RYAN: As life expectancy grows, annuities gain supporters
January 17, 2014 by J. Brendan Ryan is an East Walnut Hills insurance agent
What a difference a couple of decades make.
It was about that long ago when annuities came under constant fire from the investment community and even from the federal government for being expensive rip-offs.
One of the most common observations from the critics was that it was a waste of money to put a tax-favored annuity into a tax-favored qualified retirement plan. After all, they said, the retirement plan is already under a tax shelter. Why pay for another tax shelter to put under the existing tax shelter?
The flaw in that reasoning, of course, and one that many of the critics already knew, was that there is no extra charge in the annuity for the tax-shelter feature. It is just part of every annuity’s design. Just as there is no charge for the tax deferral in the unrealized capital gains of stock, there is no charge for the tax deferral of the unwithdrawn growth in the annuity. It is simply what the law allows.
One source of such criticism at the time was the federal Government Accountability Office in Washington. The GAO has recently taken on a different view of annuities.
At the request of the Senate Special Committee on Aging, the GAO studied promoting access to annuities through qualified retirement plans. They studied other countries’ approaches to retirement planning and found that those countries generally ensure three types of retirement payouts: lump-sum distribution, systematic withdrawal of a selected amount of money and the purchase of an annuity.
The first two methods of withdrawing retirement funds run the risk of allowing the retiree to run out of money too soon rather than safely spreading the withdrawals out over one’s lifetime. Since the vast majority of us have no reliable idea of how long we will live – only a terminal illness can change that – the only safe way to take retirement income is through an income that is guaranteed to last a lifetime. And only an annuity can do this through systematic liquidation of principal and interest.
In its report to Congress, the GAO stated that, as life expectancy grows, the risk of outliving one’s assets becomes an increasing challenge for society. It attributes part of this problem to the gradual shift in the nature of employer-sponsored retirement plans from the defined-benefit approach, which provides in effect an annuity-type lifetime income, to the defined-contribution approach, which provides simply an accumulation of a fund.
It further observed that “Annuities provide income at a rate that can help retirees avoid overspending their assets and provide a floor of guaranteed income to prevent unnecessarily spending too little for fear of outliving assets.” In short, annuities help keep the retiree from either overspending or underspending.
The report also cites the Society of Actuaries’ observation that, without the pooling of the longevity risk through the employment of an annuity that guarantees lifetime income – in other words, if a retiree does not have a life annuity that spreads the risk of living too long across a pool of many retirees – a retiree “would have to accumulate substantially more in savings to ensure not outliving his or her assets.”
The report points out that annuities may not be appropriate for those with shorter-than-normal life expectancies and that tying funds up in an annuity means that those funds will not be available for future, unexpected expenses. ⬛
