As a financial advisor, you are often required to help clients navigate an emotional and financially complex journey: retirement. The challenge to convert life savings into an income stream that will last a lifetime is no easy task. It is described by well-known economist and Nobel laureate, Professor William F Sharpe, as “the hardest, nastiest problem in finance”. There is a bit more to it than simply selecting a balanced fund, choosing a low drawdown rate and hoping for the best.
Human behaviour collides not only with the uncertainty of future market performance, but also with the unknowable timeframe of how long income should last.
Living annuities are a popular option for retirement income planning, valued for the flexibility and control they provide. Yet, they come with significant emotional challenges. Retirees worry about withdrawal rates or about withdrawing too much, they wonder whether their savings will last or whether they will become a financial burden on their family, instead of leaving a legacy. It is easy to underestimate or even dismiss this emotional burden and only focus on the financial side of the challenge, but the struggle is real and each retiree will respond differently to the fear and uncertainty.
Herein lies the challenge for advisors to deliver retirement income solutions that offer retirees the right balance between flexibility, control and peace of mind based on their unique situations, preferences and attitudes to risk.
It is important to acknowledge that we cannot solve insurance problems with investment tools and vice versa. The risk of living long is fundamentally an insurance problem. Guaranteed life annuities are insurance tools, specifically designed to address the financial risk associated with longer lifespans. They are the only financial products that perform better the longer you live, offsetting the associated financial cost of living another day. However, the risk of outliving retirement savings is a complex combination of investment and insurance problems and is unique to every retiree.
On the one hand, you have wealthy retirees who can stomach market risk and meet their income needs at very low drawdown levels and from other sources. Living annuities are designed to offer these clients with a tax-efficient post-retirement solution to preserve wealth for their beneficiaries.
On the other hand, you have clients who cannot afford to take on any market or longevity risk. These clients must prioritise a reliable income over leaving a legacy for their own benefit. Guaranteed annuities are specifically designed to address the needs of these individuals.
According to our research, around one-third of retirees fall into each of these categories. This then leaves us with one-third of retirees who can afford to take on some risk to maximise both their income and legacy objectives in retirement. The optimal solution in this situation is to blend a living annuity with a life annuity.
Don’t fall for the myths
People incorrectly believe that expected capital legacy is reduced when you blend annuities. An award-winning technical paper[1] on this topic proves that combining a living annuity with a guaranteed annuity is the most effective retirement income strategy. The findings are profound, and sometimes counterintuitive. A blended approach lowers the risk of outliving savings, increases the expected total lifetime income and maximises the potential for capital legacy. A retiree can consume more, with less risk and expect to leave a larger legacy in a blended annuity compared to a traditional living annuity.
The challenge to convert life savings into an income stream that will last a lifetime is no easy task.
The case for blending as a value-add
When done correctly, blending annuities activates a cascade of compounding forces that bring together the best of both worlds in one powerful solution. The strategy is gaining traction among forward-thinking advisors as it allows risks to be managed efficiently using appropriate tools, thereby:
- Increasing the expected income over a client’s lifetime.
- Increasing the expected capital legacy at death.
- Reducing the exposure to longevity and sequence of
returns risk. - Retaining real (not perceived) flexibility.
The knowledge that a portion of retirement income is guaranteed for life, regardless of what happens to the markets or how long your client (and/or their spouse) may live, provides the final, and arguably, the most important part of the overall solution: peace of mind.
- The retirement income frontier and its application in constructing investment strategies at retirement, Anderson, Empedocles, 2016
