Annuity Wannabee
by Richard
At long last….some serious competition for fixed and variable annuities.
You can easily understand the anguish facing investors when confronted with converting their hard earned savings into payout annuities.
It’s like going to Vegas, and placing it all on the red.
Here’s the way you win the annuity bet: You live longer than average. Since annuities are based on mortality tables, those who die prematurely fatten the pot for those who live longer.
Properly understand, the annuity is a hybrid, combining fixed or variable returns with the longevity hedge determined by the actuarial lottery.
I think they have their proper place, but not the gold-plated, fee-laden products force fed onto consumers by commission driven brokers.
Enter the new guy on the block:
Managed Payout Funds
Known as managed-payout funds, these were recently mentioned in the Wall Street Journal. (5/7/2008, page C25) All the major fund families are jumping onto this wagon, and I expect Vanguard and Fidelity will garner the lion’s share.
There’s nothing radical in the design. These are simply managed portfolios that are targeted to throw off 3%, 4%, 5% per year, with the ultimate draw-down theoretically designed to match the owner’s lifespan.
Don’t Forget Target Date Retirement Funds
In this respect, they resemble their cousins, the target date retirement funds that have grown so rapidly the past five years. Whereas the target date funds are designed to become increasingly more conservative (more bonds, less stocks) as you approach retirement, they still have the goal of preserving capital.
In order to break into the piggy bank, the logical progression would be to harvest gains from the target date fund and reinvest in the new managed payout funds. The former is designed to grow and preserve capital. The latter is designed to produce another retirement check to supplement your social security and other dedicated retirement vehicles.
Less Uncertainty…but no Guarantee
What the new breed will not offer is any guarantee. A target is by definition an aspiration. A goal.
The buzzword in investment circles is “Monte Carlo simulations” which is basically a computer generated range of “what-ifs” that could result from the portfolio construction. It might project an 85% probability of not exhausting your funds by age 90. Not a guarantee, but not bad odds either.
It also removes the retiree from the uncertain outcome of the annuity payout. This may be it’s major appeal. Even if you were to die on the short end of the mortality tables, your heirs will still inherit the remaining principal. Unlike the annuity holder’s heirs, who may end up with nothing.
It is this uncertainty that prevents most accumulation variable annuity owners from annuitizing their contract. And this is why the outrageous and costly “living benefit” riders” are such a bad bargain. Most will never be activated.
Watching out for Lapses in Judgment…
The insurance industry has this wonderful term you never heard of: the lapse rate. This is their term of art for all the policies that expire unwanted, unfunded, and unloved. The insurance company keeps all the premium income, and the policy owner keeps their shoebox full of cancelled checks.
The managed payout fund is one salvo you can use to fire back. And it presages a major sea change in retirement planning.
The investment/retirement complex is being transmuted from an asset gathering machine into an asset distribution mechanism. Freely translated, they will have to work harder to manage fewer assets as baby boomers enter retirement.
Since most are overpaid and under-tasked now, it’s a punishment that fits the crime.
The market for such funds are those who prefer not to “do it themselves”. This is a large market.
I’ll never understand what mechanism is at work, when consumers who can unerringly compare price and features for flat screen TVs or Caribbean Cruises, will somehow morph into the deer in the headlights, and profess ignorance when making choices involving investments.
It’s the same drill, actually. Compare. Contrast. Choose.
