Wish You Had a Pension? Consider an Income Annuity
By the Northwestern Mutual Life Insurance Company
In a city where the economy is driven largely by the presence of Army and Air Force military bases,1 Mark Perrault knows a lot of people in Colorado Springs who’ve retired (or are planning to retire) with a pension from the federal government. And when they talk about their pensions, Perrault, a Northwestern Mutual wealth management advisor, hears the same thing time and time again.
“Clients tell me they sleep better at night knowing that they have this steady income stream,” said Perrault. “They don’t have to think about it; they know it’ll be there on the first of every month, and it’ll keep coming until they die.”
For private-sector workers across the country, however, pensions are largely a thing of the past.
A Towers Watson study found that from 1998 to 2013, the number of Fortune 500 companies offering traditional defined-benefit plans (such as pensions) dropped 86 percent, from 251 to 34. One significant factor: cost. Because people are living longer, pension plans have to pay out over longer beneficiary lifetimes. And as the availability of pensions dwindles, it’s up to individuals to assume responsibility for funding their own retirements.
“Fortunately, for those of us who don’t have pensions, we are able to create our own income stream—with one of the major characteristics of a pension—through an income annuity2,” said Perrault. “That’s income that we can never outlive, income that we don’t ever have to worry about.”
So, if income annuities pay out in a manner much like pensions, and people love pensions, why do they hate annuities so much? Annuities, including income annuities, can be complex. And if you buy the wrong one, you may end up paying high fees and getting locked into a deal that doesn’t make sense for you.
“You have to do your research when it comes to understanding what kind of annuity product you’re buying,” said Dr. Michael Finke, dean and chief academic officer at The American College. “But with very simple, straightforward income annuity products that are offered through insurance companies, essentially what you’re doing is buying a product that pays out like a pension2, and transferring the longevity risk to an insurance company.”
Finke’s most recent research, “The Value of an Integrated Retirement Income Approach,” a study commissioned by Northwestern Mutual, looked at the financial impact on retirees of combining income from an income annuity and permanent life insurance with an investment portfolio. He used statistical analysis to simulate the financial experiences of thousands of hypothetical retirees; and in each simulation, Finke assumed the persons retired at age 65 with $2 million in retirement assets and withdrew 4 percent of their assets each year.3
Here’s what he found:
- Retirees with only investments had a 29 percent chance of outliving their assets.
- Cash value that has built up over time in a permanent life insurance3 policy can provide tax-efficient income in retirement. In contrast to a dollar in bond investments, having an equal amount in life insurance built up cash value potentially reduces the likelihood of a retirement income shortfall to 21 percent.4
- Adding a Portfolio Deferred Income Annuity5 to the mix may reduce the risk of a shortfall even further—to 16 percent.6 And with this strategy, even if all of the other assets are depleted, the annuity will continue to pay for a lifetime.
Finke’s earlier research7 also showed retirees were the happiest when they received retirement income in the form of a regular paycheck and they knew what they could safely spend every month. That’s something Perrault witnesses firsthand with his clients who have sources of guaranteed income, such as a pension or an income annuity, in retirement.
“I’m not saying it’s the Holy Grail, but, for a lot of people, having this as part of your financial plan can make your life infinitely better.”
Northwestern Mutual is the marketing name for The Northwestern Mutual Life Insurance Company, Milwaukee, WI (NM) (life insurance, disability insurance, annuities, and life insurance with long-term care benefits).
2Be aware that annuities and pensions may have different contribution limits, fees or charges and may be taxed differently.
3Full simulation assumptions are contained in Dr. Finke’s White Paper.
4Permanent life insurance is defined as whole life policies that offer guaranteed level premiums, guaranteed death benefit and guaranteed cash value. Whole life policies also offer nonguaranteed dividends, which can be used to increase the death benefit, increase the cash value, and/or reduce premiums.
5If policy performs at guaranteed level, the likelihood of a retirement income shortfall increases to 35%.
6Refers to Selectä Portfolio Deferred Income Annuity, which provides guaranteed income that lasts as long as the annuitant lives and can increase through potential dividends (dividends are not guaranteed). It does not refer to a deferred annuity (fixed and variable) that has a withdrawable cash value. If policy performs at guaranteed level, the likelihood of a retirement income shortfall increases to 31%.
7Texas Tech Retirement Income Summary, 2016
Issuer: The Northwestern Mutual Life Insurance Company, Milwaukee WI
To be used with form numbers: ICC15.PDIA.DPDB.AMDT.(1115) and ICC11.DIA.DPDB.AMDT.(0511) or state equivalent. Not all contracts are available in all states.