This past week, I have been dealing with a person who is very concerned about preserving the money he and his wife have been able to save for retirement. He’s worried because he recognizes the amount he has saved will not suffice under his current financial plan. The person he’s working with has recommended they don’t withdraw more than 4 percent per year in order to ensure that he doesn’t run out of money, but that simply won’t meet their financial needs going forward.
Worse, based on current assumptions and conventional wisdom, 4 percent is really pushing it. According to Morningstar, the “safe” amount is closer to 3 percent.
In response to that, I have been able to put together a spending plan that would guarantee a 7.5 percent payout for life, with no possibility of running out of money. He likes it, but the whole “too good to be true” meme has reared its head and is threatening to derail his ability to have the retirement he could have.
The following are excerpts from emails he has sent to me, and my responses to him. I thought sharing how this unfolded might cast some light on it.
Question: Most of the folks I work with are dead set against annuities.
Answer: According to FINRA, of people who have actually purchased annuities, close to 90 percent are happy with their decision and would make it again. The people who are dead set against them are simply people who do not understand them. The retirement industry currently holds $16 trillion of retirement investments and charges between 1.5 percent and 4.5 percent on those holdings. This is an incredibly powerful force that is fully committed to the status quo and regards annuities as one of the key threats to that status quo. Why? Because hundreds of billions of dollars are moving from markets into annuities, and once there, that money never goes back. In short, the industry regards annuities as an existential threat. Would you want to see your gravy train go to some annuity producer?
Let’s start by understanding what an annuity is. It’s simply a contract between an individual and a life-insurance company that guarantees a payout for a defined period of time based on a premium paid to the insurance company. It is simply the reverse of a life-insurance contract where you pay the company over time and it pays your beneficiaries when you die. The same calculations, investments, rules and regulations apply, only in reverse.
Annuities offer two to three times the income you could get from market-based assets, the fees are much lower, and income can be contractually guaranteed for life. In addition, any and all unspent funds are returned to your beneficiaries, and you will receive a reasonable rate of return with no market risk. Please tell me what about all that is so bad, especially when compared to a market that has lost 50 percent of its value twice in the past 20 years, and is positioned to do it again at any time?
Question: A true fiduciary is not selling any products, and you are?
Answer: This is a misconception. As a Series 65 Investment Advisor, under the jurisdiction of the Investment Advisers Act of 1940, any advice I provide having to do with any securities or ERISA-based accounts (401ks), etc., falls under the Fiduciary Standard. This means I must put client interests over mine. There is much discussion about whether a commission-based adviser can maintain a Fiduciary Standard, but there is nothing in the statute that says he cannot. Traditionally, the test has been full disclosure of all benefits and disadvantages to both the client and adviser.
Virtually all life insurance, annuities and long-term care, disability and other insurances are sold on a commission basis. There is some that is not, but the offerings are rare and limited in scope and benefits. So is it reasonable, as a fiduciary standard, to eliminate a whole class of financial solutions from our discussions simply because of the way representatives are compensated? How could that possibly represent your best interest?
Under those rules, we would only be able to discuss risk-based, fee-based products. But in reality, fee-based advisers who charge a fee based on assets under management are also subject to potential conflicts. No one has ever been able to explain to me how is it less of a conflict to earn a percentage of the amount you have under management than to earn a percentage of what you put into an annuity, other than that the fee comes out of the client’s pocket and is paid continuously for as long it’s invested, and the annuity commission is paid only once, and not by the policy holder.
Question: What happens to our principal? How does legacy fit in?
Answer: Any unspent balances are returned to your beneficiaries, outside your estate, thereby avoiding probate. This is true whether you begin or don’t begin income, and whether we are paying income to you, both of you, or just your spouse.
Question: Are things different since the AIG government bailout? If the insurance company goes belly up, are you sure it will be able to fulfill its financial obligations? I know you mentioned regulations and reserves, but I wouldn’t be surprised if they were able to wiggle out of fulfilling their obligations via some technicality.
Answer: What would be the upside for the industry if that happened? The ONLY thing it has is the perception it can’t and won’t default on its promises. Once that certainty is destroyed, who would purchase their products? There is no upside for that for anyone.
As for the AIG 2008 situation, it didn’t weaken the insurance industry, it underscored its strength. At the time, AIG had about $400 billion in assets held in its general funds. It is domiciled in six to 10 states, meaning its various subsidiaries have headquarters in those states. AIG went to the various insurance commissioners of those states proposing to swap letters of credit for cash so it could bail itself out. In every single case, it was flatly refused based on the cold, hard fact that it’s not AIG’s money; it belongs solely to the policy holders.
Could it happen? I suppose if the entire financial system melted down, yes, but it’s important to remember that, according to the U.S. Department of Commerce, during the time of the Great Depression, the insurance industry pumped more than $18 billion into the nation’s economy. If you adjust the dollars based on percentage of GDP, using the average GDP of the 10 years of the Great Depression, that equates to around $3.2 trillion in today’s dollars! At the same time, its assets and ability to pay actually increased from $18,010,000,000 in 1929 to $23,334,308,702 in 1934, representing a gain of $5,324,308,702, or nearly $1 trillion in today’s money.