Making the nest egg last: best products for senior clients

Entering retirement can be a particularly jarring experience for seniors, and not only because they’re leaving behind the familiar world of work. For the change also requires a shift in one’s financial orientation — from savings accumulation to decumulation.

Above all, the transition brings into focus one overriding goal: how best to “pensionize” a nest egg so that your money outlasts you, and not the other way around.

Among the more 78 million baby boomers in or near retirement, the oldest of whom are now over age 70, retirement income planning has thus become an urgent priority. That’s true, too, for the thousands of agents and advisors who serve these boomers — a demographic group now in possession of lion’s share of the nation’s wealth.

Related: 3 reasons annuities should help fund baby boomer retirement

“Americans age 55-plus own almost 70 percent of all investable assets  in the U.S.,” says Jafor Iqbal, an assistant vice president at LIMRA Secure Retirement Institute. “That’s a huge concentration of money. So naturally, advisors have changed their focus in recent years to incorporate retirement income planning in their practices.”

Related: Fixed annuity sales hit record $117.4 billion in 2016

In tandem with this shift, insurance and financial professionals are looking to a range of solutions that can best secure senior clients’ post-retirement objectives. Among the main aims are preservation of principal, guaranteed income for life and healthy returns on invested capital.

There’s also this not-insignificant one: tax-favored treatment of retirement assets. This can have a potentially huge impact, not only on the quality of life in retirement, but also on money available to fund a retiree’s legacy planning objectives.

Among the main aims of retirement financial planning: preservation of principal, guaranteed income for life and healthy returns on invested capital. (Photo: iStock)

A multi-purpose product

One vehicle well suited to achieving these goals is cash value life insurance. Ed Slott, a CPA, author and expert on individual retirement accounts, advocates that individuals move assets held in an IRA to a permanent, paid-up life insurance policy. The sweet spot is after 59 ½, when IRS tax penalties on IRA withdrawals no longer apply.

Related: Your 5 best arguments for life insurance (besides the death benefit)

Why do this? Because unlike an IRA, funds in a cash value life policy can be accessed free of income tax (up to cost-basis through withdrawals; and thereafter as policy loans).

The tax-favored treatment also lets policyholders avoid “stealth taxes” that kick in because of increase in taxable income. For example, an IRA distribution could boost tax on Social Security benefits or trigger a 3.8 surtax on net investment income from capital gains, investment income or dividends.

Cash value life insurance is also exempt from required minimum distribution (RMD) rules governing IRAs. Seniors can thus let their policy’s cash value grow beyond age 70 ½ (the age at which IRA holders must begin taking income) on a tax-deferred basis.

“People think of life insurance for the death benefit, but most people don’t know about the powerful lifetime retirement and tax benefits,” observes Slot. “Funds in a permanent life insurance policy can double as a retirement savings account, but without the worry about what future tax rates will be.”

Related: How to use an IUL as tax-free retirement savings strategy

All well and good. But others are unconvinced that life insurance policy is the best place to park retirement assets. If, say, the senior client’s main objective is growth potential, then alternative vehicles may be a better bet, especially in a low interest rate environment, which can depress returns on interest-sensitive universal life policies.

One option to consider: a reverse mortgage, which let homeowners borrow money against their home equity. When interest rates are low, the loan to repaid — structured so as not to exceed the value of the home, and which only becomes due at the borrower’s death or when the property is sold — will be less burdensome. Upshot: more cash on hand to fund retirement or estate planning objectives.

Or so one would hope. Experts caution against rushing into a strategy for funding retirement through loans, whether via a reverse mortgage or cash value life policy. The right technique will ultimately hinge on a rigorous analysis of the options; anything short of that could put the retiree at financial risk.

“You have to run the numbers to see which strategy makes most sense,” says Moshe Milevsky, an associate professor of finance at the Schulich School of Business at York University in Toronto. “The number one question to ask is, ‘What will be the interest rate at which I’m borrowing money?’ If the rate on a policy loan is high relative to a reverse mortgage, which can create a similar tax-free income stream, then the reverse mortgage may make more sense.”

Experts caution against rushing into a strategy for funding retirement through loans, whether via a reverse mortgage or cash value life policy. (Photo: iStock)

What am I earning?

The prevailing interest rate also must be considered when investing in interest-sensitive fixed income vehicles that can provide a guaranteed retirement income stream. These include savings accounts, bonds, certificates of deposit, money market funds and fixed annuities. Of these, only the last can assure retirement income for life, a top priority of seniors, as recent research indicates.

“Almost two-thirds of annuity sales are for guaranteed lifetime income products,” says LIMRA’s Iqbal. “And one-third of the buyers are ages 65 and older.”  

Many of these retirees are looking not only to pensionize their nest eggs, but also secure a larger monthly income stream than available through other fixed income vehicles. An annuity kick-started later in retirement (e.g., at age 67 or 70) will, like Social Security, pay out more than one begun in earlier years.

The reason: mortality credits. As annuitants taking income from a common pool of cash pass away, more money is freed up to distribute to surviving annuitants. With each additional death, the mortality credits increase, and therefore also monthly payouts.

Such credits may suffice for seniors look for a steady fixed income and can afford to postpone distributions to future years. The chief vehicles for this approach are conventional fixed annuities, including single premium immediate annuity (SPIA) or, if payments don’t start right away, a deferred income annuity (DIA).

But for those desiring growth over and above the prevailing interest rate, vehicles offering an equity component tied to stock market performance may prove more appealing.

Notable among them are fixed indexed annuities, which (depending on the insurer-stipulated formula) capture a portion of stock market returns, while also protecting against downside risk. As with a traditional fixed annuity, investors can count on a receiving guaranteed minimum interest rate.

Related: Demand growing for fixed indexed annuities

Alternatively, senior clients can invest in variable annuities, products that, through separate accounts that invest in mutual funds, boast full participation in stock market gains — a key attraction for retirees looking to ride the current bull market.

Risk-averse investors looking to protect their nest eggs against market fluctuations can also add a guaranteed living benefit, including income, withdrawal, accumulation and death benefits, to the product chassis via an optional rider.

These GLBs are, however, not as generous as they were before the market crash of the last decade, which severely taxed VA manufacturers’ balance sheets. What GLBs are still available on the products, they come with higher fees than in years past — expenses that many view as uncompetitive relative to comparable riders offered on fixed indexed annuities.

York University’s Milevsky thinks such views are misplaced.

“There’s a widespread belief that fixed indexed somehow don’t have fees, whereas VAs are laden with them,” he says. “This shows a lack of understanding about the products.”

“In fact, fees are embedded in fixed indexed annuities,” he adds. “Product manufacturers are just not forced to disclose these fees the way they do with VAs. The two products are structured differently.”