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Ready for a Reality Check

Posted on January 19, 2010 by Editor Test -

The headline on the story in this month’s Journal of Financial Planning hooked me right away: “Achieving Sustainable Retirement Withdrawals: A Combined Equity and Annuity Approach.” Just the kind of thing I troll for.

But as I read, I found the paper to be unsettling. It was so perplexing that I asked several advisors to interpret it for me. They too were perplexed. One advisor, in fact, telephoned me before I called him, to ask me if I understood the article.

For those who have seen it, I can clear up one mystery immediately: a key piece of information was missing. As author David M. Cordell, Ph.D., CFA, CFP, told me, the fact that the study’s hypothetical investor added $100 a year to savings (10% of his income) was accidentally omitted.

Here’s the gist of the article: The authors compared five financial planning strategies to determine the one most likely to fund the future retirement of a certain hypothetical 45-year-old.

This imaginary middle-aged investor earns $1,000 a year and has $5,000 in invested savings. At age 65, he wants a retirement income of $1,265 (70% of current income, adjusted for 20 years of 3% annual inflation) that will last until age 100.

Of five proposed strategies, three involved systematic withdrawals from uninsured investment portfolios: an all-equity portfolio, a 50/50 balanced portfolio, and a portfolio with an equity allocation equal to 128-minus-attained-age. The investor funds the portfolios at age 45.

The other two strategies involved annuities. The first called for a variable annuity (holding equity portfolios only) with a five percent lifetime withdrawal guarantee. The second called for an all-equity portfolio with an option to buy a life annuity at a “trigger date.”

The trigger date was defined as any date from age 60 onward when the all-equity portfolio became big enough to buy a life annuity yielding one percent above inflation that could produce the desired retirement income.

Each strategy’s degree of success was defined as the percentage of 1,000 Monte Carlo simulations in which it could produce the target income until age 100. The winner: the all-equity annuity with an option to buy a life annuity.

Time out, I thought. An all-equity portfolio, from age 45 onward? That sounded risky, given the possibility of a bear market near retirement. The authors’ assumption of a 12.9% return rate for the equity portfolio, with an 18.3% standard deviation, also seemed high. (It’s based on the return of the Russell 1000 index from inception in 1986 to the end of 2008.) Nor had I ever heard of a 128-minus-age rule of thumb for equity allocations.

As for the life annuity, the paper seemed ambiguous. The authors didn’t say the investor should buy the annuity, only that the method was deemed a success if the portfolio grew big enough to buy the required annuity at any time between age 60 and age 100.

I was confused, and I was not alone in my confusion. The advisors I consulted about the article generally shared my reaction. One said it “left me cold.” Another said it was evidence of the eternal gap between academics and practicing advisors.

A third said, “This is just this is one more SWiP [Systematic Withdrawal Plan] article with a nod in the direction of annuities. I did not find it to be persuasive . . . and it doesn’t address the idea of improving the efficiency of an equity portfolio with an annuity”—a concept that William Sharpe of Financial Engines has written about.

A fourth advisor said that age-based rules of thumb about asset allocation don’t work, as a rule. A fifth advisor, like me, couldn’t tell if the authors favored income annuities or not.

In the meantime, I also reached out to Cordell, a professor at the University of Texas-Dallas, and asked whether he advocated life annuities. Here’s his e-mail reply.

“It isn’t that we are recommending the income annuity,” he wrote. “Rather, we are saying that the existence of that option gives us the possibility of locking in the needed life income if one chooses. We define success as making it all the way to age 100. If you have accumulated enough to buy the income annuity, you have succeeded.

“However, you may decide not to buy the annuity. In the long run, a 100% equity portfolio should accumulate more money than other asset allocations, and many people will choose to retain the portfolio rather than buying the annuity. Estate planning considerations and short life expectancy are obvious reasons not to buy the annuity.

“On average, you should be able to generate the same income as the annuity by maintaining the 100% equity portfolio and still retain (at least a portion of) the corpus, but there is still risk. The annuity is obviously a way to reduce the risk.”

In the end, the authors seemed to use the same argument for maintaining an annuitization option that marketers of variable annuities with lifetime withdrawal guarantees do: if investors know they can convert to guaranteed income if necessary, they can stomach more equities. As they put it:

“By specifying the annuity purchase as a future alternative, the financial planner can encourage a higher-equities portfolio, which will likely lead to a larger accumulation in retirement.”

It’s the simultaneous endorsement of equities and annuities that leaves me at a loss, I think. If you read the article by Cordell et al, and would care to validate or contradict my reactions, please e-mail your comments to me at [email protected].

VALIC Sued Over “Redundant” Tax Benefits

Posted on January 13, 2010 by Editor Test -

For the second time in a decade, Variable Annuity Life Insurance Company (VALIC) is the target of a class action suit alleging that managers and agents employed by the AIG subsidiary engaged in aggressive and unsuitable variable annuity sales practices.

The December 21, 2009 action claims that VALIC’s agents, disregarding warnings in NASD Notice to Members 99-35 and motivated by high commissions, sold tax-deferred annuities to people they knew would use them to fund tax-deferred retirement plans. The purchasers would have been better off with low-cost mutual funds, the suit said.

The national law firm Hagen Berman Sobol Shapiro LLP filed the suit in U.S. District Court, District of Arizona, on behalf of two California teachers, John and Brenda Hall, and others who bought VALIC annuities as far back as 1974. The suit seeks return of fees paid by plaintiffs, a jury trial, costs, and punitive damages.

Evelyn Curran, a spokesperson for VALIC, which was the defendant in a similar class action suited filed by the aggressive New York firm Milberg LLP in September 2001, furnished RIJ with a prepared statement, which said in part:

“VALIC is aware that John and Brenda Hall have recently filed a lawsuit in United States District Court for the District of Arizona. VALIC, however, has yet to receive any notice of service against any of the defendants named in the lawsuit at this time.

“VALIC understands that the Hall lawsuit alleges facts and claims that appear to be identical to the same alleged in James Drnek and Maureen Tiernan, et al. v. VALIC, et al., another class action lawsuit that was dismissed by a United States District Court in Arizona in 2005.

“That dismissal was affirmed on appeal in 2007. As was the case in Drnek, VALIC believes these allegations to be without merit and we anticipate a favorable resolution to the case.”

Oddly, a plaintiff in the Drnek case, Phillip Bobbitt, filed a class action lawsuit in U.S. District Court, State of Arizona, on November 2, 2009, charging Milberg LLP with professional negligence in their representation of Bobbitt and others in their failed suit against VALIC.

Lawsuits accusing insurers of selling tax-deferred annuities to fund tax-deferred accounts have not been entirely unfruitful for plaintiffs, however. In 2007, Pacific Life Insurance settled with clients of Milberg LLP—called “one of the best known and most feared class-action firms in America” by one writer—for $60 million in a suit similar to the Halls’.

The average recovery per plaintiff in that case (“David J. Nelson and Samuel Cooper et al. v. Pacific Life”) was said to be only $7.23 per $1,000 invested, or the equivalent of six month’s M%E fees.

In that case, a notice Milberg LLP sent out in 2007 to purchasers of Pacific Life annuities read in part:

“The Settlement will provide $60,000,000 in benefits to the Class, including a $40,000,000 Cash Settlement Amount and a $20,000,000 Contract Credit Settlement Amount. The Class includes all persons who, between August 19, 1998 and April 30, 2002, inclusive, purchased a Pacific Life individual variable deferred annuity contract, purchased a certificate to a Pacific Life group variable deferred annuity contract…, where such contract was used to fund a qualified contributory retirement plan (such as an IRA, a 401(k) plan or other retirement account.”

The recently-filed Hall v. VALIC lawsuit charges, among other things, that:

“VALIC, its successors and subsidiaries, as well as VALIC officers and directors, failed to disclose that the tax deferral feature of the deferred annuity was redundant and unnecessary for class members.”
“One agent who expressed concern to his manager that VALIC was ‘thumbing their nose at 99-35,’ was told that he did not ‘have anything to worry about’ because he was ‘just an agent.’ In fact, at least two agents were fired from VALIC after selling a client a mutual fund, rather than a variable annuity.”

“At [a training] session held in San Mateo, California in May 2001 for VALIC Agents in the western United States, Howard Weinthal, who was VALIC’s National Sales Training Coordinator, and Mark Liebert, who was Director of New Representative Training, told the attendees that ‘you can basically ignore 99-35.’

“VALIC and VAMCO target 403(b) plan investors (mostly school, hospital and nonprofit organization employees) in particular for deferred annuity sales, and train their agents to recommend a deferred annuity to every prospective customer who is eligible to invest through a 403(b) plan investment, without disclosing that the deferred annuity product is redundant and unnecessary, and regardless of whether the customer has an insurance need that is met by the product. [original italics]”

“[VALIC] sales training materials explicitly tell agents to recommend deferred annuities as categorically appropriate for all qualified plan investors. In August 2000, VALIC senior compliance personnel from the home office in Texas told a convention of hundreds of VALIC Agents gathered in Las Vegas that the agents did not need to worry about scrutiny relating to the company’s non-compliance with NASD NTM 99-35 or relating to private lawsuits by deceived investors, because ‘VALIC is a big company that can withstand challenges to its sales practices.’”

The National Retirement Risk Index, 1983-2009

Posted on January 13, 2010 by Editor Test -

The National Retirement Risk Index
1983 to 2009

% of Americans at risk of being unable to maintain their pre-retirement standard of living in retirement
Source: Center for Retirement Research at Boston College

Unfinished Business

Posted on January 12, 2010 by Editor Test -

In late January 2009, the clouds obscuring the 401(k) advice landscape momentarily lifted. That’s when the U.S. Department of Labor issued final regulations for the Pension Protection Act of 2006 that vastly liberalized the rules governing investment guidance in the workplace.

But, within days, a regime change occurred. The Obama-ites put the last-minute Bush regulations on hold, intending to put a new spin on them. Where the Bushies were inclined to loosen the reins on commission-based advisors in the workplace, the new Secretary of Labor, Hilda Solis, now talks about adding “automatic annuities” to plans as an exit strategy.

Companies that provide 401(k) education and advice are now waiting for further instructions from the DOL. Among them is Ernst & Young, the accounting and consulting firm. Besides advising Fortune 100 companies on designing 401(k) plans and choosing vendors, E&Y also offers telephone help-lines and general financial education that put it on the front line of what has become a participant education battlefield.

Regulatory Timeline on 401(k) Participant Advice
1996: DOL Interpretive Bulletin 96-1. Clarifies the distinction between non-fiduciary participant education and fiduciary investment advice. 2001: DOL Advisory Opinion 2001-09A. Allows investment provider to give participants investment advice via an ‘independent financial expert’ using ‘objective criteria.’ 2001-2006: Retirement Security Advice Act, Independent Investment Advice Act. Two legislative proposals that did not pass. 2006: Pension Protection Act. Allows auto-enrollment, creates QDIAs, and allows advisors with conflicts of interest to offer participant advice under controls. 2007: Field Assistance Bulletin 2007-1. Provides guidance on allowing a ‘fiduciary adviser’ to render advice with an unbiased computer model or with ‘fee-leveling.’ January 2009: DOL Final Rules. Liberalizes restrictions on advice from advisors with conflicts of interest. Put on hold by Obama administration. December 2009: DOL Announcement on ‘Automatic Annuities.’ Secretary of Labor Hilda Solis announces interest in income annuities as a default distribution option in defined contribution plans.

“It’s one of the best-kept secrets that a large accounting firm does this,” said Lynn Pettus, national director of the firm’s Employee Financial Services Practice, which runs a telephone call center in San Diego and offers educational websites and online calculators. “We’ve been in financial counseling and rank-and-file education for about thirty years.”

To shed light on the state of participant education, Pettus and colleague Hall Kesmodel published a paper last September under the auspices of the Pension Research Council at The Wharton School. The study, “Impact of the Pension Protection Act on Financial Advice: What Works and What Remains to Be Done?”

Their paper makes timely reading for anyone who wants a better grasp of the current state of participant education, an overly politicized realm that is related to the retirement income market as Serbia was related to World War I. That may be an exaggeration, but not a huge one.

Here’s why: Plan participants desperately need neutral advice on converting their savings to lifelong income. Financial services providers desperately want access to the multi-trillion rollover market that participants as a group represent. Plan sponsors are stuck in the middle with fiduciary responsibility and costs. The stakes and the potential for paralysis are immense.

Unresolved problems

Pettus and Kesmodel aren’t entirely disinterested observers. Their paper advocates what E&Y sells: holistic financial advice as opposed to specific advice on choosing investments. But they do a good job of summarizing the existing legislative and operational landscape as well as unresolved problems in participant education. Some of those problems are:

Many participants prefer not to confide in a computer. The computer models that are now used to provide automated investment and financial guidance increasingly rely on the input of detailed personal financial information from plan participants.

But few “are inclined to input the required personal information (from all of their various accounts) to obtain investment advice, and even fewer understand advice tool outputs and investment concepts,” Pettus and Kesmodel write. (For more on issues surrounding consumer use of online planning tools, see this week’s RIJ cover story, “The Trouble with Calculators.”)

Programs lack distribution advice for older participants. “Decisions facing today’s plan participants approaching retirement include: when to commence defined benefit pension benefits; whether to elect an annuity or a lump sum; when to begin Social Security benefits; determining the appropriate level of cash reserves versus invested assets; whether to pay off their mortgage; and ordering and timing account withdrawals to minimize taxes,” the paper said.

“With so many more people nearing retirement, the thought is, ‘We’ve built these assets, and now that I have these funds, what is the distribution process?’” Pettus said. “In the past, we’ve always talked about financial planning as accumulation. But now how do we manage the drawdown?”

Retirement isn’t always a participant’s top priority. Only 30% to 45% of plan participants say that saving for retirement is their long-term savings goal, especially when compared to college tuition, home ownership or automobile purchases. Studies show that ‘don’t have enough money’ was a much more common reason (23%) for not contributing to a workplace savings plan than dissatisfaction with investment options (4.3%) or plan complexity (2.2%).

Hall Kesmodel Kesmodel believes that, generally, people who have credit card debt or who lack a ‘rainy day fund’ for routine cash crises should probably remedy those issues before worrying about their 401(k) plan, let alone take risks with their investments.

“The broader picture is that you shouldn’t pile every dollar into your 401(k),” he said. “And if you have credit card debt and no rainy day fund then you shouldn’t be in the stock market.”

QDIAs aren’t a panacea. While the PPA allowed managed accounts and TDFs as qualified default investment options in employer-based retirement plans, Pettus and Kesmodel believe these solutions may raise as many questions as they answer. Participants may need significant education in choosing one of several default options. TDFs proved not to provide adequate protection from a default option not know how to choose among advice tools and QDIAs.

Employees’ average tenure is only four years. While common sense suggests employees work longer at big companies, the average job tenure in America is only 4.1 years. Financial education is likely to be fragmented at best. And, according to one study, 43% of older workers with at least $50,000 juggle more than six separate checking, saving and investment accounts.

Universe of options still unexplored

Even when the DOL gets around to re-tooling the PPA regulations to suit Secretary Solis, the PPA didn’t have anything to say about showing participants how to convert savings to income, the E&Y authors point out.

“The PPA is focused on investment advice and fund selection in 401k, but that’s a small piece of the puzzle,” Kesmodel told RIJ. “PPA failed to consider that there are much broader issues at play here with respect to ensuring that participants have a secure retirement.”

The E&Y paper concluded that “future advice might need to include income product selection (e.g., managed pay-out mutual funds vs. annuities)” and that “employers will also confront a decision on how (or if) to automate this payment process and whether to provide employees with pay-out options inside or outside the plan, and/or educate participants on the universe of options beyond the plan for managing retirement income derived from their 401(k)s.”

That could happen in 2010, if Solis follows through with an announcement last December that one of her priorities for this year is to work with I. Mark Iwry, an advisor to the Treasury Department, to make it easier for companies to offer “automatic annuities” as an option for people retiring from defined contribution plans.

Wealthy Less Materialistic, Survey Shows

Posted on January 12, 2010 by Editor Test -

Four out of 10 (42%) of America’s wealthy have felt a negative impact on their family budget, with one-third experiencing a negative effect on their lifestyle, according to the sixth annual Wealth and Values Survey conducted by PNC Wealth Management in Philadelphia.

Nearly nine out of 10 (88%) say it is “more important than ever to live within my means” and 66% believe they have “developed a greater appreciation for the non-material wealth in my life.” Half say they “feel more centered because the recession has given me an opportunity to re-evaluate my priorities.”

Concern over children becoming more spoiled has risen dramatically in the last two years. This year’s survey revealed that 35% “believe that my children may be too spoiled by money and have too many material possessions,” up from 22% in 2007.

The survey, designed by HNW, Inc., was conducted online last fall by Harris Interactive among 1,046 Americans age 18 or over with incomes of at least $150,000 (if employed), at least $500,000 of investable assets (unless retired) or at least $1 million of investable assets (if retired).

In other findings, Just over half (51%) believe the recession has changed the way their children will manage their finances and has prompted nearly half (47%) to discuss money management with their children.

The survey of 1,046 Americans with at least $500,000 in investable assets also revealed that four in 10 (42%) have cut their spending on non-essential goods, while three in 10 (29%) have provided financial assistance for friends or family who need it.

Among the ultra-wealthy (those with $5 million or more in assets), 39% are more likely to have provided financial assistance to friends or family, compared to 26% of those with assets of $500,000 to $1 million.

“For wealthy individuals, the recession has presented an ideal opportunity for a strategic analysis of their current lifestyle,” said Steve Pappaterra, managing director of wealth planning for PNC Wealth Management.

“It is time to strip away the clutter, discern what is most important, and develop tangible action steps to ensure that key goals and dreams are accomplished and important values are passed on.”

Western & Southern Enhances Income Annuity

Posted on January 12, 2010 by Editor Test -

Western & Southern Financial Group has announced enhancements to IncomeSource, the single premium immediate annuity issued by its units, Integrity Life Insurance Company (Cincinnati) and National Integrity Life Insurance Company (Goshen, NY).

The enhancements include:

Commutation benefits. Allow access to funds for emergencies to owners of period-certain contracts.
Cash refund payout. Offers a conditional money-back guarantee for beneficiaries.
Increasing payout option. Guarantees annual increases up to five percent to offset impact of inflation.
Temporary life payout. A period-certain contract that allows the owner to benefit f rom mortality credits.

Sales of IncomeSource grew by 25% to an all-time high in 2009, surpassing a record set in 2008. Third-quarter 2008 YTD sales were $119.36 million with a 2.1 percent market share. Third-quarter 2009 YTD sales were $170.42 million, a 43% increase over the same period in the prior year. Market share increased to 3.2%.

Western & Southern is a Cincinnati-based group of financial services companies that own or manage over $43 billion. It has a Standard &Poor’s AA+ Very Strong rating, A.M. Best’s A+ Superior rating, Fitch’s AA Very Strong rating and Moody’s Aa3 Excellent rating, all with a Stable outlook, as of September 2009.

Will “Auto-Enrollment” Kill the Employer Match?

Posted on January 12, 2010 by Editor Test -

Why use a carrot when a stick will suffice?

The trend toward “auto-enrolling” employees into defined contribution retirement plans was supposed to increase participation in these plans and contribute to greater retirement security for more Americans.

But the trend has a negative consequence that somebody must have foreseen: by raising participation rates, auto-enrollment raises the cost of employer-matching efforts and may encourage some employers to reduce their match. It may even undermine the need for an employer match as an incentive to participate.

An article in the December issue of the newsletter of The Retirement Policy Program at the Urban Institute says “firms appear to reduce the rate at which they contribute to 401(k) plans when they adopt auto-enrollment. Auto-enrollment then, will not necessarily raise future incomes for all eligible employees.”

The article’s authors, Barbara Butrica of the Urban Institute and Mauricio Soto of the International Monetary Fund, found that the mean match rate for companies that use auto-enrollment is 44% (median = 46%) of the first 6% of salary, while the mean rate for companies that don’t auto-enroll is 51% (median = 53%).

A seven-point reduction in match rates offsets about 42% of the increase in matching costs caused by auto-enrollment, they said. The article doesn’t discuss whether the higher participation rates associated with auto-enrollment brings benefits to the employer that would justify the expense of higher matching costs.

“Our findings suggest [auto-enrollment] could lead to lower account balances at retirement for those who were already enrolled or would have enrolled anyway,” the authors conclude.

Anglo-American Economy Still Needs ‘Sugar Daddy’—Bill Gross

Posted on January 12, 2010 by Editor Test -

In his January editorial “Investment Outlook: Let ‘s Get Fiscal,” Bill Gross, the world’s most famous bond fund manager at Pacific Investment Management Co. (PIMCO), writes that as governments withdraw stimulus measures and their “carefree check writing” stops, asset markets in the U.S. and U.K. may see tough times ahead.

Gross, managing director and a founder of PIMCO, said the U.S. economy is likely not strong enough to handle the end of the Federal Reserve’s quantitative easing program meant to decrease borrowing costs and stimulate growth. He expressed concern over the Fed’s withdrawal of liquidity to markets and he focused on the Fed’s plans to stop its program of buying Fannie Mae and Freddie Mac mortgage-backed securities, scheduled to end in March.

“Most ‘carry’ trades in credit, duration, and currency space may be at risk in the first half of 2010 as the markets readjust to the absence of their ‘sugar daddy,’” Gross wrote. He added that if exit strategies proceed as planned, all U.S. and U.K. asset markets may suffer from the absence of the nearly $2 trillion of government checks written in 2009.

Life Insurers Face Lean Years: Ernst & Young

Posted on January 12, 2010 by Editor Test -

The US life insurance industry may face an extended period of weak earnings, slow growth and greater regulatory oversight, according to Ernst & Young’s Global Insurance Center 2010 U.S. Outlook for the life insurance industry.

Instead of relying on a “back-to-basics” strategy in 2010, insurers should focus on innovating in five key areas, said Doug French, principal, Financial Services and Insurance & Actuarial Advisory Services Leader at Ernst & Young LLP. Those areas are:

1. Optimize capital in response to ongoing pressures. Non-traditional capital markets will take years to recover, forcing companies to alter or eliminate products dependent on these sources. With low investment yields, insurers should strengthen prices for in-force business, such as increasing non-guaranteed fees. Companies should plan for liquidity crises, forced liquidation of assets into frozen secondary markets and limitations on transfers of capital within the enterprise.

2. Build more robust risk management capacity with stronger governance and transparency. Risk monitoring should start in business units and be coordinated from the corporate center. Top executives need to confirm the organization’s risk appetite and risk-taking limits. Establish procedures for communicating risk-adjusted performance results. The chief risk officer will also face increasing demands from regulators and rating agencies on risks assumed and capacity.

3. Focus on core businesses and readdress product and distribution strategies. Insurers will continue withdrawing from non-core businesses, as they conserve capital and reallocate it among the most viable businesses. As a result, the industry will consolidate. Insurers will reduce risks by re-designing and re-pricing products.

4. Operate successfully in a continually changing regulatory environment. Companies will see initiatives like Solvency II, which applies new reserve and capital adequacy requirements, and US GAAP, which may change insurance accounting rules. There will be a continuing dialogue of Federal vs. State regulatory oversight. Efforts at improving consumer protection will continue.

5. Improve the effectiveness of company infrastructure. Insurers need to reduce costs through process re-engineering and headcount reduction and prepare for a lengthy low-growth environment.

The Trouble with Calculators

Posted on January 12, 2010 by Kerry Pechter -

Anybody who has fiddled with retirement planning calculators knows they aren’t flawless crystal balls. Each has unique idiosyncrasies, and their conclusions are only as smart as the people using them. “Garbage In, Garbage Out,” as the geeks say.

So no surprise that two researchers, after deconstructing a dozen popular calculators designed for “managing risks and resources in retirement,” accused them all of biases and blind spots that limit their usefulness, especially for the amateur investor.

In the 118-page study, “Retirement Planning Software and Post-Retirement Risks,” prepared for the Society of Actuaries and The Actuarial Foundation and published last month, Pension Policy Center economist John A. Turner and attorney Hazel A. Witte found that, to some degree, all the calculators:

Produce inconsistent results from similar inputs.
Overstate rates of return, often ignoring fees and other frictions.
Favor stocks, skate past Social Security benefits and ignore annuities.
Assume an unrealistic level of financial literacy among users.
Overstate the percentage of their pre-retirement income that retirees will need.

Ouch! To be fair, this study attacked something of a straw man. The retirement income planning process entails so many variables and unknowns, is so individualized and has so many unresolved theoretical issues, that no calculator—free or professional-grade—could be perfect. It should also be assumed that most free calculators are intended mainly to generate sales leads or to make websites stickier.

Still, retirement planning calculators in general cry out for a makeover, and this aggressive study, which builds on a similar 2003 study, is an overdue wake-up call. It describes easy ways to improve calculators. It also shows how to improve the retirement income planning process itself. [An 11-page Highlights Report is also available.]

Calculators Reviewed by Turner and Witte
Fidelity Retirement Planning Guidance AARP Retirement Calculator MetLife Retirement Income Snapshot EBSA’s Retirement Planning T.Rowe Price Calculator ESPlanner’s Personal Financial Planning EISI’s NaviPlan Standard USA EISI’s NaviPlan Extended EISI’s Profiles Professional MoneyGuidePro’s SMARTware AdviceAmerica’s AdvisorVision Money Tree Software

‘You need to save more’

Turner and Witte looked at five free online calculators for consumers, one consumer program that charges a fee, and six programs designed for financial advisors. All are commonly used and were chosen non-randomly.

The advisor programs, not surprisingly, tended to be more detailed and better suited for the complex needs of high net worth investors. The consumer programs were simpler, but generally failed to reflect recent findings that many Americans don’t understand basic concepts like compound interest.

“One of the newer developments in economics is behavioral economics,” said Turner, a former government economist who worked for AARP before starting the non-profit Pension Policy Center in Washington, D.C. two years ago. “It’s been a surprise to most economists how little most Americans know about investments and financial markets. A key problem with the calculators is that they haven’t taken that insight into account.

“The calculators assume that the typical user knows a lot more than he does, and therefore they allow users to make errors studies predict they will make. They don’t offer the appropriate feedback when people make errors. That’s a fundamental but easily fixable problem.”

Overall, calculators emphasized offensive strategies (i.e., investing and accumulation) over defensive strategies (i.e., risk assessment and mitigation). That is, they reflected the still-prevalent assumption that to ensure a secure retirement you must amass a modest fortune of $1 million or more.

“Typically, calculators do a calculation and then tell you that you need to save more,” Turner said. “But they should also say, ‘You may need to retire later or buy an annuity or spend less in retirement.’” Asked if this might reflect the business goals of investment companies, he said, “There is an element of that going on.”

That bias tends to encourage bullish growth assumptions. “One of the areas we looked at was the appropriate rate of return to use. For instance, if you input an expected return of 21%, the calculator will say, ‘that’s too high.’ But you can input up to 20% percent and get no feedback from the calculator. It would be better if they provided a cue that told people to underestimate > their returns.

“When the market was doing well, people in general or on average somewhat overestimated the rate of return they could expect to receive. It wasn’t unusual for them to say think that they’d receive 10% going forward. Even after the last few years, I still think people have a tendency to overestimate their returns,” Turner told RIJ. [The calculator on T.Rowe Price’s site assumed an after-expenses average return of 8.8% for stocks, 5.75% for bonds, and 4.1% for short-term bonds.]

The more-is-better mantra also expressed itself in the calculators’ assumption that retirees need 70% of their pre-retirement income. Turner agrees with Larry Kotlikoff, the creator of ESPlanner retirement software package, who has argued that retirees can live on far less.

“The target replacement rates do seem to be very high, and that seems to be a pervasive problem, Economists assume that people want the same standard of living when they’re in retirement as when they are working,” Turner said.

“But let’s say you had two kids while you were working, and that your kids were using up a lot of income. That’s a simple point but none of the calculators take the number of children you have into account. That’s not a difficult problem. It just adds another line to the program. But that one change would be a significant improvement.”

Annuities and Social Security get short shrift

Reflecting the pro-investment tendency, these retirement-oriented calculators don’t even hint at the possibility of using annuities. Nor they do help people understand how to integrate the annuity that everyone has—Social Security—into their income planning.

“Hardly anybody, even the insurance companies, tends to push annuities,” Turner said. “None of the mutual fund companies have anything to say about annuities. They don’t sell them and their assumption is that you will stay with their mutual funds. The only questions how much you have to save or how much you can consume out of what you have saved.

“We know that most people don’t annuitize, and it’s not the fault of mutual fund companies that people don’t annuitize, but it’s still a fundamental problem with the programs,” he added. [The MetLife calculator has a link to an income annuities page and to an illustration of Social Security claiming strategies. In a footnote, the T. Rowe Price calculator has a direct link to the Social Security Administration site.]

While more detail is often good for an advisor-oriented calculator, the doctrine of less-is-more may serve consumer-oriented calculators better, Turner said. People love horoscope books, which provide reams of purported insight based on no input other than the reader’s birthday. Why not devise a retirement income planning calculator that requires minimal inputs?

“It would be interesting to ask, ‘What would the ideal calculator be?’ assuming that you only asked 10 questions, and that you provided have cues and suggestions for answering them. Questions like, ‘How many children do you have? What is your age, your income, your gender, and when do you want to retire?’” Turner speculated. [One of Fidelity’s tools, “Find retirement income products,” is a decision tree that leads users to products based on their answers to just four questions.]

Call it the paradox of consumer questionnaires. “The problem with online calculators is that if they take more than five minutes they won’t be used, but if they take five minutes or less they won’t have much value,” Turner said. “There is that tradeoff. But even in the ones with modest goals, there’s room for improvement.”

Reasons Plan Sponsors Do Not Offer Lifetime Annuities

Posted on January 6, 2010 by Editor Test -

Reasons Plan Sponsors Do Not Offer Lifetime Annuities
Unfamiliar with market offering	24%
Market offerings are not satisfactory	26%
Lack of participant demand	56%
Administrative complexity	36%
Other	13%
Note: The respondents could choose more than one option. Source: Watson Wyatt 2009 Defined Contribution Plan Trends Report.

Roth IRA Conversion Promotions Are All The Rage Online

Posted on January 6, 2010 by Editor Test -

On January 1, 2010, all of the advantages offered by Roth IRAs — tax-deferred growth, tax-free distributions and no required minimum distributions — became available to a new demographic of investors thanks to a provision in TIPRA (Tax Increase Prevention & Reconciliation Act of 2005).

Previously, individuals who had modified gross adjusted incomes above $100,000 a year or were married and filed separately were unable to convert their traditional, SEP or SIMPLE IRAs to Roth IRAs. Signed into law in 2006, the TIPRA provision eliminates these restrictions, extending Roth IRA eligibility to the higher earning investors that are coveted by top firms.

In anticipation of the impending Roth IRA conversion opportunity and the subsequent influx of higher net worth investors, more than half of the firms we cover have introduced focused Roth IRA sales campaigns and resources online over the last six months. Firms have aggressively targeted both prospective investors and financial professionals in an attempt to establish footing with these key audiences.

John Hancock and Pacific Life have been the most active firms, rolling out impressive online sales campaigns equipped with engaging education and sales resources. John Hancock’s 2010 Roth Opportunity campaign is publicly available and targets prospective investors and clients. Pacific Life’s Roth IRAS: Take a New Look campaign is featured exclusively on advisor websites and focuses on advisor sales support.

Homepage promotions, a page dedicated to Roth IRA education, an educational series of videos and four new calculators make up the comprehensive John Hancock Roth IRA Opportunity campaign. The homepage promotional images, which have been running since September, link to the informative Roth IRA Center page. A comparison table highlighting differences between Traditional and Roth IRAs is presented along with a list of nine investor suitability considerations.

John Hancock Roth IRA Center

The aforementioned Roth IRA-focused videos and calculators are also accessible from the Roth IRA Center. The three part video series looks at key strengths, investor suitability considerations and potential retirement and estate planning benefits related to the Roth IRA Conversion. The four calculators help users perform detailed comparisons between Roth and Traditional IRAs, breakeven analysis and hypothetical legacy planning.

The Pacific Life Roth IRA Conversions: Take A New Look campaign is advisor-focused and offers a diverse selection of engaging client and advisor education resources and sales materials. The firm has been promoting the campaign on the homepage for nearly three months using a variety of colorful images.

Pacific Life Roth IRA Conversions: Take A New Look Homepage Promotion

Pacific Life Roth IRA Conversions: Take A New Look Homepage Promotion

Homepage promotions all link to a campaign-exclusive sales resources page that has been frequently updated over the past three months. Advisor education brochures are made available along with a variety of sales materials for use with clients including informational brochures, pamphlets, prospecting letters and marketing flyers.

Pacific Life Roth IRA Conversions: Take A New Look Sales Resources Page

Pacific Life Roth IRA Conversions: Take A New Look Sales Resources Page

It is no secret that the past 15 months have been unkind to the financial services industry. The Roth IRA conversion represents an excellent opportunity for firms to add new clients and bolster their businesses in the new year.

Industry Views are special reports that are sponsored and independent from RIJ’s editorial content.

‘Actuary’ Rated Nation’s Best Job

Posted on January 6, 2010 by Editor Test -

“Actuary”—defined as someone who deals with the financial impact of risk and uncertainty-claimed the honor of “best job” in the new CareerCast.com 2010 Jobs Rated Report released yesterday. “Roustabout” replaced edged out “Lumberjack” as the worst job.

The Jobs Rated Report is an in-depth review of 200 U.S. professions that ranks them on work environment, income, outlook, stress and physical demands.

Actuary is rated as one of the least physically demanding jobs with little stress, great outlook for employment and income growth, and favorable work environment.

The next four best jobs are Software Engineer, Computer Systems Analyst, Biologist and Historian. Roustabout, Lumberjack, Ironworker, Dairy Farmer and Welder were at the bottom.

Tony Lee, publisher of the CareerCast.com 2010 Jobs Rated Report, said that the best jobs pay well and have the greatest potential for growth as the economy rebounds.

l;”> “Conversely, Roustabout is the nation’s worst job since it’s dangerous, pays about $31,000 per year and has a negative outlook for future growth,” Lee said, adding that. “Surgeon, the highest-paying job, ranked toward the bottom when you evaluate its stress levels, physical demands and work environment.”

Advocacy Group Campaigns for “CPI-Senior”

Posted on January 6, 2010 by Editor Test -

RetireSafe, a national organization with 400,000 senior citizen members, announced a “Let’s Get it Right” campaign for 2010 to establish a new Consumer Price Index for Seniors (CPI-S) so that Social Security benefits can be accurately and fairly determined each year.

The group also announced its support for the pending introduction of new legislation by U.S. Representative John “Jimmy” Duncan, Jr. (R-TN) which would direct the Bureau of Labor Statistics (BLS) to determine the “right” CPI-S formula for seniors.

RetireSafe, an advocacy organization for older Americans, said it “supports this critical first step to correct the faulty formula now used by the BLS, the same one resulting in a “zero” COLA for 2010.”

“The BLS, along with numerous other credible sources, has noted that each of the present methods now used (CPI, CPI-U, CPI-W, and CPI-E) to calculate inflation is severely flawed in measuring seniors’ actual costs and expenses,” said Thair Phillips, the group’s president.

“While there may be other approaches to address this problem, we believe the first step should be an accurate CPI for seniors, a true CPI-S. Fortunately, Congressman Duncan agrees that seniors deserve a fair and accurate annual COLA that can only be determined with a fair and accurate CPI-S. He will be introducing the ‘CPI for Seniors’ Act next month, and we are fully committed to help Congressman Duncan enact this important legislation.”

401(k) Management Tool Launched by Kring Financial

Posted on January 6, 2010 by Editor Test -

Atlanta-based Kring Financial Management has developed a solution, 401k ProAdvisor, for investors who want to manage their 401(k) better but don’t know where to begin.

“Everyone is concerned about the market and their retirement. We want people to realize they are still in control and to give them the tools they need to manage their 401(k) or similar retirement account,” said William Kring, CFP, of Kring Financial Management, a registered investment advisor.

Kring Financial’s advisory service will offer clients personalized advice on their 401(k), 403(b), or similar retirement plan on a quarterly basis. Clients must provide a summary of how their 401(k) money is invested, as well as information about their financial goals, time horizon, contributions, and risk tolerance.

Using that information, the 401k ProAdvisor service will analyze each available fund using multiple factors, and provide specific recommendations on what funds and amounts the client should buy or sell each quarter.

“We study technical and fundamental factors, and use research from several sources before developing our recommended list,” said Kring. 401k ProAdvisor offers forward-looking advice, using the most relevant data to help the employees grow their 401k, but minimize losses, he said. More information is available at http://www.401kproadvisor.com/index.html

Lincoln Financial Completes Sale of Delaware Investments

Posted on January 6, 2010 by Editor Test -

Lincoln Financial Group announced that Macquarie Group has completed its acquisition of Delaware Management Holdings, Inc. and its subsidiaries (Delaware Investments) for $451.8 million in cash, subject to customary post-closing adjustments.

Delaware Investments was a wholly owned subsidiary of Lincoln Financial, focused on asset management. In connection with the sale agreement, Delaware Investments will continue to manage Lincoln Financial general account insurance assets under a long-term contract, and will provide additional sub-advisory services.

Proceeds of the sale will be used for general corporate purposes.

Headquartered in the Philadelphia region, Lincoln Financial Group had assets under management of $137 billion as of September 30, 2009. Its affiliated companies offer annuities; life, group life and disability insurance; 401(k) and 403(b) plans; and comprehensive financial planning and advisory services.

Public Pension Shortfall Estimated at $2 Trillion

Posted on January 6, 2010 by Editor Test -

The U.S. public pension system faces a shortfall of over $2 trillion, and the chairman of New Jersey’s pension fund believes that the deficit will strain many states’ finances and hurt growth, the Financial Times reported.

“State and local governments are correctly perceived to be in serious difficulty,” Orin Kramer told the British newspaper. “If you factor in the reality of these unfunded promises, their deficits will rise exponentially.”

The aggregate funding requirement of the US pension system has been estimated at $400 billion to $500 billion, but Kramer’s analysis set the figure much higher.

Kramer, who is also a senior partner at the hedge fund Boston Provident, warned that outdated accounting models and unrealistic expectations of future returns had led states to underestimate pension requirements.

Instead of mark-to-market accounting, public pension funds rely on actuarial numbers that average out value of assets and liabilities over a number of years, a process known as “smoothing.” Kramer used the market value of the assets and liabilities of the top 25 public pension funds at the end of the year.

He also looked at market interest rates, which corporate pension funds use and which are much lower than the 8% that public funds use to calculate future returns. Even using 8%, the US public pension system would still require about $1 trillion in additional funding, he said.

“The accounting treatment of public retirement plans is the political leper colony of government accounting. It is a no-go zone,” Kramer said.

Thirty-six of the 50 US states, including California and New York, have plunged into budget deficits since fiscal year 2010 began, which for most states was July 1 2009, according to the National Conference of State Legislatures.

Bernanke Blames Crisis on Regulatory Failure

Posted on January 6, 2010 by Editor Test -

In a speech to the American Economic Association in Atlanta over the weekend, Fed chairman Ben S. Bernanke said that regulatory failure was the principal cause of the housing bubble and the 2008 financial crisis, the New York Times reported Monday.

“Stronger regulation and supervision aimed at problems with underwriting practices and lenders’ risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates,” said Bernanke, who is awaiting confirmation for a second term as Fed chairman.

Low interest rates set by the central bank from 2002 to 2006, when he was a member of the Fed’s board of governors, were appropriate for economic conditions at the time, he said, noting that “when historical relationships are taken into account, it is difficult to ascribe the house price bubble either to monetary policy or to the broader macroeconomic environment.”

In a separate talk at the AEA conference, Donald L. Kohn, the Fed’s vice chairman, said that the fragile economic recovery and weak job market would “warrant exceptionally low” interest rates “for an extended period.”

And In Comes 2010

Posted on January 6, 2010 by Editor Test -

This is the time of year when editors—mindful that most readers are occupied elsewhere—like to review the big stories of the past twelve months. But, after the turmoil of 2009, I’d rather contemplate 2010. Here are some of the issues or trends that I’m eager to watch unfold over the next twelve months.

Fated to live in interesting times
The big question for 2010 involves the direction of interest rates. There’s a recent historical precedent for today’s predicament. In July 2004, after reducing the Fed funds rate to 1.00% in the wake of the dot-com crash, Fed chairman Alan Greenspan raised rates in quarter-point increments, reaching 5.25% two years later under Ben Bernanke.

When that cautious strategy didn’t immediately puncture the bull market that began with the Iraq War, I thought the Fed deserved a Nobel Prize. But only 15 months later, one of America’s longest and deepest recessions began and Bernanke began knocking down to the benchmark rate to only 25 basis points.

So what will Bernanke do this year? Re-run the Greenspan strategy, or try something different? I’m no expert when it comes to interest rate policy, but advisors tell me they don’t have much faith in the rally that began last March. Unsupported by economic growth, it may be too fragile to withstand any rate hike at all.

Outlook, variable
What’s the future of variable annuities with guaranteed lifetime income benefits? Sales results from the third quarter of 2009 suggested that, despite price increases, advisors still prefer the super-dreadnought products-the ones with guaranteed roll-ups on the accumulation side and guaranteed income on the distribution side-to the new, slimmed down products without roll-ups.

But, to borrow a phrase from the NFL playoff vocabulary, variable annuity product developers don’t control their own destinies. Variable annuity sales correlate to the stock market, following it up or down. I still think of variable annuities as a transitional product, opening the way to an unbundled product like Moshe Milevsky’s ruin-contingent life annuity.

For the average young American hoping to build a personal pension, I would think that a plain vanilla variable annuity, sold direct at minimal cost, would serve just fine. They would start contributing $100 or $200 a month at age 25, and convert the assets to income (fixed or variable) at retirement. Too simple, I guess.

A time and a place to talk about income
After hearing about the low-level of financial literacy among people in their 50s, I’ve been wondering where and how participants in defined contribution retirement plans are going to learn how to convert their savings into income.

The workplace is the best place for people to learn about converting assets to an income stream. Sponsors of DC plans want to point their participants toward a secure retirement. Plan providers, including insurance companies and asset managers, certainly have the means to provide income advice.

On the other hand, plan sponsors would rather not incur either the cost of education or any liability for their ex-employees’ financial health. Asset managers and plan providers will gladly provide education because they want to rake in rollovers. But will their advice be impartial?

Plan participants could end up falling through the cracks without income-oriented education. In my experience, few DC participants formally retire. They simply leave to pursue new opportunities. There is no obvious time or place for retirement income planning.

Whither New York Life
The world’s largest mutual insurance company and America’s biggest issuer by far of single-premium immediate annuities, consolidated its annuity, life insurance, and mutual fund businesses under executive vice president Chris Blunt about a year ago.

At a conference last October in Chicago, Blunt mentioned that his group would introduce a managed account in 2010 that produced retirement income. I’m curious to see how well this product-and New York Life’s reorganization-performs.

Lincoln Financial Group and MassMutual both ran into issues when they created omnibus retirement divisions. The insurance culture and mutual fund cultures (read: equities) approach risk so differently that meshing the two groups-let alone achieving synergy-is bound to be a tall order.

Gender issues and financial advisors
An advisor I know recently told me that he was transferring ownership of his practice to his female junior partner. With the number of new financial advisors falling, it occurred to me that it would make sense for women to take up the slack.

It’s dangerous to generalize about gender. But it’s been observed that women make gains in a profession when the compensation goes down. I expect the profit margins in financial advice to fall as more Boomers move into the risk-averse world of retirement income and as the U.S. economy slows.

The future of Retirement Income Journal
These are just a few of the stories we hope to cover in 2010. I and RIJ associate publisher Randi Goldsmith will do so on the strength of the support that we’ve received so far from our individual and corporate subscribers, and from our advertisers. We intend to enrich our product and make it more useful and informative. We wish all of our readers a happy new year and a successful 2010.

AXA Trumpets a Treasury-Linked VA Rider

Posted on January 6, 2010 by Kerry Pechter -

Only two years ago, AXA Equitable was the 800-pound gorilla of variable annuity sales. In the first three quarters of 2007, the insurer sold nearly $12 billion worth of its Accumulator contract, which boasted a 6.5% roll-up on a GMIB rider.

Then the gorilla slimmed down, due largely to the financial crisis. AXA variable annuity sales totaled less than $6 billion in the first nine months of 2009, a 50% decline in 24 months. But because the whole industry suffered, its market share fell only to 6.4%, from 8.8%.

Now the global insurance giant is pounding its chest again, with its first new variable annuity product since the crisis. The new product is designed to give investors a way to benefit from the interest rate increases that seem inevitable. And if rates do go up, it could give them a higher roll-up and higher payout rate than the five percent currently offered by competitors.

Steven Mabry “In times of historically low interest rates, we’re giving clients an opportunity to benefit from rising rates. They can let their benefit base grow by 10-year Treasury rates plus one percent or withdraw at 10-year Treasury plus one percent,” said Steve Mabry, senior vice president of annuity product development. The current rate for the product, which has been rolled out through AXA Equitable career agents but not third-party distributors, is rounded to 5%, based on a 3.8% 10-year Treasury rate.

Called the Retirement Cornerstone Series, the contract contains two buckets or “sleeves.” The first sleeve is a traditional variable annuity separate account with some 90 investment options, ranging from cheap index funds to aggressive actively managed growth funds.

The second sleeve is also a separate account, but its value is protected by a living benefit rider that provides a roll-up and a guaranteed lifetime income benefit. Both the roll-up and payout rates are linked to the 10-year Treasury rate. The client pays a rider fee only on the assets (or rather, on the benefit base achieved by the assets) in the second sleeve.

On each contract anniversary during the accumulation period, the guaranteed benefit base—the sum of contributions to the second sleeve minus withdrawals—automatically compounds at a rate equal to about one percent over the prevailing 10-year Treasury rate, but no less than four percent and no more than eight percent. Every three years, the value of the benefit base is also ratcheted up to the market value of the assets in the sleeve, if it’s higher.

In any year during the life of the contract, the client can also withdraw money at a rate determined by the same formula—one percentage point above the prevailing 10-year Treasury rate (but no less than four or more than eight but percent)—without reducing the guaranteed income base. As is typical for such riders, excess withdrawals reduce the benefit base on which the value of subsequent withdrawals will be calculated.

“It’s income insurance,” Mabry said. “If you retire with $500,000, what do you do with it? If you invest in mutual funds, there’s no guarantee that if markets go down you won’t be out of money when you’re 80. With this, you’re guaranteed a certain amount of income for life. It means you can invest in equities with peace of mind.”

The contract is designed to adapt to an investor’s changing needs. The contract owner or advisor decides how much money to put in each sleeve, or when to transfer money from the growth sleeve to the income sleeve. Presumably, clients will gradually move assets into the protected sleeve as they get older as a way of taking money off the table.

“We’re targeting younger audiences by saying, ‘If you don’t want to pay for the guarantee right away, you don’t have to. When you’re ready to lock in some of your gains, you can switch to lifetime income.’ That’s where we’re seeing excitement in the field,” Mabry said.

“People can invest on the mutual side, and not incur the guarantee fee until they’re ready. When they are ready, they can do a 10% sweep per year or whatever they want into the guaranteed account. We give them a lot of flexibility to engineer their income,” he added. If the client’s account value in the protected sleeve falls to zero during his or her lifetime, the insurer pays either a fixed 4%, 5% or 6% (depending on whether the money runs out when the client is younger than 85, 86 to 94, or over 95, respectively) of the benefit base each year until death.

The contract’s separate account fees range from 1.3% to 1.7% per year, depending on the share class chosen. There’s a “ratchet” death benefit option for 25 basis points and an enhanced death benefit for 80 basis points. The guaranteed income benefit charge starts at 0.80% per year, with a maximum of 1.1%. Annual fund management fees range from 39 basis points to 1.68%, depending on the fund.

“We actually looked at this product before the crisis,” Mabry told RIJ. “We were trying to think of something for people who were worried about inflation. Now we’re in a period of historically low interest rates. Most people think rates are going up and this design allows people to participate in a rising interest rate environment.”

Noel Abkemeier, an annuity analyst at Milliman, liked the new AXA contract, based on a reading of the prospectus. “Historically, the 10-year Treasury rate has been around 6% and in the ‘aughts’ it was 4.5%. This suggests that the roll-up might average around 6% and withdrawals can be around 6%. And the withdrawals are based on a growing roll-up benefit base.”

At those rates, Abkemeier said, a healthy person stands a good chance of still being alive if or when his actual account balance drops to zero, and of getting something other than his own money back from the insurance company. “The chance of collecting is reasonably good,” he noted. He pointed out, however, the payout rates become somewhat less generous—and fixed, rather than floating—after the contract owner’s account goes to zero.

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