RETIRING: Retirees Need Less Stocks, More Annuities
July 11, 2011 by Robert Powell
By Robert Powell, A DOW JONES COLUMN
Less stocks, more annuities. That, in essence, is the advice gleaned from two
just-published reports for the benefit of those living in or approaching
Retirees should invest just 5% to 25% of their portfolios in stocks, or at
least that’s the case for those whose primary goal is to minimize the risk of
running out of money and sustaining their withdrawals, said one report published
by Putnam Investments new think tank.
And, Americans can avoid the risk of outliving their assets by saving more,
working longer, investing wisely, delaying Social Security and buying a life
annuity, according the Government Accountability Office.
For his part, W. Van Harlow, Ph.D., CFA charterholder and director of
research at the Putnam Institute, is suggesting a conservative asset mix largely
because of what he views as the greatest risk to a retiree’s portfolio: the
unfavorable “sequence of returns” in the securities’ markets.
That’s a fancy way of saying retirees who have too much money in equities
face the very risk that the stock market will keep falling at the very same time
they are withdrawing money for their accounts. And that doing so increases the
odds that they will outlive their money or, more likely, reduce their
withdrawals and presumably their standard of living. (By the way, many retirees
experienced this risk firsthand from 2000-2009. So it’s not one of those risks
that people talk about, but never have to face in reality.)
In an interview, Harlow noted that once a retiree starts taking money from
their retirement accounts, the withdrawals become “path dependent.” And if the
success of a retirement income plan rests on whether the markets go up or down,
one has to figure out how to protect oneself against that volatility, and
especially against the risk of unfavorable “sequence of returns.” And the best
way to do that is by reducing one’s overall exposure to equity to no more than
25%, he said.
Harlow also took issue with many life-cycle, or so-called target-date, mutual
funds in the marketplace today, suggesting that many have far too much invested
in equities. “The higher equity allocations used in many popular retirement
investment products today significantly underestimate the risks that these
higher-volatility portfolios pose to the sustainability of retirees’ savings and
to the incomes they depend on,” he said in a release. His advice to retirees who
own or plan to buy a target-date fund is to check the asset allocation of those
By way of background, we should note that very few retirees and would-be
retirees own just one mutual fund which also happens to be a life-cycle or
target-date fund. In fact, investors saving for retirement in a 401(k) often own
many funds, one of which might be a life-cycle fund. The research does suggest,
however, that would-be retirees do face the risk of unfavorable sequence of
returns given their mix of assets in their retirement accounts.
On average, according to a recent Investment Company Institute report, 401(k)
plan participants in their 60s have about 50% of their money in equities, spread
among a mix of stock, life-cycle and balanced mutual funds, as well as company
stock. What isn’t so well known, though, is the percent that represents of a
retiree’s or would-be retiree’s total portfolio, or what it might represent if
you factored in the net present value of, say, a defined benefit plan, or Social
Security, or the net present value of any earnings a retiree might generate. In
other words, that 50% might be just 5% of a total portfolio or it might be 75%.
So, using Putnam’s research as your guide, any overall portfolio where the
percent allocated to stocks greater than 25% would be subject to the risk of
unfavorable sequence of returns.
Meanwhile, the 79-page GAO report, which was undertaken by at the request of
Sen. Herb Kohl, D-Wisc., the chairman of the Special Senate Committee on Aging,
details how Americans can avoid the risk of outliving their savings.
In the study, the GAO found that while most retirees rely primarily on Social
Security, most Americans fail to maximize their benefits. An estimated 72.8%
took benefits before age 65, and only 14.1% took benefits the month they reached
full retirement age. By taking the benefits on or before their 63rd birthday,
nearly half — 49.5% — passed up at least 25% to 33% in additional monthly
inflation-adjusted benefits that would have been available had they waited until
full retirement age, the GAO said.
Overall, the GAO found that experts recommended that retirees systematically
draw down their savings and covert a portion of their savings into an income
annuity to cover necessary expense or opt for the annuity provided by an
employer-sponsored defined benefit pension instead of a lump-sum withdrawal.
The GAO also found that given the difficult economy and life expectancy
increases, experts recommend that most workers, if possible, continue to work
and save well beyond age 62.
And the GAO said that an immediate annuity can protect retirees from the risk
of outliving one’s savings, but that only about 6% of those with a 401(k)-type
plan purchased one at retirement.
According to experts consulted by GAO for its report, retirees ought to do
consider the following:
* Many retirees should delay taking Social Security to increase payments for
* Depending on net worth, households also should consider buying a life
annuity, particularly if they don’t have a traditional pension that guarantees
* High-net-wealth households generally don’t need life annuities.
* Middle-income households, such as those with $191,000 in financial assets
and without a traditional pension, should consider using a portion their savings
to purchase an inflation-adjusted annuity.
* Delaying Social Security is more cost effective than purchasing an annuity
to enhance retirement income because the money that a retiree would forego by
waiting until age 66 is less than the amount needed to purchase the contract.
* Retirees should make withdrawals from their investment portfolio at a rate
of no more than 3% to 6% annually at retirement, with adjustments for inflation,
to help ensure they won’t run out of money.
Sri Reddy, a senior vice president and head of institutional income at
Prudential Retirement, commended the GAO for addressing what Americans can do to
ensure income throughout retirement, saying that the recommendations are logical
and rational. “It speaks volumes that this is a pending issue,” he said.
But the GAO’s recommendations don’t necessarily take into account the human
element, he said. According to Reddy, more time and energy must be spent
educating workers about how much they need to save for retirement and how much
longer they might have to work to achieve their retirement goals, before one can
talk about whether an income annuity is the right product or not.
“We need to help people arrive at a destination with some level of comfort,”
Reddy said. “Before product, you need tools, education and support.”
In essence, Reddy said people need a baseline understanding of what they need
for retirement and some forms of protection in place while saving for
retirement. And all the rest is moot if we haven’t provided the education need
to help people get there. “We also need to focus on outcomes,” said Reddy. “Not
account values, but how much we need in terms of retirement income.”
He noted, for instance, that annuity with a guaranteed minimum withdrawal
benefit can provide those saving for retirement with some degree of protection
and an idea of how much income they will receive in retirement. That type of
annuity protects savers against investment losses and guarantees the percent and
total amount a person can withdraw from the annuity.
-Robert Powell; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires 07-11-111008ET Copyright (c) 2011 Dow Jones & Company, Inc.