In the first article in this series, I discussed my frustration with financial planners (FPs) who constantly talk about inflation as a key motivating factor when putting together a financial plan.
As stated in the previous article, once a client’s risk tolerance for investing has been determined, inflation is irrelevant when choosing the tools to grow a client’s money. Just because the client doesn’t have enough money to retire on and keep up with inflation doesn’t mean that one with a conservative investing point of view (especially an older client with a limited amount of retirement funds) should change to a moderate or aggressive investment philosophy.
Inflation is a useful part of the financial planning discussion, so advisors can help clients determine if they need to save more money or adjust the way they think about their future lifestyle in retirement. They may not have the money they think they will have in today’s dollars, due to inflation.
My frustration with FPs
I get so frustrated with financial planners who suggest that fixed indexed annuities (FIAs) are not good wealth-building/retirement tools because they have caps on their growth (meaning that the product can’t keep up with inflation and shouldn’t be used).
Again, once an advisor determines if a client is conservative or even moderate in their investment philosophy, FIAs should be an asset class used to help a client grow wealth in a protective manner.
Why do most FPs dislike FIAs? I would say because they don’t fully understand them, or their b/d forbids or discourages their use, or they don’t have trail fees that create a book of business (even though many do).
Guaranteeing a retirement income
I don’t care what kind of portfolio an FP direct their clients to use. Whether that portfolio uses stocks, mutual funds, and/or bonds, there are no guarantees.
Let’s use my example client from the previous article. He is 65 years old, has $310,000 in a 401(k) plan as his only retirement asset, and he wants to retire in five years and be able to draw $30,000 a year out of his retirement account every year until he dies He thinks he will die at age 95.
In order to extract $30,000 a year out of the 401(k) plan and not run out of money before age 95, he will have to earn a gross rate of return of 7.5 percent every year until age 95. This client has a conservative investment philosophy and is scared of putting his money into a “volatile” stock market.
How in the world is an FP going to even come close to generating a 7.5 percent gross rate of return from the example client’s age 65–95? If the FP is using stocks, mutual funds and bonds, the answer is there are no guarantees; and the client won’t be using “conservative” investments. (I’m sure you know that from 1998–2008, the S&P 500 index produced a negative 1.45 percent rate of return). If the FP recommends money market/CD accounts, there is no way over time that the client’s money will grow anywhere near 7.5 percent.
What is an FP going to tell this client?
In the real world, most FPs will tell this client that their retirement goals are unrealistic and can’t be reached with a conservative investment philosophy. Is that what the client wants to hear? No, but if that is the reality of life, then that’s what the client needs to be told.
FIAs with guaranteed income riders
Should every FP introduce an FIA with a guaranteed income benefit to clients with a conservative to moderate investment philosophy who want certainty in retirement? Yes. Whether a client buys one or not is not really the point. My frustration comes from the fact that most securities licensed advisors know very little about FIAs and their income riders. Many are forbidden by their broker/dealer from selling them, and, therefore, most clients are not introduced to these products when they can be the best guaranteed retirement vehicle at the client’s disposal.
Eight percent guaranteed return with a guaranteed income benefit of 6 percent
What if there was a product that had a 10 percent bonus, would roll up at 8 percent guaranteed for up to 20 years, and pay a guaranteed income benefit for life based on a 6 percent payment rate at a client’s age 70? It exists, and you’d think FPs would know about it. Unfortunately, most do not.
If my example client funded this FIA with $310,000, his/her guaranteed income for life at age 70 would be $30,062 every year, no matter how long the client lived (with the balance, if any, in the actual account passing to his/her heirs upon death).
Again, I’ll ask, should an FP educate my example client about this product? Absolutely.
While it’s great that the above can guarantee the client over $30,000 a year up to age 95 and beyond if the client lives that long, it, too, does not deal with inflation, because the income in this product will probably never increase.
FIA with increasing income option
This is the most powerful FIA with a guaranteed income rider in the market for clients who are nearing or in retirement. The income with this product will start a bit lower than other FIAs in the marketplace, but its income increases every year the measuring stock market increases. By design, it should increase between 4 percent to 6 percent throughout time. This allows the client to have a chance to keep up with inflation.
I don’t have time in this article to discuss how the increasing income rider FIA works. I will tell you the numbers, however. For this example client, the income will start at approximately $26,607 when he is age 70. If, over time, the returns in the product average 5 percent (below the back-tested historical return), the income at age 80 would be $45,167; at age 85 it would be $60,869; at age 90 it would be $76,761; and at age 95, when the client thinks he is going to die, it would be $103,362.
Now we are talking about a conservative retirement tool with no risk that will have a good chance to keep up with inflation.
I think this is the best product in the industry if you have clients who are going to turn their income on within five years and who think they will live a long and happy life.
Summary on inflation being irrelevant in financial planning
While inflation is not completely irrelevant when putting together a financial plan for clients, it’s close. Inflation can be used as a motivating factor to get clients to save more. It can be used as a reality check to make clients understand that their goals for retirement are unrealistic, given their financial makeup and investment philosophy.
Aside from discussing with clients whether they want to save more or live a different (lesser) lifestyle in retirement, inflation is truly irrelevant once it has been determined what investment philosophy the client has chosen. If the client is conservative, just because he/she won’t be able to live the lifestyle they want (because of inflation or not) does not mean that the client should shift philosophies to a more aggressive approach.
And, finally, if you are not using FIAs with guaranteed income rides as part of your conservative and even moderate growth portfolios for your clients in order to help guarantee them an income for life they can never outlive, you are doing them and yourself a disservice.