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Retirement Paycheck No-Brainer

February 07, 2019

Financial Advisor

Retirement Paycheck No-Brainer

Imagine if you had to replicate—at an individual client level—every mutual fund you purchased by buying individual equities. You couldn’t do it. Not even for the simplest S&P 500 fund. Not because you don’t have the skill, but because there isn’t enough scale at an individual client level. And, it would be a terrible use of your time.

Fortunately, since there are packaged solutions (ETFs and mutual funds) that can give you the range and diversity of investments you need in an inexpensive, efficient way, you don’t need to replicate those strategies. You just buy them rather than build them. Better for your client. Better for you. No-brainer.

Now, instead of trying to replicate a simple S&P 500 mutual fund, let’s consider what it takes to build a retirement income portfolio. What you’re trying to do is replicate an annuity rather than a mutual fund. At an individual client level. A far more complex proposition which, for a long list of reasons, can’t be done. Again, not because you don’t have the skill. It’s simply not possible, at an individual client level, to have a broad enough portfolio of investments to generate the yields and have the diversification of risk that you can buy through an annuity. Nor can you provide a guarantee, or leverage risk pooling and mortality credits to further enhance payout rates. Annuities do all of this very well. 

Numerous academic studies demonstrate that annuities are a more efficient means of generating retirement income than traditional portfolios. Studies also show the psychological benefits annuities bring to retirees. But most RIAs have been handicapped in generating retirement paychecks for their clients due to their aversion to annuities. If you examine the process RIAs have to endure to generate retirement paychecks without annuities, well…annuities are a no-brainer.

But instead RIAs try to build income portfolios.

I am struck by the significant executional challenges RIAs face in trying to create retirement paychecks without annuities. Here are just a few of those challenges:

  • Trying to find sufficient yield in a low interest rate environment
  • Trying to find diversified income sources (dividend yielding equities, bonds, REITs, etc.)
  • Managing the risks and varying returns these sources can generate
  • Determining the tax implications (qualified accounts, non-qualified accounts, short-term gains, long-term gains, dividends, tax brackets, impacts on Social Security)
  • Selling assets to “top up” income
  • Finding ways to manage sequence of returns risk while still finding yield
  • Planning for an uncertain (and growing) life expectancy 

So why do RIAs even try to replicate annuities when annuities are academically demonstrated to be a more efficient means of generating retirement paychecks? When the value of annuities is “beyond dispute,” according to Dr. Michael Finke of The American College?

Replicating an income stream is an incredibly difficult, time consuming, complex thing to do. It is no wonder that Michael Kitces recently described these income strategies in an article he wrote for an industry publication as “remarkably difficult to simply figure out where the actual cash comes from,” involving “a non-trivial amount of complexity,” and requiring clients to take risk in the market that “doesn’t always pay the level of income one desires.”

And on top of that…none of these strategies can prevent clients from running out of money, nor do they protect their income from sequence of returns risk that can significantly impact retirement income levels.

So why would an RIA even think about undertaking such an endeavor? I’ll answer in one word—commissions.

The commission-driven nature of the insurance business has made annuities untouchable for RIAs for decades. On top of that, commissions drive up the pricing, making it easy for RIAs to question their value. Not to mention the deceptive sales tactics that some annuity salespeople employ. They’re easy to sell against.

Also, to recommend an annuity to a client, an RIA has had to refer the client to an outside insurance professional—inviting a competitor into their client relationship, potentially losing significant assets (revenue) and putting their client into a product they deem expensive. It makes no sense. So instead, RIAs must try to replicate the income stream created by annuities to generate paychecks for their clients in retirement.

Not a great solution, but better than sending a client to a competitor and losing revenue.

Fortunately for RIAs and their clients, there are many no-load annuities now available in the market—variable annuities with guarantees, fixed-indexed annuities, fixed annuities, SPIAs, DIAs, buffers and more. Designed, built and priced for the RIA market, these products enable RIA clients to enjoy the many benefits of annuities, while enabling RIAs to address the retirement paycheck problem with a solution that more efficiently generates income, simplifies the “paycheck” process, and mitigates longevity and sequence of returns risk.

Perhaps because I am very familiar with the academic research around the benefits of annuities and have seen the powerful benefits they can deliver in a financial plan, I have been an advocate of no-load annuities for many years (and a basher of traditional annuities because of commissions).

It reminds me of my consulting days when I was often hired by a firm to explore and asses their processes. Frequently, I’d find a very inefficient process that had been employed for so long that the business had gotten used to its shortcomings and the inordinate amount of effort it required. 

Sometimes you need an outside voice to say, “You know, there is a much better way of doing that…”

Spend your time building your practice, engaging with your clients, and otherwise adding value. Stop the madness of trying to replicate an annuity!


My Personal Experience With The Power of Annuities

While I am not a financial advisor and do not have clients that rely upon me to generate retirement paychecks, I do have two sets of older parents in my life—my own and my wife’s—who are very concerned about this topic. I don’t insert myself into their finances but am happy to provide insight when asked. I see the emotional toll the subject exacts.

My in-laws, an upper middle-class couple in their early 70s who are retired in Naples, Fla., fret the market…daily. There is not a conversation I have with them where they are not asking me about where the market is headed. They are keenly aware of every fluctuation and its impact on their income both today and in the future. They live in fear of outliving their money. Their financial advisor is an RIA that I respect but has consistently advised against annuities. And so they fixate on the market and worry ceaselessly if they’ll be okay.

My parents are wealthy. My father literally is a rocket scientist who once worked for NASA and has had a very successful career in business. To say he understands the math around investing and probabilities is like saying Ted Williams knew how to hit. Yet, he was emotionally unable to retire. Until recently.

My father’s advisor was a very successful RIA that I referred him to years ago. They discussed methods for generating a paycheck in retirement. For years my family just assumed my father had not retired because he enjoyed working. Recently he told me the reason he hadn’t retired was because of the uncertainty and unpredictability of his retirement income. We showed him an annuity and the effect it had on his financial plan. He got a new financial advisor and retired on Dec. 31.

While I’m thrilled for my dad, I’m not suggesting annuities are the right solution for every client.  But I do believe the rationale for using them as instruments to generate retirement income is so compelling that for advisors to ignore them as an option is a disservice to their clients and inefficient for their business.


My Annuity Challenge For RIAs

So, my challenge to RIAs is to explore—with an open mind—an annuity as a possible solution for generating retirement income for a client nearing or in retirement. Present it as an option to your client with the support of an improved Monte Carlo score. Let your clients know that the annuity is low-cost, commission-free and aligns with the values of your practice. Discuss the academic support for using annuities in a retirement portfolio. Give them the peace of mind that comes with knowing their essential living expenses can be guaranteed for life. I think you’ll be surprised by their grateful reaction. 

Bottom line: Your client hired you to be their general contractor, not build every part of their house. You’ve already outsourced the carpentry and foundation to mutual funds and ETFs. You’re using bonds for the roofing. You’ve purchased technology as the plumbing. Don’t do the electrical work yourself—use an annuity. Do it yourself and you’re bound to get zapped a few times in the process, and if the wiring isn’t good enough, your client’s entire house may burn down.

David Lau is founder and CEO of DPL Financial Partners, a firm focused on the distribution of financial services products geared toward the RIA and fee-based advisor channel.