SPIAs are Embedded Option Contracts
Throughout tumultuous markets, it's reassuring that retirees who rely upon income from single-premium immediate annuities (SPIAs) remain confident in the automatic payments they receive. That comfort allows individuals to go about realizing retirement dreams with relative peace of mind. Absent a SPIA, a myriad of strategies are promoted as "better," but few can match the SPIA for its efficiency, reliability and effectiveness.
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Option No. 1: Laddered bond portfolio
When planning a fixed retirement income for retirees, planners often suggest building a laddered bond portfolio. Generally, this can only be accomplished through the use of U.S. Treasury bonds. With a series of strip coupons, a laddered portfolio can be designed to deliver a series of "dollars on dates" far into the future. The treasury has ceased issuing 30-year bonds, so longer dates are scarcer. A laddered bond portfolio can also include some corporate zeros, though it might be tough to find a rich offering and sufficient choices.
A laddered bond portfolio is deemed liquid and readily available upon demand. The risk of this strategy is that of interest rates. Rates are at historic lows, yet, they appear poised to rise. Although the latest economic woes continue to plague the markets, volatility is the greatest concern. If a laddered portfolio is structured, then interest rate risk is minimized. However, that risk remains in the event of any demand call on the laddered bond portfolio.
Option No. 2: Systematic withdrawal
Within a laddered portfolio, the concept of systematic withdrawal is met with a laddered portfolio. Alternatively, if a portfolio is supposed to deliver returns of both principal and interest over time, a blended stock/bond portfolio has good possibilities. It might be important to examine the problems with the "modern portfolio theory". In today's market, that theory is under pressure.
The use of equity or stock holdings to deliver steady "dollars on dates" performance is highly risky by itself and only partially offset by bonds. The reason for this disconnect is the trauma experienced in the fixed-income markets. While subprime might be grabbing the headlines, the whole lineup of structured fixed income products, such as collateralized debt obligations (CDOs) and collateralized mortgage obligations (CMOs) has undergone transformation. Without adequate capital or reserves, these structures must stand alone in a world of mark downs and pricing issues.
Option No. 3: Legacy interests
Each of the above strategies can be implemented as a portfolio. As such, whether the structure is implemented within an IRA or a personal account, the interests of beneficiaries should be considered. The IRA or personal circumstance can be a single party or married couple. But in either case, the income plan can remain intact for a spouse. These portfolios must be updated and rebalanced periodically as the portfolio may run short of money over time. Legacy interests are in conflict with income planning because the capital is being consumed. If the capital is consumed according to a timeline, then remainder interests will eventually expire. So, the relevance of legacy interest is an argument that vanishes with time.
Option No. 4: Tail coverage
Now the age-old argument about living too long comes into play. Or, let's say, the potential risk of living a long and prosperous life in retirement must be considered. The traditional approach to remedy this problem is the presumption that equity returns on yet another basket of assets will guard and protect a future income. This has historically held true; however, if you research those who retired over the last 10 years who might have adopted such a plan, you might find a few skeptics. This would be a great research project, but it's possible that the conclusion just might be that it hasn't worked well for everyone.
Longevity risk is real - not imagined.
In previous articles, we have discussed the aging phenomenon of our population. The social and financial ramifications of this fact are real and important to individual well-being. Consider this: If the greatest risk to retirement is longevity, then why don't professionals offer an appropriate solution?
Within these few embedded options, we purport that the SPIA contains all of the requirements within a convenient package.
Option No. 1: Laddered bond function: Supported by the carrier's entire portfolio
The SPIA is, in fact, a laddered bond portfolio. Each payment is part principal and interest. The possible disruption of an income due to market volatility or interest rate risk does not exist. Payments are made as "dollars on dates."
What is a SPIA?
It's a laddered bond portfolio. It also pays regardless of the possible default of a single bond. A SPIA is a payment plan supported by the entire general account of investments. The portfolio contains treasuries, corporate bonds, private placements, mortgages, CDOs, CMOs, cash, stocks and a sprinkle of private equity for spice. SPIAs contain accelerated benefit provisions, nursing home acceleration options and other features to satisfy the planning needs.
Therefore, a SPIA is the ideal laddered bond portfolio.
Option No. 2: The systematic withdrawal syndrome - available in better form
While it is true that a fixed SPIA does not have an equity component, a variable SPIA does, so balancing a SPIA with a fixed segment and other subaccounts is truly a dynamic program. What few professionals realize is that the success or failure of the asset allocation plan in a variable SPIA will mimic what a systematic withdrawal plan does. There is, however, an important distinction: A variable SPIA is available with that extra feature know as "tail coverage." So, while the risk that a systematic withdrawal plan will run out of funds does exist, the variable SPIA will not.
Therefore, a SPIA is the ideal systematic withdrawal, whether needed in a fixed only or equity exposure version.
Option No. 3: The legacy interest issue - it's out of place
This argument doesn't stand; SPIA is not supposed to be a legacy product. If your clients need legacy assets, update your client's plan with some whole life insurance to the extent that legacy interest is a "need."
If legacy interest is not a need, but a goal, then realize this: Every scheduled capital consumption plan has an expiration date - period. So, that argument has validity only to the extent that it is an optional goal and not a basic need.
SPIAs are conveniently available with legacy insurance attached, if needed. SPIAs have many forms of legacy coverage:
- Period certain:
- Partial refund:
- Commuted value:
- Commutation feature:
Some products are available with up to 50 years certain. We won't discuss the issues of perpetuity of estates here. Just be aware that there is such an issue and plan accordingly. Period-certain features can be structured to supply a legacy guarantee for nearly any future date. This is insurance, so the cost goes up as the guarantee desired is extended.
Some products have been available with a partial refund expressed as a percent of original premium. In these products, the refund is usually 50 percent or 75 percent of the original premium. The availability of this feature is scarce; however, it can be duplicated in another way: a life annuity with seven or eight years certain - or any period that returns what is desired for legacy purposes.
It is now a common practice for carriers to consider a commutation feature to settle outstanding legacy interests. Said simply, whether you structure a period certain or installment refund feature for a client at death, the option exists to request that the carrier settle the balance through commutation.
Many carries have now begun to feature a commutation privilege within their basic SPIA product. Such an option goes a long way to assuage the buyer's concerns about liquidity. Access to cash via commutation addresses the most common complaint against SPIAs. This argument is no longer valid, as the industry has met this demand.
Option No. 4: The tail coverage argument - more economical in an embedded form within a SPIA
Some carriers have designed and marketed tail coverage products as a stand-alone offering. I suspect that these products do not offer sufficient incentive or economic sense to warrant high sales levels. These products are inflexible and do not appear to be attractive on the surface. The options built into variable deferred annuities appear to be more practical due to the downside protection.
We had heard about annuities and were investigating them for our IRAs. We also heard bad things about pushy brokers over the years. So when we went to the ImmediateAnnuities.com site we were skeptical about calling them. But whenever we called their staff was really friendly. They answered all our questions and one of their reps even told us that at our ages there was no advantage to buying the annuity with our IRAs. These guys are really honest!
In summary, the best form of tail coverage is that from the embedded option within a life-based SPIA - period.
SPIAs offer dynamic features. Product optionality is built in as demand for flexibility is sought by the markets. Those reluctant to offer life-based SPIAs ignore the greatest risk and need: longevity insurance. Living past life expectancy is a growing risk - not a diminishing one.
What have we learned?
The market is moving; SPIAs are changing. The SPIA product has become more dynamic. Those planners who embrace SPIAs will open new possibilities and fill a void created by others. Retirees will accept a SPIA when it is properly positioned and structured based upon needs.
Remember, SPIAs are the perfect retirement income planning device. SPIAs contain all of the individual subsets of options needed for a retirement income plan.