SPIA on steroids, Pt. 4Article added by Joe Bellersen on March 25, 2010
Joseph Bellersen

Joe Bellersen

Joined: August 21, 2010

The controversy of providing a "lifetime income" option is drawing heated debate. The Obama Administration's Request for Information ("RFI") proposes guidance on its rule making to mandate a lifetime income annuity arrangement at retirement. Advisors should get up to speed. Here is a little context on this, click here.

Failure of asset linked retirement plans

During the past few years, we have commented on the risks in retirement. These comments were directed at the fallacies of what we now call the "Law" of Future Returns. Asset growth within the U.S. throughout the past decades has been nothing short of phenomenal. This asset growth has been slammed by the "Great Recession." Some forecast that we may be entering a period of decline. Retirees who linked their retirement security to asset growth are now rethinking that strategy. Unless the country returns to fiscal responsibility, the potential costs of paying unprecedented debts will burden society and stifle growth. If growth is stifled, then goods and services will be provided by those countries that are able to manufacture at far lower cost than in the U. S. Will the auto manufacturers regain world dominance? I just don't know the answer to that question.

Homes as retirement plans

The American Dream is to own a home, retire at 60, own a retirement home in Florida, and play golf. Many have been able to live that dream. Many are unable to imagine that dream ever becoming reality. Housing will ultimately recover, and home prices will stabilize and grow once again. Housing is not a speculative means to retirement wealth. Losses in home equity have crushed many retirement plans based upon leverage. Mortgaging one's home as part of a retirement plan may now be a necessity via reverse mortgages. America has mortgaged its retirement. Literally.

Common sense and cash

It will take time to repair huge losses and damaged asset pools for current retirees. Lifestyles will be forced to change in a painful process. Many have withdrawn assets from the stock market only to miss the rebound. This only adds to wealth disparity. Both retail and institutional cash balances in money market funds tracked by the Federal Reserve grew from $8.241 trillion on December 31, 2008 to $8.524 trillion as of December 31, 2009. Money only appears to have been modestly redirected back into the market. More important is growth in savings deposits at banks and thrifts from $4.112 trillion on December 31, 2008 to $4.849 trillion on December 31, 2009.1 Clearly, people have become savers, even at the lowest rates in history. The mantra "cash is king" has taken hold for a while.

What's this got to do with SPIAs?

SPIAs are capital efficient engines that pay for lifetime and are a form of insurance. SPIAs are priced by gender, age, and health. One size does not fit all. Functionally, SPIAs pay systematic principal and interest. Survival beyond life expectancy is an assured risk taken by the insurer. SPIAs can be likened to a private pension or a private Social Security plan. And since they are private plans, they can be customized to achieve a number of personal objectives, including providing for legacy interests through refund provisions.

SPIA efficiency

We have attempted to share concepts regarding the efficiency of a SPIA contract in delivering income. The Taxable Equivalent Yield Power Index(TM) table below illustrates the very high comparable bond equivalent yield necessary to generate an equal dollar of spendable annuity income. Understanding these principles will assist in counseling clients on how to arrange lifetime income solutions with SPIAs.

Summary

As the need for retirement income security grows, individuals will seek alternatives. A SPIA answers many consumer needs. We now know there is no "Law" of Future Returns.

Conclusion

Lifetime SPIAs are insurance. Positioning assets to provide lifetime incomes is still an art. Financial advisors need to help their clients to arrange for appropriate solutions, including annuitization.

Rate commentary:
Spread Analyzer results for The Bellersen TEq Yield Power IndexJ illustrate SPIA cash flows on a taxable equivalent yield basis. This is a clear picture of SPIA yield power.

The Bellersen TEq Yield Power IndexJ
MaleFebruaryMarchChangeT BondTSpread
659.85%9.99%-.14%4.57%+5.42%
7011.50%11.68%-.18%4.57%+7.11%
7513.78%13.95%-.17%4.57%+9.38%
8016.84%16.99%-.15%4.57%+12.42%


* QAS SPIA Rate Database B May-June, 2008
** Yahoo! Finance - Bonds B Apr, 2008

1 See Federal Reserve Money Stock Measures HR-6 http://www.federalreserve.gov/releases/h6/Current/ *For further information, or to contact this author, please leave a comment and your e-mail address in the forum below.
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