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Bonuses enhance yield in Allianz Life’s new indexed annuity
When stocks and bonds are trading at record or near-record prices and risk premiums shrink to almost nothing, investors, advisers and product developers have to get creative in their search for safe yield. All of today’s fruit is high-hanging.
In the absence of attractive bond yields, some life insurers offer annuity contracts with bonuses. Allianz Life of North America has led the indexed annuity market for some two decades with its bonus products. It rolled out the latest version this week.
Allianz Benefit Control is the product’s name. If the contract owner earns an annual credit from the appreciation of the underlying equity index-linked options, Allianz Life enhances the credit and, as directed by the owner, adds it to one of the two sleeves in the contract.
One sleeve is the contract’s account value. That’s what owners receive if they cash out today (net of surrender fees and market value adjustments). The second sleeve is the “protected income value” or PIV. The insurer multiplies the PIV by an age-adjusted payout percentage to calculate the annual income that owners can receive for the rest of their lives.
Owners who want the highest possible future income can raise their PIVs by 250% of annual earned interest, if any, and also raise their account values by 50% of their earned interest. In other words, if someone earns 4% for the year, the PIV goes up by 10% and the account value goes up by 2%. That’s option one.
Alternately, owners can raise their PIVs by 150% of earned interest and raise their account values by 100% of earned interest. If someone earns 4%, the PIV goes up by 6% and the account value goes up by 4%. That’s option two.
The product brochure offers an example. It hypothesizes a 58-year-old woman who makes a $100,000 contract payment. She plans to retire at age 65. Allianz Life immediately raises her PIV to $110,000 with a 10% purchase bonus.
In her first year of ownership, she earns 4%. If she has chosen option one, her PIV goes up by 10% and her account value goes up 2%. If she has chosen option two, her PIV goes up by 6% and her account value goes up 4%.
When she reaches age 65, her PIV has grown to a projected $186,000 or so. At that age, her age-adjusted payout percentage is 3.75%. She’s entitled to about $7,000 a year for life. That income can go up if she earns additional interest from the fixed indexed annuity, which keeps on going even after income begins. If for some reason she needs nursing home care, she could double her annual rate of withdrawal under the contract’s Alliance Income Multiplier benefit. Future annual withdrawals will be substantially lower, however.
The contract is complex, to be sure. Part of the complexity comes from the flexibility. The product can be used for accumulation or income. Liquidity is available but limited by the surrender fee, which starts at 9.3% in the first year and declines to 1.05% in the tenth year. The bonuses need to be weighed against the low payout percentages, which reach no higher than 4.75% for a single contract owner age 80 or more.
Part of the complexity also stems from the fact that the “planning process”—the kind of planning that a fee-based or fee-only adviser might provide to a client—is pre-baked into the product and lasts for the life of the client. The adviser or agent who sells an annuity contract is getting paid a commission by the issuer for distribution services, not necessarily for giving advice.
To use an analogy from the Internet world, buying an indexed annuity with lots of complex flexibility is like buying software as a service (SaaS). SaaS products often give their subscribers a lot of cloud-based functionality but rely largely on the subscriber to run it. There’s telephone or chat support after the sale, but the value of the product depends a lot on the subscriber’s own capability and perseverance.
Few fee-only advisers would sell a product like this, even if it were available on a no-commission basis. They earn asset-based, hourly, or by-the-project fees for offering guidance, not products. If they were looking for a scalable way to help mass affluent clients, such a product might fit into their practices.
But it probably wouldn’t suit their personalities. Fee-only advisers tend to regard annuities and other packaged products the way master woodworkers regard ready-made retail furniture. They’re certain they could produce something better and cheaper on their own workbenches.
But the larger point here is that low interest rates—which have lasted for years and could last for many more—send players in different niches of the retirement business in different directions toward different solutions for different types of customers. For life insurers who manufacture indexed annuities, bonus contracts like Allianz Benefit Control make the most sense.
© 2020 RIJ Publishing LLC. All rights reserved.
Yes, I Finally Bought an Annuity
Last week’s market bungee-jump told me that my wife and I were right to buy an income annuity in late 2018. We bought a deferred period-certain contract that will deliver monthly income for our first 10 years of retirement.
By luck, we bought it before the 2019 rate cuts. Added to Social Security, it will cover our basic expenses. Our other savings is in stock funds, balanced funds, my wife’s small TIAA annuity, or cash. Annuity experts may groan at our decision. We bought “an expensive bond ladder.” We got no “mortality credits.”
But my wife is six years younger than I am. The payout from a joint life annuity looked unattractive. And she rejected any solution that jeopardized our heirs. The term-contract also gave us the nominal monthly income we needed for the portion of savings that we were prepared to spend on it. (The deferral period helped close the gap.)
Yes, we “discounted” our chances of living too long; but future equity gains might allow us to buy more years of safe income. (We hope.) As a backup, we have home equity and three daughters. Deciding to buy the contract wasn’t easy. Maybe it wasn’t even rational. But we feel relieved. We don’t sweat these short-term market slides.
© 2020 RIJ Publishing LLC. All rights reserved.
“Buffered” ETFs for sensitive stomachs
Jittery investors don’t necessarily have to use index-linked annuities or structured notes to get protected equity exposure based on the purchase of options. They can use exchange-traded funds, or ETFs.
Since August 2018, Innovator Capital Management LLC, with subadvisor Milliman, has been issuing one-year ETFs that deliver returns between an upside cap and a downside buffer, with a choice of exposure to five different indices.
So far, Innovator has issued 41 one-year buffered ETFs. The funds now have about $2 billion in assets under management, Innovator CEO Bruce Bond said in a release this week.
The latest offering, the March Series of Innovator S&P 500 Buffer ETFs, started trading on the Cboe (Chicago Board Options Exchange) on March 2, Innovator Capital announced this week.
Like structured annuities (aka registered index-linked annuities or RILAs), the Defined Outcome ETFs use options to generate a customized range of returns based on the movement of an equity index. Investors can earn up to a capped return, while downside “buffer” zones limit their exposure to loss.
The products’ buffers, like airbags in cars, are designed to give retail investors a sense of safety—enough to prevent them from bailing out of equities during rocky markets. The ETFs give investors “defined exposures on broad benchmark indexes, where the downside buffer level, upside growth potential, and outcome period are all known, prior to investing,” the release said.
Each fund in the series has an annual management fee of 0.79%. Exposures to the S&P 500, NASDAQ 100, Russell 2000, MSCI EAFE, or MSCI EM indices are available. Investors can get protection from the first 9% of losses, or the first 15% of losses, and any losses between 5% and 35% over the one-year investment period. The upside caps for each fund are fixed when it is issued.
Like all ETFs, funds in the Innovator series trade throughout the day on an exchange. They’re more liquid than structured notes, Innovator said. Investors can buy into a one-year fund after its launch date, and they can roll their investment over for another year at the end of each “outcome period.” The original buffers and caps are likely to have changed, however.
A tool at the Innovator website shows where the ETF stands at any given time and what the current crediting terms are. The ETFs reset annually and can be held indefinitely.
Crediting formulas for the March Series of Innovator S&P 500 Buffer ETFs, as of 3/2/20 were:
*The caps above are shown gross of the 0.79% management fee. “Cap” refers to the maximum potential return, before fees and expenses and any shareholder transaction fees and any extraordinary expenses, if held over the full Outcome Period.
According to Innovator, each ETF holds custom exchange-traded FLEX Options with varying strike prices (the price at which the option purchaser can buy or sell the security, at the expiration date), and the same expiration date (approximately one year).
The layering of the FLEX Options with varying strike prices provides the mechanism for producing a Fund’s range of outcomes (i.e., the cap or buffer). Each fund intends to rollover options components annually, on the last business day of the month associated with each Fund.
Milliman Financial Risk Management LLC (Milliman FRM), the subadviser of the ETFs, also helped design the Cboe S&P 500 Target Outcome Indexes. The Innovator Defined Outcome S&P 500 Buffer ETFs are benchmarked against them.
© 2020 RIJ Publishing LLC. All rights reserved.
DCIIA Retirement Research Center’s Founding Members
At These Rates, Why Bother to Save?
Responding to last week’s stock market plunge—when fear literally went viral—the Federal Reserve lowered its benchmark fed funds rate by 50 basis points. The central bank was signaling that investors should… what, exactly? Is the message:
- Remain calm and stay invested, because liquidity will remain cheap and abundant, or
- Don’t bother saving, because safe assets won’t yield enough to make delayed-gratification—the very essence of saving—attractive.
The answer may depend on how much you earn per year and what you think your retirement will be like. For people in households with incomes under $62,000 a year and below-average health, the answer is likely to be “2,” according to a new paper from Stanford University economist John Shoven and three of his top former students.
If people behave rationally, as classical economists assume, then they are bound to notice that the return on government bonds is now less than the inflation rate. They may therefore decide to spend freely in early retirement rather than save their money until later, when it will buy less and when they might not be able to enjoy it.
“We find that for many, perhaps most, people in the bottom half of the lifetime earnings distribution, it is optimal to spend out their retirement wealth well before death and to live on Social Security alone after that. Very low earners may find it optimal to not engage in retirement saving at all,” they wrote in “Can Low Retirement Savings Be Rationalized?” NBER Working Paper 26784, February 2020.
Shoven and his co-authors—Jason S. Scott, Sita N. Slavov of George Mason University and John G. Watson of Stanford—challenge at least two major assumptions about retirement planning. One is the life-cycle hypothesis, which says that people want their consumption to be fairly constant over their entire life-cycle. The second, which is related, is the idea that people will need to 65% to 85% of their pre-retirement income in retirement to avoid feeling a decline in living standard.
This might apply to affluent people, the paper says. But people for whom Social Security will replace a large percentage of their pre-retirement income, and who expect to rely on Medicaid if they live long enough to need long-term care, have more reason to behave like the grasshopper in Aesop’s fable than the ant.
John Shoven
“Today, the real rate of interest is negative,” Shoven told RIJ this week. “So if you set aside money today, you’ll be able to afford lower consumption in the future than today. There are significant consequences to this era that we’re living in. For many people, their return on savings is less than zero. Bank accounts pay a quarter of a percent. They’re basically offer a minus two percent yield.
“If you said today, ‘Boy, I want to consume $30,000 per year when I’m 80,’ you realize that with today’s low rates you’d have to save a lot more to have $30,000 when you’re 80,” Shoven told RIJ this week.
“You might say, with rates so low, I’ll change the tilt of consumption. You’ll take that trip to Europe at age 70. We’re saying that declining consumption during retirement can be attractive—given the market rewards for patience. You might feel differently than you did fifteen years ago when you could get 2.5% real return if you invested in safe assets. the safe real rate of return was 2.5%.”
Shoven was asked if conserving money against the fearful possibility of big medical bills in old age would be rational. “With respect to high medical expenses, particularly with the cost of long term care, it is so expensive that it’s difficult to provide for,” he told RIJ.
“Many people who need long-term care will be supported by Medicaid. They’ll get about the same level of care whether they go into care with $50,000 in savings or if they have zero.”
[For people in the bottom half of the income distribution], “any achievable goal will be so small compared to the size of the need, that they lose by hoarding. They say, ‘I could be frugal and save $50,000, or I could enjoy myself now.’” If you spend your last $50,000 on long-term care, “You’re basically helping Medicaid instead of yourself,” he added.
While there’s an old saying about saving for a rainy day, Shoven suspects that people feel little motivation to save for tomorrow if they believe they will be sick tomorrow and won’t feel like vacationing.
“A representative sample of individuals are asked to imagine there is an even chance that they are in good or poor health at age 80,” the paper said. “They are then asked to how they would allocate a $10,000 windfall between those two possibilities. Would they prefer to have all, most, some or none of the windfall in the healthy or unhealthy state? Of interest for our work is that the answers, while volatile, tended to allocate wealth between the unhealthy and healthy outcome at an approximately 1:2 ratio.” A healthy day is worth twice as much as a sick day.
It’s not likely, Shoven added, that low-income savers will respond to low yields by taking more risk. “The model says, ‘Declining consumption is optimal, given the way the market fails to reward delayed consumption,” he said. “In other words, whatever resources you have, you’ll spend more in your younger years.
“We don’t address the possibility that, in the face of extremely low interest rates, some people will say, ‘I’ll take more risk with my investments.’ We didn’t go into that. Typically, as people get older, they want to be in safe assets.”
If correct, this paper’s conclusions clash with more than one of the basic rules of thumb for retirement planning. The paper suggests that it doesn’t make much sense for people in the bottom half of the income distribution to defer Social Security benefits until age 70 or to buy life annuities.
“The considerations in this paper may help to explain the lack of demand for private annuities,” the authors wrote. “Spending liquid assets for annuities whose payout pattern does not correspond with optimal consumption isn’t particularly attractive. It is well known that private annuity markets suffer from adverse selection [the tendency for people with long life-expectancies to buy annuities]. Adding a sub-optimal pattern of payouts [with constant rather than declining consumption] further reduces the attractiveness of annuities, especially for those in the lower part of the income distribution.”
The paper’s reliance on the concept of homo economicus—the assumption that ordinary people think like economists—might raise the eyebrows of behavioral economists who believe that many people exhibit “irrationality” or “bounded rationality” when dealing with money.
“There could be a criticism of our approach in the sense that people might behave with rules of thumb rather than completely rationally,” Shoven conceded. “This is a rational approach. Like a lot of economists, we assume rationality on the part of the investor. The simple, rational model that economists use doesn’t argue for a constant standard of living as you age.”
© 2020 RIJ Publishing LLC. All rights reserved.
Project LIMA Aims to Solve the Annuity Puzzle
Let’s assume that most American retirees would be better off with pensions. And let’s assume that most people who want a pension would have to buy it with part of their 401(k) savings. How then would you retrofit the 401(k) system to make that possible?
One new proposal is Project LIMA, or Lifetime Income Managed Accounts. This specific idea comes from the math laboratories of Milliman, the actuarial consulting firm whose risk-management algorithms are embedded in a wide range of mutual funds and annuities.
If a 401(k) plan sponsor adopted LIMA, a participant who has elected to use a managed account (as opposed to a target date fund) could apply a percentage of each payday contribution to the gradual purchase of a qualified lifetime annuity contract, or QLAC. In retirement, the QLAC would deliver inflation-adjusted monthly income for life.
We’re hearing about LIMA now because the SECURE Act finally passed. The Act makes it less likely that a participant might sue an employer over any adverse consequences of buying an in-plan annuity. That includes QLACs inside managed accounts as well as target date funds with “guaranteed income riders.”
But legal liability hasn’t been the only reason that illiquid, life-contingent deferred income annuities haven’t taken up residence in 401(k)s (though they’ve long existed in 403b plans). The fund firms who provide investment options for 401(k) earn a percentage of assets under management, or AUM.
Until now, any money diverted into multi-premium annuities would disappear from AUM and from recordkeeping statements. One of the proposals within Project LIMA is that the annuity value stays in the managed account, shows up in recordkeeping statements, and is in turn part of AUM. Richter is hopeful that providing this substantiated valuation process for the annuity income stream will provide a basis for billing.
Michelle Richter
“Milliman’s contribution to the recipe, and it’s essential to the design, is the valuation and dynamic re-valuation of the annuity within the managed account,” said Michelle Richter, the Milliman consultant who is leading the Project LIMA effort.
“Providing this substantiation valuation process for the annuity income stream will provide a basis for billing,” she added. “We are starting from a ‘safety first’ perspective [i.e., aiming to generate enough guaranteed income through the annuity to cover basic retirement expenses] and ladder into guaranteed income across the rate environment. But there are a lot of ways that this could be implemented.”
Growing income gradually
In a hypothetical example offered by Milliman, a 40-year-old participant, Jane Doe, has a $50,000 DC plan balance. She plans to retire at age 67. She’s a conservative investor who has chosen a managed account over a target date fund, and an asset allocation of 50% stocks and 50% bonds.
Jane is offered the option of enrolling in a managed account with a QLAC. She fills out a questionnaire that will reveal her estimated basic expenses in retirement and how much more guaranteed income, above Social Security and pension, if any, she will require to cover those expenses. She then chooses either to start a) buying a QLAC that will meet her essential monthly retirement expenses, b) buying a QLAC with her employer’s matching contribution, or c) not buy a QLAC.
The LIMA algorithm determines that approximately 3% of her savings should be contributed to a QLAC each year. At the end of the first year, she’ll have $25,000 in stocks, $23,519 in bonds, and a QLAC with a book value of $1,481. Fast-forward 13 years: At age 53, Jane now has $123,632 in stocks, $69,894 in bonds, and a QLAC with a book value of $44,293.
During those 13 years, the adviser handling her managed account would have rebalanced her portfolio allocations back to her conservative risk level. The LIMA algorithms would also determine the amount of annuities Jane Doe needs to acquire over time to achieve her ‘Safety First’ income targets. As Richter envisions the process, Jane will have purchased pieces of QLAC from several different life insurance companies by then.
If Jane decides to leave her employer, she can roll over to a managed IRA provided, perhaps, by the same fund company that provided her 401(k) managed account. Somehow—and this part isn’t complete—her slivers of QLAC from different insurers would be resolved into a single payment. She would begin receiving income from the QLAC sometime between age 72 and age 85.
“Several insurers tell us they have capacity for and interest in QLACs, assuming that the distribution likes it. A lot of new recordkeeping work would have to be done to handle QLACs in-plan, as opposed to selling them as standalone products,” Richter said.
“To the extent that the QLACs are embedded in a managed account structure, it’s easier for the recordkeeper and the asset manager to handle, as opposed to managing separate assets,” she added. “Since SECURE passing, there has been more discussion about how annuities as retirement income solutions are expected to make their way into 401(k) plans, and we are excited about the potential of designs like Project LIMA.”
What’s old is new again
The efficiency (or “utility” in economics) of this concept was recognized long ago. Many have seen the wisdom of buying annuities incrementally instead of with lump sums and delaying payouts to age 80 or later, when each premium dollar buys the most income.
In 2004, Moshe Milevsky of York University proposed the Advanced Life Deferred Annuity, or ALDA. It was contingent on both life and exhaustion of a deductible. “A consumer can invest or allocate $1 per month… and receive between $20 and $40 per month in benefits, assuming the deductible in this insurance policy is set high enough,” he wrote.
Jason S. Scott, Ph.D., the current director of the Retiree Research Center at Financial Engines, wrote in 2007, “A new type of annuity, a longevity annuity, is optimal for retirees unwilling to fully annuitize. For a typical retiree, allocating 10%-15% of wealth to a longevity annuity creates spending benefits comparable to an immediate annuity allocation of 60% or more.” But in 2011, when Financial Engines launched its managed account income-generation tool, Income+, automatic annuitization of assets was not in the design.
In 2008, six months before the financial crisis, MetLife and Barclays Global Investors collaborated on an ambitious but never-launched 401(k) program called SponsorMatch. Participants would apply their employers’ matching contributions to purchases of future income. That same year, MassMutual and entrepreneur Jerry Golden experimented with a rollover IRA product, the Retirement Management Account, which turned qualified retirement savings into income.
CANNEX, the provider of annuity data and comparative analysis tools, has been working for years on the problem of valuing income annuities so that they fit better into advisers’ AUM business models. Some of its technology might find its way into LIMA.
“We’ve been waiting for something to change in the industry to facilitate quotes in this area. The SECURE Act helps considerably,” Tamiko Toland, head of Annuity Research at CANNEX USA, told RIJ.
Several big retirement plan providers, such as Prudential and Empower, have already approached the in-plan annuity challenge, but from a different angle. They’ve offered target date funds with lifetime income riders as a 401(k) investment option. Their products are called IncomeFlex and SecureFoundation, respectively.
Unlike QLACs, these riders offer participants liquidity and a guarantee that, if their own account hits zero before they die (and they have obeyed the contractual limits on annual withdrawals), the insurer will continue making their monthly annuity payments as long as they live. Such contracts offer life insurers an attractive combination of high fee income with low risk exposure.
But sales of that TDF-based product have been low, in part because most plan sponsors hesitate to put their participants’ nest eggs in one life insurer’s basket. (Connecticut-based United Technologies Corp. solved that problem by using three living benefit providers that compete through a bidding process.) Richter is hopeful that multiple insurers will want to participate in Project LIMA.
“We started to quietly investigate the premise of the LIMA project back in the fall, with some reasonable industry interest,” Richter told RIJ. “We’re talking with a number of organizations spanning the asset management, recordkeeping and insurance industries. More than one version of what we’re imagining would require all of those three communities’ joint collaboration.”
© 2020 RIJ Publishing LLC. All rights reserved.
Investors pump money into bonds: Morningstar
Long-term mutual funds and exchange-traded funds gathered $82.8 billion in January—their best month since January 2018. But the mix of recipients has shifted in two years. In January 2018, 46% of inflows went to U.S. and international equity funds; in January 2020, however, those two categories combined suffered net outflows, according to the monthly fund flow report from Morningstar Research.
Instead, investors pumped money into fixed-income funds last month. The taxable-bond group took in a record $63.6 billion, topping the previous record of $50.5 billion set only one month prior. Those flows accounted for almost 77% of all long-term fund inflows in January.
The strong January marked 13 straight months of inflows into taxable-bond funds. Both actively and passively managed funds in the category benefited. Actively managed taxable-bond funds raked in $36.9 billion in January, their best showing since September 2009. Their passively managed counterparts added $26.7 billion.
Within the taxable-bond space, investors took interest in core strategies focused mostly on investment-grade securities. Intermediate core-bond funds gathered $17.3 billion for the month, just shy of the $17.4 billion record reached in January 2018. The intermediate core-plus category’s $12.7 billion of inflows was a record, beating the old mark of $10.9 billion set in December 2019.
Records fell for municipal-bond funds, too, as investors continued to hunt for sources of tax-free income. With $14.1 billion in January inflows, they blew past the previous mark of $11.2 billion set in February 2019. Prior to that, the last time muni flows hit $11 billion in a month was in September 2009 as the U.S. began to recover from the global financial crisis. Funds in the muni national intermediate category fared the best, pulling in $5.2 billion in January. That built upon a solid 2019, when the category led all muni cohorts in total flows.
Meanwhile, U.S. equity funds had their worst month since February 2018, suffering $22.5 billion of outflows. Some of this is likely due to portfolio rebalancing after a strong 2019 for U.S. equities overall. Actively managed funds felt the most pain. More than $30 billion flowed out of those products; conversely, passive options netted $7.9 billion.
International equity funds were a bright spot, taking in $18.7 billion—their best month of inflows since February 2018. On a net basis, all the money went to passively managed funds. They garnered $20 billion in January while their active colleagues saw $1.2 billion in net redemptions. Investors generally sought broad exposure to international equities. Vanguard Total International Stock Index was a top recipient of passive-product inflows, amassing $4.8 billion during the month.
Among equity categories, U.S. large-growth funds had their third-worst outflows—$9 billion—since the start of 2017. Investors’ money has been exiting that style-box segment for a while now. The category has had net redemptions every calendar year since 2004. Though its total net assets grew by nearly 137% to $1.9 trillion over that 16-year period, the outflows whittled large-growth funds’ share of the open-end/ETF universe from 16% in early 2004 to only 9% in January 2020.
© 2020 Morningstar, Inc.
Interpreting SEC’s new ‘principles-based’ advertising rule: Wagner Law Group
In early November 2019, the Securities and Exchange Commission (SEC) released proposed amendments to the advertising rule and solicitation rule under the Investment Advisers Act of 1940 (“Advisers Act”), Rules 206(4)-1 and 206(4)-3, respectively.
The proposed amendments attempt to modernize the rules to reflect technological changes, today’s investor expectations, and current industry practices. Over the years, both rules have been interpreted and supplemented via no-action letters and other guidance.
The relevant letters and guidance are listed in the SEC’s release and they will be reviewed to determine whether any should be withdrawn in connection with the adoption of the proposed amendments, which shift the rules’ existing “specified limitations” approach to a more flexible so-called “principles-based” approach.
Given the broad scope of the proposal, and the potential for a significant increased effort by chief compliance officers to comply with the changes, we will address a few elements of the advertising rule proposal below, and discuss the solicitation rule in a subsequent Investment Management Law Alert.
Amendment to Advertising Rule
The advertising rule should be understood against the backdrop of the anti-fraud rule. Section 206 of the Advisers Act makes it unlawful for any investment adviser, whether registered or unregistered, to directly or indirectly engage in any act, practice, or course of business that is fraudulent, deceptive, or manipulative. Advisers have an affirmative obligation of utmost good faith and full and fair disclosure of all material facts to their clients, as well as a duty to avoid misleading them. A financial adviser’s “intent to deceive” is not relevant per se and is not required by the language of the Advisers Act.
The rule is broad and applies to all firms and persons meeting the Advisers Act’s definition of investment adviser, whether registered with the SEC, a state securities authority, or not at all. It also applies to all written correspondence, not just to advertisements. Section 206(4) of the Advisers Act grants the SEC authority to define acts that are fraudulent and to prescribe means reasonably designed to prevent fraud.
Definition of advertisement. First, the proposed amendment would change and broaden the definition of “advertisement.” The SEC views the current definition in Rule 206(4)-1(b) as inflexible and proposes a new definition that is intended to be more “evergreen” in light of ever-changing technology.
The proposed amendment would redefine “advertisement” to include any communication disseminated by any means, by or on behalf of an investment adviser that offers or promotes investment advisory services or that seeks to obtain or retain advisory clients or investors in any pooled investment vehicle advised by the adviser.
The proposed “dissemination by any means” language would change the scope of the rule to cover all promotional communications, which would better focus the rule on the goal of the communication, rather than on its method of delivery. The proposed “by or on behalf of the investment adviser” language would cover advertisements disseminated by an adviser’s intermediary.
The amendment proposes to exclude the following from the definition of “advertisement”:
(1) Live oral communications that are not broadcast;
(2) Responses to certain unsolicited requests for specified information;
(3) Advertisements, other sales material, or sales literature that is about a registered investment company or a business development company and is within the scope of other SEC rules; and
(4) Information required to be contained in a statutory or regulatory notice.
Observations:
- Excluded communications may not relate to performance or hypothetical performance information.
- Must consider communications authorized by adviser to be made by third-party intermediaries, as well as affiliates.
- Specifically applies to investors in pooled investment funds.
- Replaces “written” communications with “any communication, disseminated by any means.”
Testimonials, endorsement and third-party ratings permitted. The advertising rule has four specific prohibitions (hence, the “specified limitations” approach) and one “catch-all” provision.
Advertisements that refer, directly or indirectly, to any testimonial concerning the adviser or any advice, analysis, report, or other service rendered by the adviser, is one of the four prohibitions.
The proposed amendment would permit the use of testimonials, endorsements, and third-party rankings in advertisements, subject to specific disclosures including whether the person providing the endorsement is a client, whether compensation was paid for the endorsement, and certain criteria pertaining to the preparation of the rating.
Observations:
- The SEC is addressing the ability of technology platforms that allow instantaneous sharing of testimonials and endorsements.
- Must disclose both cash and non-cash compensation provided by or on behalf of the adviser, but does not define any definition to the term “non-cash compensation” nor does it have a threshold amount.
- SEC is attempting to protect the integrity of third-party ratings by requiring that the adviser reasonably believe that any questionnaire or survey used in preparing such third-party rating is structured so that it is equally easy for a participant to provide both favorable and unfavorable responses.
Performance reporting and retail investors. The Advisers Act and underlying rules do not contain any direct prohibition concerning the use of performance data in advertising, nor does it articulate a prescribed method by which past performance must be calculated. Rather the calculus turns on whether the advertising of performance is false or misleading, based on a “facts and circumstances” approach.
Under this approach, the use of performance results is false or misleading if it implies, or a reader would infer from it, something about the adviser’s competence or about future investment results that would not be true had the advertisement included all material facts. The proposed amendment would permit the use of performance advertising with some specific prohibitions. The investment advisor must meet more rigorous requirements when the intended audience is a retail investor.
Observations:
The proposal makes a distinction between retail and non-retail advertising. In simple terms, a non-retail advertisement is distributed to a “qualified purchaser,” or a “knowledgeable employee,” and a retail advertisement is all other advertisements that are not “non-retail.”
The proposal identifies numerous classes of performance data: net, gross, related, extracted, and hypothetical. Ported performance is not directly covered in the proposal.
The proposal addresses other areas of advertisements:
It would require a rigorous pre-review and compliance approval by a designated person, who the SEC indicates should be competent and knowledgeable, and should reside in the compliance or legal department. Comments are invited as to whether an outside party could perform the requisite review.
Certain communications to a single person or private fund investor, and live oral communications that are broadcast over TV or the Internet would be exempt from pre-review.
The proposal would also amend the books and records requirements under Rule 204-2 to create and maintain specified communications, third-party questionnaires and surveys, and records that evidence the pre-review process.
© 2020 Wagner Law Group.
Lifetime income withdrawals from FIAs up 39%: Ruark
Ruark Consulting, LLC has released the results of its 2020 industry studies of fixed indexed annuity (FIA) policyholder behavior, which include surrenders, income utilization and partial withdrawals. Ruark’s FIA studies cover products both with and without a guaranteed lifetime income benefit (GLIB).
“With new data contributors, and rapid growth in the FIA market, data exposures in key areas continue to increase,” said Timothy Paris, Ruark’s CEO. “More data enables us to do more detailed analysis, identify new patterns, and—critically—help our clients achieve meaningful risk reduction in their models.”
Among the notable increases in exposure:
- Total exposure years grew to 23 million, a 21% increase over the 2019 study
- Double the exposure years for GLIB contracts past the end of the surrender charge period
- A 39% increase in lifetime income withdrawals, to $5.4 billion
- The study data comprised over 4 million policyholders from 17 participating companies spanning the 12-year period from 2007-2019, with $296 billion in account value as of the end of the period. GLIB exposure constituted 44% of exposure overall, and 49% of exposure in the last 12 study months.
Highlights include:
Lifetime income commencement rates are low: 6% overall in the first year following the end of the waiting period and then falling to less than half that subsequently. But there is evidence of a spike in commencement after year 10, particularly where the benefit is structured as an optional rider rather an embedded product feature. Age, tax status, and contract size all influence commencement rates.
Lifetime income commencement increases sharply when policies are in the money, that is, when the benefit base exceeds the account value. After normalizing for age, tax status, and contract duration, commencement rates are about five times higher for contracts that are 25% in the money or more.
Surrender rates continued to climb in 2019, particularly among contracts past the surrender charge period. The increase is broadly consistent with the rise in FIA sales that has been reported across the industry. This trend is also evident for contracts with a GLIB, where surrenders rates are much lower, particularly after lifetime income commencement.
While surrender rates for contracts with a GLIB appear insensitive to nominal moneyness (the relationship of account value to the benefit base), an actuarial moneyness basis which discounts guaranteed income for interest and mortality rates indicates surrender rates are lower when the economic value is higher, as should be expected.
The relationship between higher surrender charges and lower surrender rates can be quantified. The study examined the relationship of surrender rates to the effective surrender charge, that is, the difference between account value and cash surrender value, which includes the potential effects of market value adjustment (MVA) and bonus recapture.
Surrender rates are sensitive to credited rates and external market pressures. Contracts earning less than 2% exhibit sharply higher surrenders than those earning more. As market interest rates increase, so do surrenders, though there is some indication that a higher credited rate tempers the increase. In contrast, equity market returns are negatively correlated with surrenders.
Detailed study results, including company-level analytics, benchmarking, and customized behavioral assumption models calibrated to the study data, are available for purchase by participating companies.
Ruark Consulting, LLC (www.ruark.co), based in Simsbury, CT, is an actuarial consulting firm. It provides a platform and industry benchmark for principles-based insurance data analytics and risk management. Ruark has an ongoing collaboration with the Goldenson Center for Actuarial Research at the University of Connecticut.
© 2020 RIJ Publishing LLC. All rights reserved.
Top Ten U.S. Fund Families (Jan. 2020 Flows)
Why Bernie is So Demanding
If Bernie Sanders, the left-of-center senator from Vermont, becomes the Blue candidate for president, expect political dirt like you’ve never seen. But underneath the mud and memes, behind the deepfakes and denials, we may witness a legitimate debate over the relative merits (and demerits) of supply-side and demand-side economics.
Supply-side economists believe that if you lower taxes and cut regulations, entrepreneurs will be unleashed to create new businesses, hire more workers, produce more stuff, and even generate more tax revenue for government.
Supply-siders have been in the macroeconomic saddle for the past 40 years. The word “saddle” is apt: the concept roared out of the American West. Arthur Laffer (who advised Donald Trump in 2016) was its premier economist. Journalist Jude Wanniski popularized the term “supply-side” and published a 1978 book about it. Ronald Reagan implemented it, more or less. After the “stag-flation” of the 1970s, supply-side economics blew in like a refreshing zephyr.
And many people became gloriously rich as a result. The early 1980s saw the start of the longest bull market, in both stocks and bonds, that the universe had ever seen. Though factories went dark, the deregulated financial and tech sectors flourished. The fact that tens of millions of baby-boomers were working, saving, buying homes and procreating didn’t hurt.
Wage deflation
But today, there are signs that the supply-side miracle has run its course. Boomers are retiring. Interest rates have no room left to fall. Tax cuts have added to unprecedented deficits. Homes and financial assets are priced to the max. The financial crisis showed that deregulation has a downside.
Supply-side economics brought, or coincided with, rising inequality. America gradually divided into two camps: A minority with large amounts of appreciated assets, like homes and securities, and a majority with few or no assets that appreciate. The ever-widening gap between haves and have-nots is well-documented.
As the Pew Research Center reported this month, national income is concentrated among fewer people. Eighty percent of Americans now receive only 43% of national income, down from 56% in 1968. Instead of inflation (the bane of creditors), we’ve seen wage deflation (the bane of debtors). Consumer prices have almost doubled since 1990, but wages have grown only 26.5%. We’re at full employment, but the civilian labor force participation rate is lower than it was in 2000.
This creeping poverty, linked to globalization, shows up in the falling life expectancies of rural white workers with less than college educations. Unable to earn adequate pay, many don’t marry, form families or set up households. Frustrated by their failure to meet their own and society’s expectations, they become prey to OxyContin, heroin and anger. Once proudly self-reliant, they welcome someone to blame.
The president rode to victory on that wave of anger, and on promises to reopen coal mines and steel mills. Instead, he lowered taxes and interest rates, which was good for stocks. But that hasn’t helped people whose income and taxes are already low, who pay double-digit interest rates on credit cards, and who own few if any equities.
Another turning point
Bernie Sanders
Hence the return of demand-side economics. Also known as post-Keynesian economics or the (much maligned and misunderstood) Modern Monetary Theory, demand-side economics held sway from 1932 until 1971, when Richard Nixon abandoned the gold standard. Bernie Sanders is its atavistic avatar.
Demand-side is the flip-side of supply-side. Supply-siders and other neoclassical economists believe, for instance, that a higher minimum wage will lead to higher prices, layoffs, and a slowdown. Demand-siders and other “heterodox” economists believe that higher wages will lead to higher demand, more production, and more employment. They insist that less inequality means more prosperity for everybody, even the rich.
So if you hear Sanders fulminate about universal health care or free college, think “demand-side” economics. He’s addressing the same malaise that Trump exploited, but with a bottom-up solution that’s been out of favor for more than 40 years. Supply-side economics has been so dominant for so long, in fact, that you almost have to be Bernie’s age to remember that demand-siders once ruled the field.
© 2020 RIJ Publishing LLC. All rights reserved.
NAIC approves revised “best interest” rule for annuities
In a meeting of the National Association of Insurance Commissioner (NAIC) Plenary last week, the association approved revisions to the Suitability in Annuity Transactions Model Regulation (#275), a February 13, 2020, NAIC release said.
The revisions clarify that all recommendations by agents and insurers must be in the best interest of the consumer and that agents and carriers may not place their financial interest ahead of in the consumer’s interest in making the recommendation. The model now requires agents and carriers act with “reasonable diligence, care and skill” in making recommendations.
“These changes underscore the commitment of U.S. insurance regulators to protecting consumers purchasing annuities,” said Ray Farmer, NAIC President and South Carolina Insurance Director. “Nearly every state has adopted the model, which has been protecting consumers for 15 years. I encourage my colleagues to work with their state legislatures to pass these updates to provide even stronger protection.”
The revisions incorporate a “best interest” standard into the model revisions that require producers and insurers to satisfy requirements outlined in a care obligation, a disclosure obligation, a conflict of interest obligation, and a documentation obligation. The model revisions also include enhancements to the current model’s supervision system to assist in compliance.
© 2020 RIJ Publishing LLC. All rights reserved.
Once scorned, FIAs are now embraced: Cerulli
Fixed-indexed annuities (FIAs) made up nearly 57% of total annuity sales in 2019, climbing to a new all-time high of nearly $74 billion, according to Cerulli’s latest report, U.S. Annuity Markets 2019: Adapting to Financial Advisory Trends.
Favorable market conditions, growing acceptance from the broker/dealer (B/D) channels, and innovative product design features are factors that will contribute to further growth. By 2023, Cerulli predicts FIA sales will outpace those of the total retail variable annuity (VA) marketplace.
In sharp contrast to the steady outflows VAs have experienced since 2012 due to de-risking, FIAs are generating positive net flows. Bolstered by the overall performance of index strategies, as well as designs offering greater transparency (e.g., surrender charges, participation rates), FIAs allow insurers to both accumulate assets and keep assets in place to sustain profits. According to the report, FIAs should not be harmed greatly by Fed rate cuts, and if markets become volatile and or bearish, fixed annuities will once again serve as safe havens for risk-averse investors.
The repeal of the Department of Labor (DOL) Conflict of Interest Rule and passage of the Setting Every Community Up for Retirement Enhancement (SECURE) Act also contribute to Cerulli’s optimistic outlook.
“The threat of the DOL rule had been a key reason for reduced sales especially into VAs and FIAs. The passage of the SECURE Act may open the door for further growth,” said Donnie Ethier, director at Cerulli Associates, in a release this week.
The largest catalyst of growth comes from changing distribution dynamics. FIAs are accumulating assets at a solid pace for many B/Ds. The independent broker/dealer (IBD) channel experienced the largest 10-year gain in fixed annuity marketshare at nearly 8 percentage points; regional B/D marketshare has grown too, by almost 7 percentage points, according to the report.
“Broker/dealers have embraced the solution as products become more transparent and consumer-friendly,” said Ethier. “Investors value the product’s protection of principal coupled with tax-deferred growth of assets.”
The report finds that insurers are optimistic about the prospect of increased FIA sales within the independent agent and IBD channel—59% of insurers surveyed expect sales increases of 10% or more.
Insurers are innovating and appealing to B/Ds with tailored products. Cerulli expects this process will continue, if not accelerate.
“Insurers should continue to devise FIA features that will resonate with the B/D community and be open to developing fee-based models,” Ethier said, adding, “There will be a need for the solutions due to advisor migration to fee-based models and new regulations that should encourage—if not require—industry movement away from traditional upfront commissions.”
© 2020 RIJ Publishing LLC. All rights reserved.
Mike Bloomberg’s Retirement Security Plans
“Social Security is under demographic pressure and needs shoring up for the long-term, but it faces no imminent crisis,” Democratic presidential candidate Michael Bloomberg’s campaign announced this week in a white paper titled, “Mike Bloomberg’s Retirement Security Policy.”
Bloomberg didn’t specify any tax increases, benefit cuts, or appropriations he might recommend for Social Security. With the senior population growing and the fertility rate falling, the 12.4% payroll tax that funds Social Security is projected to cover only 75% of promised benefits after 2034.
Although the former three-term New York City Republican mayor, billionaire, and founder of Bloomberg L.P. declared his candidacy late and missed the Iowa and New Hampshire primaries, he qualified for a spot in last night’s Democratic debate on the strength of a poll showing him with 19% support among Democrats and Democratic-leaning voters, according to a report yesterday in the New York Times.
Bloomberg’s proposals amount to far less than an overhaul of the U.S. retirement system, but some of them echo Obama-era initiatives that brought out opposition from private industry, such as:
- A public-option national savings plan with a government match and annuitization
- A $2,000 annual cap on personal expenses for prescription drugs under Medicare
- A reduction in tax benefits in 401(k) plans for high-income savers
- Recommendations for simpler reverse mortgages
Social Security
Any privatization of Social Security that would shift a portion of contributions into the stock market was absent from Bloomberg’s proposals, which instead included:
- A new minimum benefit that could lift about 10% of current recipients out of poverty, replacing the Supplemental Security Income program, which the whitepaper called complicated, under-used, and insufficient
- Higher cost-of-living (COLA) adjustments that reflect seniors’ high level of exposure to health care cost inflation
- Higher benefits for low-wage family caregivers, and a remedy for the fact that surviving spouses lose up to half their benefits without a commensurate drop in expenses
Tax-deferred retirement savings plans
Bloomberg favors a national savings program for workers without tax-deferred retirement savings plans at work, modeled on the Thrift Savings Plan for federal government workers. The program would include a government match paid for with “a reduction in the tax break for high-income retirement plan contributions.”
The new savings plan would:
- Automatically invest savings in an appropriate target-date fund and provide savers with prudent alternatives
- Auto-enroll savers in a low-cost, inflation-indexed annuity at retirement age
- Allow savers to consolidate all of their retirement savings in one public-option account
- Designate a small part of the accounts as an emergency fund, which savers can tap for short-term needs without a penalty.
Medicare and Medicaid
- A cap on Medicare beneficiaries’ out-of-pocket drug spending at $2,000 per year
- Costs above a “catastrophic threshold,” now paid by Medicare, would be shared among Medicare (20%), drug manufacturers (via a 30% discount) and the participant’s drug plan (50%).
- A federal safety net to insure against catastrophic long-term care costs, in response to weakness in the private long-term care insurance market.
- New programs at the state level to deliver support services to those needing long-term care at home.
- Dental, vision and hearing care for older Americans via Medicare benefit, similar to the drug benefit, to cover those services. Beneficiaries would pay a separate premium of roughly $25 and low-income beneficiaries would receive premium subsidies.
Reverse mortgages
The candidate said he favors:
- Simpler and less-expensive products
- Strong advisory services to improve financial literacy pre-retirement
- Education for financially-stressed seniors explore their options
- Federally-subsidized loans for qualifying low-income seniors
- State programs allowing low-income seniors to defer property taxes on their homes, leaving them with more income to live on
© 2020 RIJ Publishing LLC. All rights reserved.
Annuity sales reach 12-year high in 2019
Total annuity sales for 2019 were $241.7 billion, up 3% from 2018 and the highest annual annuity sales recorded since 2008, according to the Secure Retirement Institute’s (SRI) Fourth Quarter U.S. Annuity Sales Survey. Sales in the fourth quarter were $57.6 billion, down 8% from 4Q2018.
The positive numbers were driven by sales of deferred fixed rate and fixed indexed annuities, which together represented 58% of annuity sales in 2019. Total fixed sales in 2019 were $139.8 billion, up 5% from 2018. That broke the previous record of $133.5 billion despite a weak fourth quarter when sales dropped 18% to $30.8 billion.
“Fixed annuity sales have driven the overall growth for the annuity market over the past four years,” said Todd Giesing, director, Annuity Research, SRI (formerly LIMRA SRI), in a release. “Much of the overall growth in the fixed market can be attributed to the continued growth in the fixed indexed annuity market (FIA).
“FIA sales have increased 11 of the past 12 years, accounting for more than half of the fixed annuity market sales,” he added. For the year, FIA sales were $73.5 billion, up 6% from 2018 results. This surpasses the sales record for FIA sales set in 2018.
“Falling interest rates in the third quarter dampened fixed product sales in the second half of the year,” Giesing said. “Most fixed products experienced declines in the fourth quarter, pulling down total annuity sales results for the quarter.”
In the second half of 2019, Federal Reserve chair Jerome Powell announced three quarter-point cuts in the benchmark Fed funds rate. President Trump had openly pressured Powell for looser monetary policy despite the apparently booming U.S. economy. Rate cuts generally help the stock market but hurt the annuity market.
In the fourth quarter, FIA sales were $16.9 billion, down 13% from prior year’s results. SRI researchers attributed the drop to low interest rates and competition from registered index-linked annuities, which offer a similar value proposition.
Fee-based indexed annuity sales continue to fall. In the fourth quarter, fee-based FIA sales were $140 million, down 17% from prior year. Even though fee-based products represent less than 1% of the total FIA market, this trend bodes poorly for life insurers, who are eager to grow sales among the growing numbers of advisers who charge only for advice and don’t sell products or take commissions from annuity issuers.
Fixed-rate deferred annuity sales dropped 29% in the fourth quarter to $9.4 billion. But thanks to a strong first half, fixed-rate deferred annuity sales totaled $47.5 billion for the year, up 4% from 2018. This is the highest level of fixed rate deferred sales since the financial crisis.
Single premium income annuity (SPIA) sales were $9.9 billion in 2019, up 2% from the sales record set in 2018. The record sales came despite a drop of 22% in the fourth quarter, to $2.1 billion. Deferred income annuity (DIA) sales fell 20% in the fourth quarter, to $527 million. For the year, DIA sales totaled $2.5 billion, up 8% from 2018.
For the third consecutive quarter, variable annuity (VA) sales recorded positive growth. VA sales were $26.8 billion in the fourth quarter, up 8%, from 2018. VA sales were $101.9 billion for the year, up 2% from 2018. This is the second consecutive year of annual growth.
Sales of registered index-linked annuity products (RILAs) drove growth in the VA market. In the fourth quarter, RILA sales were $4.9 billion, 39% higher than in the same period in 2018.
“When you look at VA sales excluding RILAs, VA sales dropped 5% in 2019, compared to the 8% increase recorded with RILAs included,” said Giesing. “One driver of growth in the RILA market is GLB riders. More than $400 million of fourth quarter RILA sales were with GLB riders, representing 8% of the total RILA market.” In 2019, RILA sales were $17.4 billion, representing 17% of the VA market.
Fee-based VA sales were $850 million in the fourth quarter, 5% higher than prior year. This matches the record sales experienced in the second quarter 2018. For the year, fee-based VAs totaled $3.0 billion, which is 5% lower than 2018 results. Fee-based VAs represent just 3% of the total VA market.
© 2020 RIJ Publishing LLC. All rights reserved.
Ask the Wizard: Can I Retire?
Retirement readiness calculators are back in the news, thanks to a provision in the SECURE Act that requires retirement plan sponsors to send participants an annual “lifetime income disclosure” that would show how much monthly income their savings would generate in retirement.
That monthly dollar figure would be based on the monthly payout from a SPIA (a single premium immediate annuity, single life or joint and survivor) that the participant would purchase at retirement with his or her entire account balance.
Another provision of the Act orders Secretary of Labor Eugene Scalia to write a “model disclosure” to serve as a standard for projecting and reporting monthly incomes. The SECURE Act also exempts plan sponsors from liability for participant misuse of that information, as long as they use the standard.
The idea for disclosing future income estimates to 401(k) participants has kicked around since the mid-Obama administration. Behavioral finance and “nudges” were in the air. Experts agreed that if 401(k)s were to replace pensions, then people should start viewing their 401(k) balances through a prism of monthly income.
The Department of Labor has offered an online calculator since 2012. It more or less takes your current 401(k) balance, grows it by 4% a year (7% growth minus 3% inflation), and spits out a hypothetical annuity quote (monthly income, in today’s dollars).
Not ideal
This government-issue calculator is quite simple and easy to use, and it was offered as a model for 401(k) plans when it was created. But it assumes that plan participants purchase a SPIA. In practice, very few participants buy, intend to buy, are encouraged to buy, or will be required to buy a fixed annuity with even half of their savings, let alone all of it.
(The DOL does offer a detailed online questionnaire/calculator and a 68-page workbook, “Taking the Mystery Out of Retirement Planning,” but their purposes are different from the kind of brief annual disclosure that’s contemplated for 401(k) participants.)
Another problem: You can’t assess a household’s retirement readiness using only one person’s current 401(k) balance. Even as a crude benchmark, it’s as likely to scare people (when they see how underfunded they are) as it is to encourage them to save more.
So, as the Secretary of Labor works on the new disclosure, we decided to survey half a dozen private sector calculators for ideas that the DOL might use to make the disclosure more useful, but still simple.
RIJ played mystery-shopper and test-drove half a dozen online calculators. From countless eligible candidates, we chose those at Fidelity, Vanguard, Schwab, Pacific Life, New York Life and the Alliance for Lifetime Income, which is the retirement industry’s non-profit “protected lifetime income” education group.
As we knew they would, different wizards yielded different outcomes, depending on their assumptions. Some assume a classic 4% withdrawal rate. Others assume a life annuity rate, which pays out about 6%. Some calculators seek input on only one person, others about couples.
Hypothetical inputs
To fill the data fields on each wizard, we assumed the following hypothetical couple:
- A 50-year-old primary worker, earning $100,000/year
- A 50-year-old secondary worker, earning $50,000/year
- No defined pension or existing annuity
- Moderate risk tolerance (60% equities)
- $150,000 saved so far by the primary worker; savings rate $6,000/year
- $75,000 saved by the secondary worker; savings rate $4,000/year
- Target retirement ages of 67
- A home worth $250,000 with $100,000 left on the mortgage
- A retirement length of 25 years
- No known inheritance
- Zero non-mortgage debt (for simplicity)
We thought that a single 50-year-old American earning $100,000, with savings of $150,000 and new contributions of $6,000 a year (or a two-income household earning $150,000, with $225,000 saved and contributions of $10,000 a year) would surely be “on track” for retirement. Those numbers put them in the top 15% of Americans, money-wise.
Vanguard Retirement Income Calculator
A major retirement plan provider, Vanguard may have designed this wizard for its plan participants. It asks for only one person’s information, uses a conservative 3% withdrawal rate (4% minus inflation) and suggests an 85% replacement rate (i.e., a retirement income equal to 85% of pre-retirement income). It asks the user for an expected asset growth rate for the $150,000 in savings plus future contributions. We input “5%.” The wizard reduced it automatically to 4% for inflation and got $440,000.
In our case, the wizard said we’d need a pre-tax $7,083 per month (in current dollars) in retirement, but have only $4,099. That included our estimate of $3,000 from Social Security and $1,100 from investments (3% of $440,000).
If we used the tool’s handy sliders and shoehorned in the second earner’s salary ($50,000) Social Security ($1,500) and savings ($4,000 per year; $75,000 accumulated) to the equation, assumed a 6% growth rate and 70% replacement rate, the expected monthly income rose to $6,463, but the monthly need became $8,750, based on the higher income ($150,000). To achieve that income, the couple would need to save $41,000 every year for the next 17 years.
Pacific Life Retirement Income Translator
Pacific Life’s wizard compares the advantage of a life annuity over the 4% rule. Based on our primary earner’s $150,000 in savings today, the calculator estimated savings of $435,231 by age (67). Assuming a 6% return, 2% inflation, and a 4% withdrawal rate, the wizard projected total income of $675,343 over 28 years (to age 95).
The wizard highlighted the fact that the total retirement income would be $822,506 if the investor bought a single premium income annuity (SPIA) at retirement, or $147,163 more than the 4% rule provided. Pacific Life assumed a 3% internal rate of return. (Interest rates and annuity payouts have declined since the Pacific Life wizard was created.)
Fidelity Retirement Score
From Fidelity
Fidelity’s calculator needed six pieces of information to create a retirement readiness score. Along with age, current salary, accumulated savings, and monthly savings rate, it asks if the investor intends to spend more or less in retirement than he or she currently does. (We chose “less.”) The wizard assumes when the person reaches age 65 he’ll claim $2,114 in monthly benefits and that he’ll live to age 93.
The calculator offered nine risk profiles, from “Short-Term” (all cash) to “Most Aggressive” (all stocks). He chose “Balanced,” which allocated 50% to stocks, 40% to bonds and 10% to cash.
He scored a dismal 48 on a scale where 100 represented full funding. His projected monthly income of $3,447 (including Social Security) would fall far short of his estimated pre-tax need of $7,185.
Using the digital toggles on the web page, the investor could score 73 (a solid “C”) by saving $1,000 a month, retiring at age 67, reducing retirement expenses by 15%, and allocating 60% to equities.
But his new income of $4,596 would still be $1,700 a month (27%) shy of security. By retiring at age 67 and adding his wife’s savings and Social Security benefit, the couple might squeak through—if they could “live as cheap as one.”)
Schwab Retirement Calculator
Schwab asks for current age, income, expected age of retirement, risk tolerance (five options, from Low to High), Social Security claiming age, savings rate, current savings amount and—this was unusual—“Supplemental Income in Retirement.” This question allowed the user to report rental income or a spouse’s income during the primary earner’s retirement. The wizard calculated the Social Security benefit automatically. When prompted, we stipulated a 70% replacement rate instead of estimating the couple’s retirement expenses.
The calculator estimated that the saver would need savings of $1.36 million by age 67 but would have only $610,000 saved by the retirement date. Dauntingly, the wizard suggested that the investor retire at age 76, start saving $27,000 per year, or cut retirement spending to $44,600 per year. It offered sliders to adjust age of retirement, savings rate, and retirement spending rate. If we added the secondary earner’s savings and Social Security benefit, and set the couple’s spending at $60,000 in retirement, then a secure retirement appeared within reach.
New York Life Retirement Savings Calculator
New York Life’s calculator is built for a couple. It provides fields for partner’s income, accumulated savings and annual savings rate. The wizard self-calculates the couple’s combined Social Security income. We entered 5% for expected rate of return, 25 years for expected length of retirement, and a 70% replacement rate. ).
From New York Life
Based on our couple’s data, the calculator estimated their total savings at retirement of $792,633 and a combined Social Security income of $74,823. To reach the 70% desired replacement rate, the couple would have to save an additional $1,866 a month over the next 17 years. By cutting their replacement rate to 60% and doubling their savings rate to $20,000, the couple would be assured an adequate income to age 92, with some $642,577 left over. New York Life had assumed annual increases of 2% and 1%, respectively, in salaries and savings rates. Taxes were left out of the model. (New York Life has another online calculator for 401(k) clients, but it doesn’t appear geared to retirement income adequacy.)
Alliance for Lifetime Income Retirement Income Security Evaluation (RISE)
Life insurers and asset managers started the Alliance for Lifetime Income in 2018 as a non-profit vehicle for educating the public about annuities. Its calculator, like Fidelity’s, produces a score. Like New York Life’s, it accommodates couples or singles.
Our hypothetical couple’s inputs ($225,000 in current savings, $10,000 saved per year, $4,500 in combined Social Security benefits, monthly expenses of $6,000 in retirement, and a 20% allocation of savings to an unspecified annuity) earned them a score of only 398 on a scale of 800. That was “Poor.”
“The expected income in retirement, including portfolio withdrawals, may cover 73% of expenses in average scenarios and 59% of expenses in the worst 10% of scenarios,” the Alliance’s calculator showed. Milliman, the global actuarial consultant, engineered this wizard.
According to a disclosure sheet, this wizard modeled annuity-related results using deferred variable annuities, and fixed indexed annuities with guaranteed lifetime withdrawal benefits, as well as SPIAs. This was the only calculator that modeled all of the types of deferred annuity products that life insurers are likely to offer plan participants under the SECURE Act.
Takeaways
Our hypothetical couple turned out to be much less prepared for retirement than we expected. Every calculator found them deeply underfunded. Yet this imaginary couple is far better off than most. The median 401(k) balances among Vanguard plan participants for those ages 45 to 54 is $40,243, according to Vanguard research. The average balance, which by rule of thumb represents roughly the 75th percentile, is only $115,497 for that age bracket.
Our exercise was educational, however. A simple annual “disclosure” of future income based on one person’s retirement plan balance—which Congress has asked the Department of Labor to create this year—might be worse than useless. (See the Anecdotal Evidence column in today’s issue of RIJ.) Calculators should accommodate the incomes and savings of a couple, as well as individuals. “Sliders” that allow participants to adjust their inputs will be essential for motivating people and enabling changes in savings habits. Otherwise, a secure retirement may look discouragingly out of reach.
© 2020 RIJ Publishing LLC. All rights reserved.
US Annuity Sales Estimates (2019 Year-end and 4th Qtr)
Divorces over 50 roil estate planning
“Gray divorce,” which refers to the increasing rate of divorce for those over 50 years old, along with prolonged life expectancy and rising healthcare costs, is having an impact on financial planning, specifically estate planning, according to TD Wealth, a unit of TD Bank.
A survey conducted by TD Wealth at the recent 54th Annual Heckerling Institute on Estate Planning found that 40% of respondents, comprised of estate planners and attorneys, said that gray divorce is causing a rise in family conflict, a significant challenge in estate planning. The institute is part of the University of Miami School of Law.
“Gray divorce is adding another layer of complexity to the estate planning process that already arises with blended families, designation of heirs and the ever-changing domestic structures,” said Ray Radigan, Head of Private Trust at TD Wealth, in a release.
Of those responding to the survey, 39% identified retirement planning and funding as a highly impacted factor of estate planning for those divorcing over the age of 50. Gray divorce is also having an impact on determining who will be responsible for enacting power of attorney, determining appropriate social security benefits, and drafting of a will.
The TD Wealth survey also found that “not communicating the estate plan with family members”” is the most common cause of conflict (43%), followed by dealing with blended families” (29%). Only 13% of respondents cited designation of beneficiaries as a cause for conflict in 2020, down from 30% a year ago.
For two consecutive years (2018 and 2019), the survey showed that family conflict was the leading threat to estate planning. In 2020, equal numbers of estate planners expressed concern over family conflict (25%); tax reform (25%); prolonged life expectancy and increased healthcare costs (25%).
A large share of estate planners said they are reconsidering the implementation of traditional strategies to work with the gift exemption under the Tax Cuts and Jobs Act, rather than treat it as an obstacle.
Thirty-nine percent (39%) of respondents suggest to clients to gift now when the exemption is high. However, 23% of respondents suggest advising clients to consider trusts to protect assets from future claims, and 20% suggest planning to minimize future capital gains tax consequences.
“Even though there is a higher exemption on gifting now, we are advising some clients to consider retaining more now because people are living longer, and those associated costs are impacting their estate plans,” Radigan said.
The total sample included 112 survey respondents who attended the 54th Annual Heckerling Institute on Estate Planning, including attorneys, trust officers, accountants, charitable giving professionals, insurance advisors, elder law specialists, wealth management professionals, educators and non-profit advisors. The survey was fielded January 13-14, 2020.
© 2020 RIJ Publishing LLC. All rights reserved.
T. Rowe Price adds growth to its TDFs
T. Rowe Price Group, one of the “big three” target date fund issuers (along with Fidelity and Vanguard), announced in a release this week that, over a two-year period, it will “gradually increase equity exposure in the Retirement and Target portfolios’ glide paths early in the accumulation years and post-retirement and add emerging markets and U.S. large-cap core equity strategies to further diversify the underlying investments.”
Such enhancements, based on proprietary research, “are designed to help improve retirement outcomes and address the headwinds investors face in achieving retirement security, including longevity risk, inflation risk, and market risk,” the release said.
T. Rowe Price’s research finds that “outcomes in retirement may be improved by adjusting the amount of growth-seeking assets in the longer (pre-retirement) and shorter (post-retirement) ends of the glide path without increasing the level of risk at retirement. For example, raising equity levels led to higher average balances at retirement, more sustainable levels of income and consumption replacement, and greater residual wealth,” the release said.
Based on T. Rowe Price’s research, the following changes will be made:
Retirement glide path
- Raise the equity allocation of the glide path at the start of the investing lifecycle (30 or more years from retirement) to 98% equity from the current 90% equity
- Hold the 98% equity allocation constant until 30 years from retirement
- Maintain a 55% equity allocation at retirement
- Raise the equity allocation after retirement, reaching a final 30% equity allocation 30 years past retirement, an increase from the current 20% allocation
Target glide path
- Raise the equity allocation of the glide path at the beginning of the lifecycle to 98% equity from the current 90% equity
- Hold the 98% equity allocation constant until 35 years from retirement
- Maintain a 42.5% equity allocation at retirement
- Raise the equity allocation after retirement, reaching a final 30% equity allocation 30 years past retirement, up from the current 20%
The transition will occur over a two-year period starting in April 2020. Portfolios closest to retirement will not experience an increase in equity from their current levels, while other vintages/dates will adjust their equity allocations gradually each quarter.
As a result, many investors will see no change to their current equity allocation. The firm believes these updates will help preserve the wealth investors have worked hard to build while seeking growth, both in the early accumulation years and post-retirement, to help preserve spending power and keep pace with inflation.
Building-block additions
T. Rowe Price also announced the addition of two investment strategies to the underlying building-blocks of several target date products:
Emerging Markets Discovery Stock will be added to all the firm’s target date strategies
U.S. Large-Cap Core will be added primarily to actively managed strategies (Retirement Funds, Retirement I Class Funds, Retirement Income 2020 Fund, Retirement Trusts, Target Funds, and Target Trusts).
Adding the Emerging Markets Discovery Stock further diversifies target date portfolios’ existing exposure to emerging markets stocks. U.S. Large-Cap Core helps diversify strategy concentration in longer-dated portfolios and reduces the concentration of S&P 500 exposure in the shorter-dated portfolios.
Mutual fund fee structure changes
For its Retirement and Target mutual funds, T. Rowe Price is moving to a unitary, top-level fee structure in which expense ratios will no longer vary depending on the management fees and expenses of the underlying funds.
This modification provides shareholders a simplified fee approach across the firm’s target date mutual funds that provides greater predictability around the fees they will pay. The new fee structure will be implemented in April 2020. There are no current plans for pricing changes on collective investment trusts (CITs) or other vehicles.
As a result of this change, none of the firm’s target date portfolios will experience an increase in expense ratios, and some will see their expense ratios decrease.
According to an article in PlanSponsor magazine, “Vanguard, which managed 33.6% of TDF assets in 2017, has grown to control 37.8% of the marketplace. The four next-biggest providers are Fidelity, which controlled 21.2% of assets in 2017 versus 19.4% in 2019; T. Rowe Price, controlling 16.4% in 2017 and 12.4% in 2019; American Funds, managing 7.2% in 2017 and 10.5% in 2019, making it the only other top-five provider besides Vanguard to gain market share; and J.P. Morgan, which managed 5.0% of TDF assets in 2017 and now manages 4.3%.
All other TDF providers manage 15.6% of the marketplace—down from 16.6% in 2017. The other largest providers include Nuveen/TIAA, BlackRock, Principal Funds and John Hancock Investments.
© 2020 RIJ Publishing LLC. All rights reserved.
