so it comes down to the percentage to allocate to an annuity some of this we find, when we’re working with our clients, gets down to that person’s risk aversion. Are they the type of person that’s basically grown their portfolio in a very safe and secure way, and they value annuities for what they do, in terms of safety, security, and controlled growth or are they the type of person that’s been very aggressive with their portfolio, so they’re very comfortable with not having much in safety and security. They may have a very large portfolio, and feel that they’ve got the room to have a very small foundation of safety aspect of corporeal.

Eric: If you’ve got such a large asset base that even if you shock tested it and said, “If we lost half of it and it still is enough to meet your basic income needs.”

Dick: Right, carry us through, throughout our lifetime, right.

Eric: Now for some people when they say, “What’s the percentage?” My answer’s always “The smallest amount that we need to meet that basic need.”

Dick: Exactly, and what we like to do and a lot of the advisers that we’ve worked with, like to do for clients is to look at that objective and figure out what that income need is, and then find the least amount of money that we have to spend to get the proper annuity that meets that need, and that could be Eric, an immediate annuity. It could be a hybrid style annuity.

Eric: Then it’s what options do you want? Immediate may give you a bigger payout, but you’re giving up your asset. A hybrid style may be a little bit less income, but you have a lot more flexibility, as well as some other options with long-term care potentially, or other rider pieces that come into play.

Dick: One thing, folks, that you really always want to keep in mind on anything that you allocate to annuities, especially if you’re allocating for some reason a lion’s share of your portfolio, you always want to keep something available that’s liquid. It should be fairly sizable, because we don’t know what type of emergencies might arise.

Eric: We always talk about inflation, and how are you going to gauge for inflation, and you’re better off to have assets out there that continue to grow, that can continue to work against inflation, especially if you’re set on a level, if you take an immediate income or an immediate annuity and it’s level, how are you going combat increases in expenses?

Dick: That’s one thing, folks where the hybrid style or the fixed index annuity with the income rider works so well. If you can maybe have a portion of your income that, if you need income right away, that you can go ahead and maybe set that up in an immediate annuity or one of your investments or some other area of asset in your portfolio that you can pull money from, while you allow that hybrid annuity to defer over five or ten years. It’s a great inflation hedge to get that income boosted up pretty dramatically.

Eric: I like to call it laddering annuities or laddering and if you haven’t seen that video you can actually look for that afterwards, because there should be one out there. There are strategies to basically, help you as the GAO says here.

Dick: We will put this on the blog site, so that you can see the full report and the article that we’re reading from that addresses Social Security, and again how to maybe, use strategies with annuities for Social Security. Eric, if I ask you the question this week what’s the proper allocation to put in an annuity?

Eric: My answer is the smallest amount that meets your foundational needs.

Dick: I like that. Eric did not say, “Well, it depends.” That’s my famous line, “Well, it depends.” I think you’re right Eric, and I think that it also depends on… Here we go. It also depends on the individual preference for safety and security. We have to always take that into account.

Eric: Yes, it should be suitable for your investment style. Very good; thank you very much for tuning in today.

Dick: Thank you.

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