(Kiplinger) As 10,000 Baby Boomers a day leave the workforce behind, only 28% believe they are doing — or have done — a good job preparing for retirement. What’s more, only 25% believe they will have enough money to live in retirement, according to the Insured Retirement Institute.
Americans are living longer and healthier lives. Life expectancy has increased 30 years over the past century, and now there is a 1-in-2 chance that one member of a 65-year-old couple will live to at least age 95, according to the Society of Actuaries. But for many, reliable sources of guaranteed retirement income aren’t a given.
To reduce the risk — and the fear — of outliving their savings, Boomers can incorporate insurance into their holistic financial plans. If you’re a Boomer preparing for or living in retirement, low-cost, no-load insurance may give you a solution for more tax-deferred savings, may allow you to participate in the market while protecting against downturns and provide a steady stream of guaranteed income to protect against longevity risk.
The retirement income challenge is real. Here are three ways insurance can help tackle it.
Challenge No. 1: Maxing Out Tax-Deferred Savings
Qualified retirement savings plans, like employer-sponsored 401(k) plans, traditional IRAs and Roth IRAs, offer the opportunity to save tax-deferred. But high-earning Boomers can easily max out the annual contribution limits of their 401(k) , capped at $19,000 (plus $6,000 catch-up contributions for those over 50), as well as their IRA and Roth IRA, each capped at $6,000 (plus $1,000 catch-up contributions) as of 2019.
Adding more tax deferral helps Boomers maximize compounded accumulation potential — and the more they accumulate, the more income they can generate in retirement. Investment Only Variable Annuities (IOVAs) are insurance products designed for more tax-deferred accumulation. According to Morningstar, IOVAs offer lower costs and more funds than the typical variable annuity. They can be used by investors who max-out the contribution limits of their qualified plans, and also by investors who do not have access to employer-sponsored plans.
An example: Consider the cases of Ellen and Mary, both single 55-year-old advertising executives. With 10 years before each retires, both Ellen and Mary are high-earning professionals who are aggressive savers, but they have different financial needs.
Ellen wants to maximize tax deferral beyond the limits of her 401(k) and other qualified accounts. An IOVA allows her to accumulate more on a tax-deferred basis, and skillful use of her IOVA also allows her to avoid the annual tax headache that comes with dividends, ordinary income and short-term capital gains on certain types of tax-inefficient investments.
While qualified accounts offer the advantage of being funded with pretax dollars, and IOVAs are typically funded with after-tax dollars, there are virtually no restrictions on the amount Ellen can invest in her IOVA. This means she can continue investing in her IOVA after age 70½ — something not allowed with a traditional IRA — and her IOVA has no minimum distribution requirements during her lifetime, unlike her qualified accounts.
On the other hand, while Mary is also focused on maxing-out her qualified accounts and making catch-up contributions, she has expenses that require unrestricted access to her assets. Because annuity withdrawals before age 59½ may incur tax consequences, an annuity might not fit for someone with more immediate liquidity needs like Mary.
Challenge No. 2: Guaranteed Income Now
Many Boomers are concerned about the inherent hazards of drawing down on an investment portfolio to generate retirement income. This strategy can expose a retiree to market downturns and sequence-of-returns risks (when the market falls early in someone’s retirement, making it very difficult — if not impossible — for them to recover).
For those already in retirement, certain insurance products, such as a single premium immediate annuity (SPIA), can generate guaranteed income now — providing an income floor to complement their withdrawal strategy, generating another income stream to supplement Social Security, or even filling the income gap until Social Security payments begin.
An example: Consider Lauren and her twin brother, Todd, 65-year-old recent retirees. As Lauren and Todd approached retirement this year, both of them knew it was the right choice to delay taking their Social Security benefits until age 70 to qualify for the maximum benefits. Research shows that many retirees miss out on thousands of dollars in guaranteed annual income by taking Social Security too soon.
But Lauren was uncomfortable relying exclusively on withdrawals from her investment portfolio for the five years before her Social Security payments would start, concerned that market volatility could reduce her income — and erode the value of her retirement savings.
She decided that investing a portion of her portfolio in a single premium immediate annuity was the best solution for a guaranteed stream of retirement income that is protected from market downturns. It can complement withdrawals from her portfolio, and in some cases provide more income than a bond- or CD-laddering strategy. With part of her portfolio allocated to a SPIA, another part can be invested more aggressively for greater growth potential.
While Todd also delayed his Social Security benefits to age 70, a career on the local police force provided him with a pension. Between his pension and investment portfolio, Todd projects to have enough to cover his retirement income needs for the five years until his Social Security payments begin, so a SPIA may not be necessary.
Challenge No. 3: Guaranteed Income Later
Younger Boomers need to know that money invested now will be able to finance their retirement — especially if retirement could last 30 years or more. Certain types of insurance, such as a variable annuity (VA) with an income guarantee, can allow them to potentially accumulate more tax-deferred, and then turn on a stream of income later, to cover their cost of living and protect them against the risk of outliving their assets.
An example: Consider Douglas and Robin and Fred and Rosie, two couples in their early 60s. Both couples have been married for 30 years, recently sent their children off to college and are now empty-nesters who plan to transition into retirement over the next 10 years.
Douglas and Robin maxed out their tax-deferred savings accounts — including 401(k)s, IRAs and health savings accounts — so they invested in a low-cost, no-load variable annuity with an income guarantee. It can help them accumulate more on a tax-deferred basis when the market is up, protect their assets when the market is down and help ensure they’ll save enough to enjoy the lifestyle they’ve planned for retirement. And when they’re ready to retire, they can turn on a stream of guaranteed lifetime income that will limit the need to draw down their investment portfolio, help supplement their Social Security and help mitigate longevity risk.
While Fred and Rosie were also diligent savers, they have been focused on financing their children’s education. Now, Fred and Rosie’s priority is maxing-out their qualified plans and making catch-up contributions, before they consider investing in additional tax-deferred vehicles such as variable annuities.
Take on the Retirement Income Challenge
If you are a Baby Boomer, retirement is no longer a distant goal. For many, it is now your reality. Insurance is often overlooked, but it can be key to a holistic financial plan that helps you protect against outliving retirement savings, while living the life you want in retirement.
Be sure to max-out qualified accounts first. Consider your liquidity needs. And consider your tax situation. Withdrawals from insurance, such as IOVAs and variable annuities, are taxed at ordinary income rates instead of lower long-term capital gains rates — but assets can benefit from years of tax-deferred accumulation, and many investors are in lower tax brackets after they retire.
The next time you meet with your adviser, ask how the right kind of low-cost, no-load insurance can help you take on the retirement income challenge. More tax-deferred accumulation, market participation with protection against downturns and guaranteed income for life can help reduce the risk — and the fear — of outliving your retirement savings.
