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Why Longevity Annuities aren’t as Popular with 401k Fiduciaries as Regulators Think

December 09
00:41 2014

They’re still relatively new, but there doesn’t appear to be a rush of individual investors or even 401k plan sponsors knocking the doors down to obtain Longevity Annuities. Why not? Perhaps it’s because they’re relatively new and 1097589_52168074_bored_cat_stock_xchng_royalty_free_300untested. Maybe because the only ones who could afford them don’t need them and the ones that need them can’t afford them. Maybe they simply fail for the standard behavioral reasons. Maybe, just maybe, they aren’t as popular as regulators thinks because the intended market doesn’t know what they are.

“We all have heard about insurance for our cars, house, and health,” says Michael Clark, Retirement Plan Advisor at Keiron in Orlando, Florida. “A Longevity Annuity is insurance for your income in retirement. It is basically an insurance policy to make sure will not run out of income.” They are, however, a relatively new form of insurance. Clark says, “The general public (and the advisors helping them) does not understand the concept. It is still a fairly new product to the market and the lack of understanding has hurt the demand from pre-retirees.”

Despite the lack of understanding, there is a purpose for the Longevity Annuities use in retirement plans. The use was recently permitted by government regulators to address a specific need they felt needed to be addressed. What was this pressing need? According to “Stan The Annuity Man,” (a.k.a.: Stan Haithcock), a national independent annuity consultant based in Ponte Vedra Beach, Florida and the author of The Annuity Stanifesto, “With the IRS & the Department of the Treasury approving the use of QLACs (Qualified Longevity Annuity Contracts) in Traditional IRAs and 401ks as of July 1st of this year…..the short answer is our government is encouraging people to set up their own personal pension plans.”

Perhaps “pension plan” is a bit of a stretch. Although Longevity Annuities do behave in ways similar to pension plans, their real purpose is not that different from any other form of insurance. “Longevity annuities offer insurance against many retirees’ biggest risk, which is outliving their money,” says Kris Carroll, Chief Investment Officer at Carroll Financial Associates, Inc. in Charlotte, North Carolina. “Essentially, you are purchasing protection from living too long. If you die early, we all know you will have plenty of money. This is to help protect you from outliving your assets.”

Even the term “Annuity” can be a bit misleading. Dan Danford, Founder and CEO at Family Investment Center in Saint Joseph, Missouri, says, “Though it is called an annuity, that’s mainly because the payments are annuitized when you reach an advanced age. So you might invest a portion of your retirement savings into a longevity annuity and it doesn’t pay anything until you reach age 80. Then it pays a monthly benefit for the rest of your life.”

Still, the fact that it’s known as an annuity may impede its acceptance in the market. “The term annuity has been completely muddled by insurance companies,” says Gary Hall, Portfolio Manager at FutureAdvisor in San Francisco, California. Hall says “have significant conflicts of interest in their compensation structure. I completely understand why the average investor would just avoid anything offered with the word annuity in it.”

Despite the negative connotation of the name, Longevity Annuities can offer important advantages within the retirement planning strategy. Gary Baker, President of CANNEX USA in Doylestown, Pennsylvania feel these products offer “a. The most efficient and least expensive option to specifically address Longevity Risk; b. Tax advantages, especially when deferring income past 70 ½; and, c. The chance to obtain better performance compared to other guaranteed income products on the market.”

That’s not to say there aren’t any potential problems with these products. In fact, perhaps their greatest liability is they suffer from the same disadvantage as any other insurance product. Danford likens Longevity Annuities to “an insurance policy that pays a benefit starting at age 80. Like most other insurance, it doesn’t pay anything unless you file a claim – in this case, you reach your 80th birthday. One of the negative issues for buyers is that a portion of your existing retirement savings is being used to buy a benefit that you may never collect. In other words, if you die at age 78, there’s no claim or payment.”

In addition, there’s that other risk one takes whenever one buys insurance, any form of insurance. Mathew Dahlberg, owner of 111th Street Investments LLC located in Kansas City, Missouri, says. “One of the not-so-hidden problems, as it always is with insurance of any kind, is that no consumer, or regulator for that matter, can truly predict whether the company backing the insurance will be around in the long term or otherwise be able to back the claims. In fact just recently Genworth made headlines when they announced that they had drastically underpriced their long-term care insurance policies and would therefore have to increase their premiums steeply. The hidden cost with this particular type of insurance/annuity offering is that human longevity, in itself, is a relatively new phenomenon over the last century and these products are therefore untested.”

Don’t discount the financial risk, too. “The downside to Longevity Annuities would be the lack of liquidity. Once the contract is in place, you cannot access your money lump sum,” says Haithcock. Although the liquidity risk is real, he sees the primary reason why there hasn’t be a rush to obtain Longevity Annuities “is the low commission paid to the selling agent. Annuities are sold for the most part, and most agents gravitate toward the higher commission products, even though Longevity Annuities are so pro-consumer.”

Just because a product may be “pro-consumer” doesn’t mean consumers will be pro-product. Longevity Annuities face the same stark behavioral hurdles as other annuities and long-term investing in general. “I think ultimately the lack of interest in the longevity annuities stems from the same problem that we as a society have in saving for the long term, i.e. it’s just very difficult to understand that we will need to have resources put away for 30 years into the future and therefore it’s very easy to avoid doing so,” says Dahlberg. “Truly long-term strategies such as planning for retirement and planning in retirement seem like such formidable tasks that we as human beings are overwhelmed and the natural result is inertia.”

Finally, once you solve for the insurance product risks, once you get around the financial risk, once you eliminate the behavioral disincentive, you still have to deal with the investment risk. “The deep risk of inflation would decimate holders of longevity annuities,” says James A. Winkelmann, Principal at Blue Ocean Portfolios in Saint Louis, Missouri. “Purchasing power must always be a consideration.”

Hall summarizes how all these obstacles conspire to thwart the early adoption Longevity Annuities when he says, “The downside is that you have to give a good portion of your nest egg to an insurance company (loss of control) and hope they live as long as you do (counterparty risk). Obviously this limits the potential growth of your money in the long run (upside limit).”

Worse, the product seems to be made for a market that can’t find the money to pay for it. Carroll says, “A typical retirement saver won’t be in the position to use a Longevity Annuity, yet a relatively affluent saver may.”

Unfortunately, the alternative to buying a Longevity Annuity may be just as daunting as paying the premium. Dahlberg says, “I hate to say it but the most practical alternative to longevity annuities is also the most boring: save more than adequate amounts during your working career. For relatively well-off clients who have ample sums put away so that they will be able to afford to live from their investment income (on a purchasing-power basis), longevity annuities make little sense. However for those who fear they might come up short in their retirement savings and they have a family history of living into their 90s and beyond?  They would do well to consider one.”

It’s a Catch-22 that would make Joseph Heller proud: If you can afford it, you don’t need it; and if you need it, you can’t afford it. “The paradox on all of this is that the people who might need this most are the people least likely to buy one,” says Danford. “Simply, if you have sufficient retirement accounts already, you probably won’t run out of money in your older ages. If you don’t have sufficient retirement accounts already, you aren’t likely to purchase a longevity annuity anyway.”

If you’d like to discover other important topics confronting 401k fiduciaries, then you’re invited to explore Mr. Carosa’s book 401(k) Fiduciary Solutions and discover how to solve those hidden traps that often pop up in 401k plans. His forthcoming book Hey! What’s My Number? – How to Improve the Odds You Will Retire In Comfort will be available later this year.

Mr. Carosa is available for keynote speaking engagements, especially in venues located in the Northeast, MidAtantic and Midwestern regions of the United States and in the Toronto region of Canada.

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About Author

Christopher Carosa, CTFA

Christopher Carosa, CTFA

9 Comments

  1. Tom O'Brien
    Tom O'Brien December 09, 11:26

    Hi Chris:

    One thing I always wonder about is the plan sponsor perspective. The shift from DB to DC was the plan sponsor washing their hands of the future. Retirement (and investment) risk was transferred 100% to the participant.

    Annuities bring back some of the “we’ll take care of the future” characteristics of DB plans. Who is going to choose the annuity provider. What is the fiduciary risk of this choice? Will the plan sponsor retain some risk long after participants have retired?

    Interested in feedback on this question.

    Tom

  2. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author December 09, 11:52

    Tom: I think you’re right. This a latent liability in a company putting the annuity in the plan – i.e., who pays if the firm goes under or otherwise fails to provided the promised benefits? From a fiduciary perspective, it seems better to keep any annuity decision between the insurance company and the individual, and leave the company out of it.

  3. Peter Gulia
    Peter Gulia December 10, 08:40

    Chris, is there any reason why this shouldn’t be left to IRAs?

    A retiree who feels a need for retirement income protection is welcome to rollover her balance from her workplace retirement plan into her IRA.

    Is there anything that can be accomplished by in-plan annuities that can’t be accomplished by IRA annuities?

    Or is it just about the behavioral push that comes from the employer’s context?

  4. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author December 10, 10:15

    Peter: Great question. This is actually the point I make in my BenefitsPro article this week. Check it out and let me know what your think. Like Tom said, there’s no value to the plan sponsor in adding these to the company’s menu options – there’s only an unknown fiduciary liability risk. Why take on the risk when the employee can address the matter outside the plan?

  5. john Blossom
    john Blossom December 15, 09:11

    Of course Qualifying Longevity Annuity Contracts have an important place in retirement income thinking and planning.

    Among the important advantages is the ability for a person with more than adequate retirement assets to avoid RMD payments on the amount held in the QLAC.

    No reason to worry about too much concentration since QLAC can not exceed the lesser of $100,000 or 25% of the retirement account

    The regulation allows a return of premium in the event of death feature, so risk of death before guaranteed payments begin is not a deal breaker.

    It is only a matter of weeks before institutionally priced, competitively bid Qualifying Longevity Annuity Contracts will be available to retirement plan participants. If the plan sponsor doesn’t offer QLAC’s, an in-service withdrawal will give easy access to the products.

    It is unrealistic for many savers to build a large enough capital base to self-insure the longevity risk of a lifespan reaching beyond age 90. That is where QLAC plays apart in good planning.

    This offers a great opportunity for the advisor who offers unbiased planning and who includes Social Security in the solutions.

  6. John Blossom
    John Blossom December 15, 12:17

    Chris, did my comment on this topic make it through the review process?

  7. Christopher Carosa, CTFA
    Christopher Carosa, CTFA Author December 15, 13:32

    John: Yes, your original comment made it through. I apologize for the delay, but the way things are currently set up, we have to review every comment and remove any live links. We are working on a new commenting system that is self-policing and we anticipate it becoming available in January 2015.

  8. Jay Weinstein
    Jay Weinstein February 17, 23:16

    Annuities structured properly ( and that’s saying a lot) offer an aspect that is right along side the DB plan, that is: Life expectancy Credits. No other street or bank type of investment offers to an individual this: as you get older, you’re payout % can increase for lifetime income, on layered blocks of annuities.

    Not stumping for my book here but I explain this in detail in Beating the Retirement Income Trap, with Financial Harmonics on Amazon.

    Now my question: Are annuities able to be put into SEPP IRAs at work ( I assume no fiduciary responsibilities). Is this something that can be done or on the table? As I see it this could open the door to turning SEPPS into a DB look-a-like without the TPA and the expense

    Jay Weinstein

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