by Brian Hufford, CPA, CFP®
Never has there been a time when retirees need good strategies to safeguard retirement income throughout a long retirement. The combination of increased life expectancies and near-zero income creates the need for a new retirement thought process.
Currently, financial planners use a paradigm of "safe withdrawal rates” and "expected returns” for different allocations of stocks, bonds, and cash to chart a higher probability of retirement success. Inflation and Social Security are somewhat unfathomable variables in the equation, further complicating the process of achieving a confident outcome. Unfortunately, the use of mathematical probabilities can seem somewhat hollow when one's life is at stake -- "Mr. Hufford, you have an 80% probability of not spending your final days in a flophouse.”
The current breakthrough for how to improve the probability for retirement success is coming through the combination of two unlikely bedfellows -- traditional investments and insurance products. In the financial advisory world, the possibility of combining the two for a retirement strategy carries the same likelihood as the creation of a new political party called either Dempublicans or Republicrats.
Fee-only investment advisors avoid commissioned products from insurance companies, and insurance salespersons tend to recommend only complex annuity or whole-life products. It tends to be an all-or-nothing world in both camps.
To illustrate the potential for a breakthrough, let's use a simple case study of a 65-year-old male who has $3 million in retirement savings and would simply like an inflation-adjusted income of $150,000 per year exclusive of Social Security benefits. This amount of income represents a 5% withdrawal rate on the $3 million portfolio (5% x $3 million = $150,000). Let's also assume that this case study needs to create the highest probability of success for 30 years of retirement.
The insurance product that seems to hold the most promise for a retirement breakthrough is called a Single Premium Immediate Annuity. This is perhaps one of the oldest of annuity products. In exchange for a lump sum of money, the retiree receives guaranteed periodic payments for life from the insurance company.
In our case study example, a single male in today's world could likely achieve a lifetime payout of approximately 6% of the initial premium. Retirement problem solved: guaranteed income of $180,000 per year for life. The challenge, however, is in the details. What if the retiree dies after one year? How does one leave a legacy to dependents with this arrangement? What if inflation heats up in the future? What if the insurance company goes bankrupt? The SPIA annuity products have compromise solutions for many of these challenges. For example, the retiree could select an inflation-adjusted income plan. The bankruptcy of the insurance company presents a different challenge.
The most elegant solutions can come from combining a diversified stock portfolio and a single premium immediate annuity. In effect, the retiree is replacing fixed income from bonds with fixed income from an annuity. Instead of a portfolio of stocks and bonds, the retiree could think in terms of a portfolio of stocks and an SPIA insurance product during the retirement withdrawal phase of life.
Although one cannot know the future, typically a 100% stock portfolio would present the highest terminal value probability after 30 years, with a lower probability of ultimate retirement success. A 100% SPIA insurance product would present the highest probability of ultimate retirement success with the lowest terminal value probability.
By combining both into a portfolio, it is possible to reach a custom combination of terminal value and probability of success through the insurance company guarantee. The retiree could tilt the portfolio combination either to higher terminal value or higher probability of success.
For example, a 60% stock/40% SPIA portfolio might tilt toward higher terminal value, while a 40% stock/60% SPIA portfolio might tilt toward a higher probability of retirement success. This combination could obviously be customized infinitely through the use of inflation riders and other annuity features, as well as the overall combination percentages to suit the retiree's personal situation.
In summary, this is a complex topic and the reader should never attempt to implement a strategy involving annuities and financial investments without the guidance of qualified professional advisors. When pursuing future outcomes, one can think only in terms of probabilities and not certainties. The future is the future. It is also necessary to evaluate the financial viability of any insurance company and the potential for high and hidden commission costs.
Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064 or [email protected].
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