The couple would like to stop work when Elton is 62. They have concerns about a big chunk of their savings, which is in a variable annuity that pays a guaranteed 6.5 percent a year.
“My broker contacted me recently and said that we should expect to hear from the insurance company soon as they want to offer a buyout offer to me,” Elton says. “I am assuming that they no longer think it is in the best interest of the company to have contracts with 6.5 percent returns guaranteed.”
Elton isn’t sure what the buyout offer will be, but he wants to know his options. He says he’d prefer to stay with the current contract because of the benefits, but he’s concerned about future fees and other risks.
The couple, whose names have been changed, have saved $400,000 in that annuity, $48,000 in a 401(k), $555,000 in an IRA, $24,000 in Certificates of Deposit and $8,000 in checking. Elton also just started receiving a monthly pension of $3,100 per month from a previous job.
The Star-Ledger asked Brian Power, a certified financial planner with Gateway Advisory in Westfield, to help Elton and Annie review their retirement outlook.
“With the combination of the nice pension Elton has earned and their commitment to saving, they have done a great job saving for retirement,” Power said.
For his analysis, Power used a very modest after-tax retirement lifestyle of $60,000 per year, increasing for inflation, based on the budget Elton worked up. Power says it incorporates an increase of their current lifestyle by approximately $750 per month to take into consideration higher health care insurance premiums in retirement.
They will have a very strong cash flow between the pension and their Social Security benefits, covering most of their retirement expenses without touching their investments.
Instead of assuming a constant rate of return on assets, Power used a Monte Carlo simulation, which varies the rates of return and inflation to simulate the fluctuations that can be experienced in the marketplace.
Based on their very modest retirement lifestyle goal, strong retirement cash flow and accumulation of a nice-sized retirement nest egg, projections show the couple has a 100 percent probability of success.
That’s part of the reason Elton and Annie should think seriously about Elton’s annuity, Power said.
“Older policies like the one Elton owns have gotten caught with the rich guarantees originally offered and the ensuing debacle in the markets and the low interest rate environment and (insurance companies) are trying to get out from under some of these losing annuity contracts,” Power said.
Elton’s original investment, or market value of his annuity, is still down 13 percent from late 2007. There is a $200,000 difference between the market value and the guaranteed death and income base benefit, Power says.
“Elton has so far come out way ahead on this contract,” Power says. “Elton would need to have a 65 percent rate of return on his money for the market value to catch up to the guaranteed values.”
That makes it sound like he should keep the annuity no matter what the insurance company buyout is — but of course, the decision is not that simple.
Power says within the context of their overall financial projections, the decision becomes more complex and seems to be more of a death benefit decision than a guaranteed minimum lifetime income decision.
“Since they’ll barely touch investment principal to supplement their retirement lifestyle, Elton will never even need to turn on the lifetime income guarantee water faucet,” Power says. “What many people may not understand about lifetime guarantee income annuity benefits is that the annuity company is just returning the client’s principal to them until the money runs out, and then and only then does the insurance company have to kick in.”
Plus, with the annuity being inside an IRA, he shouldn’t be in a rush to take out more than needed because he’ll have to pay taxes on withdrawals, Power says.
If keeping the annuity is a death benefit decision, the question is whether or not it’s worth paying fees of approximately 2 percent per year of the death benefit guaranteed amount — approximately $11,000 a year — to carry $200,000 of death benefits plus what he has already paid in fees since 2007. Cumulatively, he’s already paid $35,000 to $40,000.
“If the buyout offer is at least how much he has paid in fees up to this point, he should consider taking the offer since…he doesn’t need the additional life insurance to protect his wife, and, unless he is uninsurable, he can replace the death benefit for much less cost if he really wants to keep the death benefit,” Power says.
Looking at the rest of their investments, their risk tolerance is moderate but their asset allocation is more aggressive, with 69 percent in equities. Power recommends they move to a 50 percent equity stake instead.
“If you dig a bit deeper to see what kinds of equities they own and what kinds of bonds they own, they are heavily weighted in U.S. large-cap equities at 36 percent, versus our suggestion of 13 percent,” he says.
They also hold 20 percent of intermediate bonds versus Power’s 7 percent recommendation.
“Their intermediate-term bond exposure may surprise them or may have already surprised them on the downside since interest rates have started to rise,” he says. “They could spread those heavily weighted assets more evenly across other asset classes.”
Power also recommends Elton wait until age 70 to take his Social Security benefits because this would ensure the highest possible survivor benefit for Annie, who is four years younger than Elton.
He also recommends they review their wills and estate planning documents to make sure they take advantage of the New Jersey estate tax exemption of $675,000.