THE NEW RETIREMENT CONVERSATION Transcript 7/26/2013 #1005

July 26, 2013

CONSUELO MACK: This week on WealthTrack, the new architecture for retirement. Personal finance pros Mary Beth Franklin and Kim Lankford discuss the different building blocks now needed for a secure financial future and why insurance will be an important part of the foundation, next on Consuelo Mack WealthTrack.

 

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. What is the next big thing in investing? For your answer, think baby boomers and their retirement. The baby boom generation, some 71 million Americans born between 1946 and 1954, have had an outsized impact on the economy, markets and financial services industry from the beginning. As investors, we turned from the individual stock and bond choices made by our parents and grandparents to open-ended mutual funds, mostly actively managed ones to start, but in recent years passive ones, making the switch years after Vanguard founder Jack Bogle launched the first index fund in 1976. According to the Investment Company Institute, the mutual fund industry is now a $13 trillion plus behemoth.

The next big investment idea, the exchange traded fund, or ETF, was created in 1993 by the late Nathan “Nate” Most, an American stock exchange executive at the time who wanted to bring new trading volume to the exchange. The first ETF was the SPDR 500 Trust, managed by State Street Global Advisors. Most was quoted as saying he never thought ETFs would be this big. At the time of his death in 2004, they were a $190 billion dollar industry. Today it’s over $1.3 trillion and growing fast. Investors, many baby boomers among them, opt for low cost, passive index investments with the instant ability to get in and out.

 

But now that baby boomers are switching from the accumulation phase of their investing lives to the distribution phase to fund their retirement, their needs are changing and so are their circumstances. What is their biggest need? Income to last a lifetime. With the demise of the defined benefit plan or old fashioned pension fund, where are they going to find that holy grail? What is the next big investment trend? Today’s WealthTrack guests have an answer that might surprise you. They say think insurance products!

 

Mary Beth Franklin is contributing editor of InvestmentNews, a leading publication for financial advisors. For many years she was a senior editor at Kiplinger’s Personal Finance magazine. She is a familiar face on WealthTrack because of her expertise on retirement income and social security. Kimberly Lankford is a contributing editor and columnist for Kiplinger’s and author of several books including The Insurance Maze: How You Can Save Money on Insurance-and Still Get the Coverage You Need. I began the interview by asking Franklin about what she calls the new conversation we should be having about retirement income.

 

MARY BETH FRANKLIN: We all grew up with this concept of the three-legged stool of retirement security. It was pensions, social security, and personal savings. Well, we all know that those pensions are going away, and that personal savings are inadequate, at best. And social security is a bit wobbly. So right now our three-legged stool has basically become a pogo stick. And that’s not going to be good enough for most Americans.

 

CONSUELO MACK: So what is the new model? If the three-legged stool is no longer adequate, what is the new model for us?

 

MARY BETH FRANKLIN: I think individuals and their financial advisors should think of a retirement pyramid, and that the base of this pyramid is going to be a nice, broad, solid foundation of social security. For the majority of Americans, this is going to represent half or more of their entire retirement income. And then the next layer, for a lot of people, will be their 401(k) savings or IRAs. Layer on top of that for a lot of people, home equity. And that doesn’t mean necessarily taking a home equity loan. It could be selling your house and downsizing to something smaller. Or paying off your mortgage and living in that house mortgage free, so you need less retirement income.

 

And then on top of that, for some people it’s going to be continued employment, whether it’s part time or seasonal, or intermittent. And at the very top of that pyramid, for the people at the top of the income heap, it’s going to be other investments, or other income producing assets. So everyone’s going to have access to some or all of the layers of this pyramid, but everybody’s combination, their retirement income puzzle, is going to be very individual. And that’s the big retirement income challenge.

 

CONSUELO MACK: Right. So do you agree with this, that we need a new model, and that this is a model that you would subscribe to as well, Kim?

 

KIM LANKFORD: I definitely agree, and there are all these pieces. And I think it was over simplified in the past. And now, one of the challenges is that piece that the 401(k) and the IRA or retirement savings, as you know, part of that whole pyramid is, how do you translate that into retirement income? And that’s one of the biggest challenges that people are having, is to take all that money they’ve been accumulating for years and years. They’ve learned how to do that, learned how to save, hopefully, and trying to figure out how to translate that into income that will last for their lifetime. And the big problem is, you don’t know how long you’re going to live. So that’s where insurance products come in that could help provide some of that longevity insurance.

 

CONSUELO MACK: So Mary Beth, just address that, that one of the key aspects of financial planning for retirement is to have a base of a secure foundation of income.

 

MARY BETH FRANKLIN: That’s right.

 

CONSUELO MACK: And social security is at the bottom of your pyramid.

 

MARY BETH FRANKLIN: Frankly, I think before the market crash of 2008, many Americans looked at social security as, oh, you know, it’s greens fees. You know, I’ll take it at 62. So what if it’s reduced? It’s no big deal. Now we’ve realized, particularly for people who have lost pensions, is that social security for most Americans will be the only source of guaranteed cost of living adjusted income that will last the rest of their lives. And people should treat the decision of when to claim their social security benefits as seriously as any other part of their investment decision. What a lot of people don’t realize is, sure, you could get your benefits early at 62, but they’re going to be reduced by 25 percent for the rest of your life.

 

CONSUELO MACK: Which is huge.

 

MARY BETH FRANKLIN: That’s huge. And if they wait till 66, which is the current for retirement age, they get a full retirement benefit. But so many people don’t realize, if they wait a little, they will get an increase of eight percent per year between age of 66 and 70. That means if you waited till 70 to get your benefits, your benefit is a third larger than it would have been.

 

CONSUELO MACK: And that’s for life.

 

MARY BETH FRANKLIN: That’s for life. And it also creates this larger benefit, that when there’s annual cost of living adjustments, they are applied to a larger base. So this is really huge, and now consumers are starting to be aware of it. The financial advisory community is aware of it. But the nuances are so complicated, it’s really worth going to an expert who can tell them the best way to claim this.

 

CONSUELO MACK: All right. And let me just add one more thing that you’ve talked about in the past with us as well, is the fact that to separate the decision of when to take your social security and the decision of when to retire, that they can be quite different.

 

MARY BETH FRANKLIN: Right. I think if someone took away one piece of information from this interview, it’s when you retire, and when you begin collecting social security benefits are two separate decisions.

 

CONSUELO MACK: Right. So Kim, let me bring you into this. So we have the floor, which is the social security benefits. And then the second thing, so I’m looking for another layer of secure income for life. So explain to us how insurance can provide us with that next layer of secure income for life.

 

KIM LANKFORD: And that’s exactly right. I mean, social security, you just, when you see how social security can work, it is, it is a lifetime income that’s adjusted for inflation. That is going to help you pay a lot of those expenses that are going to continue every month for the rest of your life. But it’s really important to look at what those expenses are. Subtract your guaranteed sources of income such as social security and the pension, and see if there is a gap. And for many people, especially people who don’t have a pension, there’s going to be a gap there. They’re going to need … maybe it’s several hundred extra dollars every month and they figure out probably for the rest of their lives, they even need more as expenses grow through inflation. And that’s where they want to have something that converts their savings into a lifetime income, something they’re never going to outlive. And that’s where a lot of people are looking into various forms of annuities, because that’s one of the few things that can actually do that. And the key thing is, is not to invest too much of your money in one of these products.

 

Some of these are expensive. Some are not flexible. But they do provide lifetime income. So look at it as the filling in that gap between what your expenses are and your sources of income. And then, once you have that base covered, then you can feel more comfortable investing the rest of your money more aggressively, not having to be so conservative, because you know your regular expenses are covered.

 

MARY BETH FRANKLIN: Right, exactly. You want to match up your guaranteed sources of income with your fixed cost, your known costs.

 

CONSUELO MACK: So talk to us about, so what would you include in your fixed costs?

 

MARY BETH FRANKLIN: Basically your housing, your food, your taxes, your health care, anything that’s a …

 

CONSUELO MACK: Health care.

 

KIM LANKFORD: … recurring cost that you know you’re going to be paying month after month, year after year. You want to have as much of that covered by either guaranteed or stable sources of income. Now, frankly, five years ago we would have said, you know, ladder bonds, or certificates of deposits. But because interest rates are so low right now, you’re just not getting a lot of income from those kind of investments. And that’s where insurance products like an annuity can help you leverage your money a little more.

 

CONSUELO MACK: So talk to us, because a lot of people don’t understand why insurance products can give you higher income than is out there in the market place, even in a low interest rate environment. How does an annuity work?

 

KIM LANKFORD: Well, I mean, technically the way it works, and the way you can get the extra money is, is the pooling of risk. And the basic annuity that’s been around for a very long time is an immediate annuity. You give the insurance company a lump sum and they give you a set amount of income for the rest of your life. And if you’re a 65 year old man, invest $100,000 in an immediate annuity right now, you’ll get a pay out per year of about $6,800 per year.

 

CONSUELO MACK: So that’s 6.8 percent a year.

 

KIM LANKFORD: Exactly. Now the key thing is that, you know, some of this money is your principle. And some of this money is earnings. And, also, people live different amount of time. So some people who live for a very long time are ultimately going to be getting a lot more money than others. The way that you get the most money from an immediate annuity is to buy a single life version which, the payments stop as soon as you die.

 

Now, many people don’t want to do that because they might have a spouse, or they might want to just make sure their heirs get something if they die after … within five years or so. And so there’s all kinds of different variations that, you know, all slightly decrease that annual income that you can receive, but give you a big more flexibility.

 

MARY BETH FRANKLIN: To show you a comparison of why this pooling of risk gives you a bigger payout, there’s been something called the four percent. It’s been a rule of thumb for years, that a retiree could safely withdraw four percent of their nest egg in the first year of retirement and then take out a little bit more each year to adjust for inflation, and that theoretically would last 30 years.

 

CONSUELO MACK: Yeah. And we know the fallacy in that, because if you happen to retire with a million dollars, for instance, and supposedly you could take $40,000 a year out for the rest of your life …

 

MARY BETH FRANKLIN: And then 2008 happened …

 

KIM LANKFORD: Exactly, the first year.

 

CONSUELO MACK: And suddenly you don’t have … right, a million dollars, you’ve got $800,000 or $750,000. It’s a whole different ball game. Okay. So that’s …

 

MARY BETH FRANKLIN: It’s early years, it’s such a difference. But it shows you an example right there, if a safe rule of thumb was four percent or $40,000 out of a million, and you put a million dollars into that same immediate annuity, you would be getting $68,000 out of it. You’d be getting a third more basically because you’re pooling the risk with other people. So it’s the trade off. You’re losing access, perhaps, to a chunk of your money. But you’re getting a bigger payout. And that’s what people are going to have to understand when it comes to spending money in retirement as opposed to saving money for retirement. It’s a totally different ball game. When you’re saving money for retirement, you basically save as much as you can, as soon as you can, for as long as you can, and for pretty much everybody, the rules are the same.

 

But when you get to taking the money out of retirement, this is where it gets tricky, and where your individual situation is going to dictate. Are you married? Are you single? Are you divorced? Are you healthy? Are you dealing with an elderly parent? Do you have a boomerang kid? Do you have a pension? Don’t you have a pension? That’s where this retirement income puzzle becomes so personal, and so tricky.

 

CONSUELO MACK: So what is the other, you know, basic annuity that we should know about and understand?

 

KIM LANKFORD: Well, right now, the tough thing with the immediate annuity is, it does start to pay out immediately. So you really can’t do advance planning with that. And as Mary Beth was talking about with social security, I mean, a lot of times you might not need the money right away. And the longer that you can delay taking some of the money, the more it can grow, or the older you are when you buy an immediate annuity the higher the payouts will be because you’re expected to live not as long.

 

So there’s been several versions of annuities that have come out for people who are planning their retirement, planning to retire in five or ten years, who are in their fifties or early sixties, but they don’t need the money yet. But they want to lock in something now so they know it’s there. And one of the popular ones over the last several years has been variable annuities with income benefits. So these are annuities that, you know, the money can grow tax deferred. You have it invested in mutual fund like accounts. But the very important thing for people is that there is a lifetime income guarantee. And so even if your investments lose value, you have a guarantee of either what that original investment was, or, in many cases, the highest point that it had reached through time, and your lifetime income is based on that amount. And so you know you’ve got that. But, if you do want to withdraw money, you’ve got the flexibility. This is unlike the immediate annuity. You don’t have to start taking the money right away.

 

However, the key thing is, if you take a withdrawal, you withdraw all the money, then you only get the actual account value. You don’t get that guaranteed value. So these are very complicated. They can serve a purpose. Some have much higher fees than others. You need to really shop around and be careful. But it can serve that lifetime income guarantee need, without having to take the money right away, and without having to totally lock it up forever.

 

MARY BETH FRANKLIN: It also demonstrates that the main difference, again, between saving for retirement and spending money in retirement is that when you’re saving, all you’re thinking about is accumulating.

 

CONSUELO MACK: Sure.

 

MARY BETH FRANKLIN: How much can I accumulate? Once you get to the retirement income phase you really want to build a floor of some sort of guarantee. And those guarantees cost money. And then, once you’ve locked in this floor of whatever adequate income you need, then you can start building for growth. You know, put the floor in and then grow on top of it.

 

CONSUELO MACK: Right. But with interest rates so low, is this any time to be thinking of any of these insurance products?

 

KIM LANKFORD: Well, that’s the thing. And that’s where there are some of the very different versions. Immediate annuities right now, it’s a really tough time for immediate annuities because …

 

CONSUELO MACK: Right. I mean, because they’re giving you low rates as well compared to what …

 

KIM LANKFORD: Exactly.

 

CONSUELO MACK: … they have in the past. Right.

 

KIM LANKFORD: What some people are doing, if they do want to lock in some income, they may be laddering immediate annuities. So they may buy a little bit now just so they know they have it. But in the other very popular product that just was introduced about a year and a half ago, is called the deferred income annuity. And this is one where you invest a lump sum, or you can make several investments through time, and … but it’s like an immediate annuity in that way, but you don’t actually start taking the money for anywhere from 13 months to 30 years.

 

CONSUELO MACK: Hence deferred.

MARY BETH FRANKLIN: Yes. And it’s fairly simple because it’s based on a fixed interest rate, so you know when you purchase it what your payout is going to be sometime in the future.

 

CONSUELO MACK: But so again, in a low income environment, what are the fixed interest rates that you’re being offered now?

 

MARY BETH FRANKLIN: Well, actually, when I first wrote about this, which was about two years ago, at the time, someone who invested a chunk of money and started taking withdrawals maybe ten years in the future were getting about a 12 percent payout. Now that’s down to under about $10,000.

 

KIM LANKFORD: Right, well, someone who defers for about nine years starts taking out the money at age 67, it would be, if they had invested $100,000, would get about $9,200 or so. It varies a lot from company to company. So you are still getting some of the mortality credits. You’re still getting the benefit of deferral, so you really need to think, okay, this is something I’m not taking out right away. Do I want to invest in it now, knowing it’s going to be deferred for many years? Or do I want to wait and see what happens to interest rates and …

 

CONSUELO MACK: Do you time insurance products?

 

MARY BETH FRANKLIN: And that’s part of it is, you don’t want to blow the whole wad at once during historic low interest rates. If you’re an existing retiree who really needs money now, maybe you’d want to put some money in, but you want to keep your powder dry because interest rates will eventually go up. And I know we’ve been saying that for a very long time.

 

CONSUELO MACK: And it looks like it’s starting.

 

MARY BETH FRANKLIN: Exactly. So that’s … higher interest rates is actually going to solve a lot of problems for retirees. They will get more payouts on just straight savings, CD sort of things. And they will probably get higher payouts from annuities. And they may want to be pulling back on bonds, because bonds don’t do so well when interest rates go up.

 

CONSUELO MACK: Right. So there’s another aspect to the insurance issue, which we’ve talked about with both of you in the past. And it’s that tail risk that everyone’s worried about, as Kim has put it. And the tail risk is that I really live much longer than anyone thinks I’m going to live. And there’s something that you both have recommended in the past, longevity insurance. So give us the latest, Kim, on longevity insurance.

 

KIM LANKFORD: Well, so, actuaries and academics love longevity insurance because it really does pinpoint that real specific risk.

 

CONSUELO MACK: And tell us what longevity insurance is again, just …

 

KIM LANKFORD: So longevity insurance is like the deferred income annuity. But it’s deferred for a very long time. So for example, you invest a certain amount of money when you’re 65, and it only pays out if you live until 85. However, if you live until 85, it pays out a much higher amount because the odds of people living that long are not as great. So they really, really have that pooling of risk. And the key thing is that, you know, when you talk with academics and actuaries, they point out that your longevity risk is not an issue when you’re in your sixties, when you’re in your seventies. That’s just kind of managing your money that you’ve saved. It’s after you’re in your eighties, when you really haven’t planned for your money to last longer than a certain amount, that’s when you really need to think about what to do. So the academics love this. However, it’s been really a hard sale. Not many people…

 

MARY BETH FRANKLIN: Right. It’s sort of the ultimate roulette wheel of insurance. Everything’s red or black at this point. You don’t get that payback in between because it’s pure insurance. But when you think about what’s the biggest question in retirement income is, how long am I going to live? You could do something like, all right, I have longevity insurance, going to start paying at 85. That means the rest of my money only has to last till 85.

 

KIM LANKFORD: You have a start and end date. And that’s a big problem with retirement …

 

MARY BETH FRANKLIN: Makes it a lot easier.

 

KIM LANKFORD: …. planning otherwise, is you don’t know how long it has to last. So this way you know. It just needs to last to 85, and then you’ve got that income coming in.

 

MARY BETH FRANKLIN: Now, here’s another dichotomy of the difference between saving for retirement and retirement income. When you’re saving for retirement, you’re pretty much just dealing with market risk. Market volatility. When you’re spending money in retirement, you have market volatility, you have interest rate volatility, and you have this longevity risk, the risk of living too long. And so you can see where people in retirement have so many more pieces they have to juggle.

 

CONSUELO MACK: Right. Right.

 

MARY BETH FRANKLIN: And insurance is one of the only ways that you can pool your risk with other people. And if you’re one of the lucky ones that live a long time, you’re going to get a great return on your investment.

 

CONSUELO MACK: Right. As the baby boom generation to retire …

 

MARY BETH FRANKLIN: Right. We have 10,000 people a day aging into retirement …

 

CONSUELO MACK: Right, retirement.

 

MARY BETH FRANKLIN: … and they’re looking for guarantees. And they grew up 20, 30 years, through their 401(k) plan was the way they were introduced to the stock market, like it or not. And I think now, as they transition to retirement, they’re going to be looking for guarantees that only insurance can provide.

 

CONSUELO MACK: So unfortunately, we are almost at the end of our conversation and we could go on forever, but … so I need to ask the one investment for long term diversified portfolio, and Kim, I’ll start with you. What would you recommend that we do?

 

KIM LANKFORD: Well, these annuities can solve many needs, but they’re very complicated. And so many times, since they’re deferred, it’s ten years or more have passed between when you bought them and when you start taking out the money. So if you do have an annuity, especially a variable annuity with guarantees you need to be very careful because if you take out too much money you could jeopardize those guarantees. And you could make little tiny changes that jeopardize all of those things you paid for, for years. So there’s a website that I like. It’s called annuityreview.com. And for $199 they will review up to three annuity products, and they will let you know what you need to do. They’ll help you figure out kind of the most efficient investments to have to match with those guarantees. And also some of the best ways to take out that money so you don’t jeopardize some of those guarantees, but you also really make the most of what you’ve been paying for for years.

 

CONSUELO MACK: Great. So we’ll have a link to that on our website. Mary Beth, what would yours be?

 

MARY BETH FRANKLIN: Well, just last week John Bogle, the founder of Vanguard, was quoted at the Morningstar investors conference saying “Social Security is the best fixed income investment you can find.” And taking the tip from St. John…

 

CONSUELO MACK: Jack Bogle St. John.

 

MARY BETH FRANKLIN: … people should really try to optimize their social security benefits, and it can be complicated. But there are some great websites. My favorite one for consumers is called socialsecuritysolutions.com. It is a fee for site. There’s a range of about $50 to maybe $150 where you will get a personalized recommendation for you and your spouse if you’re married, or even if you’re divorced or widowed, of what your optimum strategy is, when you should claim benefits, how much you’ll get.

 

CONSUELO MACK: Right. Great information, and so essential and valuable to us. We love having you on. Thank you both so much. Mary Beth Franklin from Investment News, and Kimberly Langford, Kim Lankford, from Kiplinger’s Personal Finance magazine. Thanks very much.

 

KIM LANKFORD: Thank you.

 

MARY BETH FRANKLIN: Thank you.

 

CONSUELO MACK: At the conclusion of every WealthTrack we try to leave you with one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: calculate how much money you need to retire comfortably. And if you have already done so, you might want to review your assumptions using the new approaches Franklin and Lankford just talked about: maximizing your social security benefits, considering the impact of some insurance products, including immediate annuities, longevity insurance and long term care insurance. Then see how they can improve the results.

 

This is an exercise you should do with your family, financial advisors and for do-it- yourselfers on line. There are numerous websites to help you. Among Franklin’s favorites are the retirement calculators found at T. Rowe Price’s and Fidelity’s websites. We will have links to both on our website, wealthtrack.com.

 

Next week, during public television’s fund raising week, we will continue our retirement focus by revisiting our conversation with award winning financial planner Harold Evensky, including why he has his clients assume a lifespan of 95 years! If you have missed any of our past Great Investor or Financial Thought Leader guests you can find them on our newly revamped website wealthtrack.com as well as access exclusive interviews and research in our WealthTrack extra feature. In the meantime, have a great weekend and make the week ahead a profitable and a productive one.

 

 

 

 


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