In a financial marketplace replete with options for investors looking to have retirement income they will not outlive, it helps to know the facts about what's available. TIAA-CREF, the national financial services organization with a ninety year history of helping clients meet their financial needs to and through retirement, offers guidance to help investors select a combination of mutual funds and annuity accounts to help protect their savings, optimize performance and assure they'll never run out of money.
While the guidelines that follow are not a substitute for objective, personalized investment advice, they offer a starting point for investors for whom guaranteed monthly income is a goal.
Check the Company's Rating
You want to make sure that the company you depend on for retirement income will be there to provide income to you as long as you or your beneficiaries live. A company's guarantee relies on its claims-paying ability. Look for a company with the highest rating from major rating agencies to ensure that they have the means to provide the financial security that they promise. Please keep in mind that these ratings are for the insurance company and do not apply to the performance or safety of the variable investment options.
Read the fine print
When considering how to invest, it helps to know how that investment will operate. Some mutual funds tout the stability of a guaranteed payment combined with the freedom of having access to the principal assets. Be sure to read the fine print. The ability to withdraw assets in excess of a guaranteed monthly payment can often involve surrender charges and penalties. Not to mention, of course, that withdrawing funds inevitably reduces total account balance, and therefore may adversely affect future monthly payments.
Consider a life annuity
A life annuity is a contract by which an insurance company agrees to make regular payments to someone for life or for a fixed period, and can be either a fixed annuity or a variable annuity. A fixed annuity guarantees principal1 and a specified interest rate. This is different from a variable annuity, the value of which fluctuates based on the market performance of an underlying securities portfolio. Unlike fixed annuities, there is no guarantee of principal repayment or rate of return for a variable annuity.
Look for a guaranteed investment that can produce the monthly income you need.
Life annuities can come with an optional rider known as a guarantee period, which can assure the buyer that the estate can receive assets upon early death, and therefore offer protection beyond lifetime income. Look for a life annuity with a guaranteed period backed by the claims paying ability of a well-rated carrier, and determine what the monthly payments will be.
Two recent papers by TIAA-CREF discuss the advantages and protections a life annuity offers. To learn more, investors may want to read: "Life Annuities: What They're Saying Isn't So," by Mary Pat Campbell and Benjamin Goodman, and "Annuities: Now, Later, Never?" by Benjamin Goodman and Michael Heller.
Make your investment work efficiently
A number of alternatives in the market offer a Guaranteed Minimum Withdrawal Benefit (GMWB). For example some offer a withdrawal of 5% of the initial balance, which can ratchet upwards if market performance is good, but will not decline even if the market performs poorly. Please note that there are generally additional fees for this rider.
Below is a hypothetical graph comparing the differences in guaranteed income for an individual, age 65, who retired in 1983 and invested $100,000 in either a life annuity or a 5% guaranteed minimum withdrawal product. Keep in mind, past performance is no guarantee of future results. Note that there are material differences including limitations and restrictions between the two income options and based upon your personal situation one may be advantageous over the other. Be sure to consult professional, objective advisors about account and rider fees, fees accompanying underlying investments, as well as any withdrawal charges. Please note that TIAA-CREF does not offer a GMWB as an income option.
Exhibit 1: Single Life Annuity vs. Guaranteed Minimum Withdrawal Benefit2
CREF Stock Account's Standardized Performance Chart as of 12/31/07
As Exhibit 1 demonstrates, the 5% GMWB would not have reacted as efficiently to market increases as the annuity would have throughout the 1980s and 1990s. Also note that for the year 2000 the life annuity would have paid out over $19,000 more than the GMWB from the same original $100,000 investment.
While the GMWB payment remained steady during the market declines in the early part of this century, during that time the total account balance was decreasing even if the payments were not. This would have made it much more difficult for the GMWB to recover when the market went back up.
Like any conservative investment strategy, the GMWB minimizes both risk and reward.
While the GMWB may appear attractive in times of market volatility, remember that retirement income options are long-term investments. It would be unwise to base a 25 year investment plan on a few months' performance.
Because a life annuity can react efficiently to market increases, it may be a more useful vehicle for maximizing retirement income. And, with a guaranteed period, can be a low risk investment.
Because a life annuity is a product you purchase, rather than invest in, there is no 'account balance.' Instead, the column on the far right of the chart is for hypothetical comparison only, calculated by subtracting the GMWB annual payment from the life annuity annual payment and reinvesting the difference in the CREF Stock Account. For instance, in 1983 you would subtract $5,000 from $6,646, and reinvest the difference ($1,646) in CREF Stock at 1983's CREF Stock account's rate of return, and end up with a balance of $2,059 in the 'excess benefit' account.
This figure can act as an accurate comparison to the GMWB account balance, as both show the amount available to the beneficiary should the annuitant die. If the annuitant who purchased the GMWB died in 2007, they would pass $420,328 on to their beneficiary, while if the annuitant who purchased the life annuity died in 2007 (had they utilized the strategy of investing the 'excess benefit') would pass on $568,776 — a difference of over $140,000 coming from the same $100,000 original investment — while having enjoyed annual payments equal to that of the GMWB.
Further, for the sake of comparing concepts, we assumed the fees for the GMWB product and the life annuity were equal (around 40-55 basis points). However, many GMWB products have substantially higher fees, charging 150 or even 200 basis points a year. Had we incorporated the higher fees — for example, 65 basis points in addition to the historical CREF Stock fees — in our hypothetical calculations, the GMWB product's accumulation at the end of 2007 would be $80,000 lower than it is on the chart. The GMWB annual payment over the years would have been lower as well.
As shown, the life annuity can allow you either to enjoy higher annual payments than the GMWB, or equal annual payments with a potential to more efficiently grow your assets.
Because individual situations vary, you should always seek professional, objective advice before considering your investment options.
Aim to Combine Low Risk with Optimal Performance
If ready access to funds is essential, a life annuity can still be an option when combined with other investments. Because a life annuity, in order to guarantee lifetime income, may not allow immediate access to funds, one strategy may be to annuitize part of your assets and keep part of your assets in a more liquid investment, such as a target-date retirement mutual fund.
By keeping ready money and guaranteed income for life separate but as part of one retirement portfolio, you can potentially take advantage of both without one adversely affecting the other.3
About TIAA-CREF
TIAA-CREF (www.tiaa-cref.org) is a national financial services organization and the leading provider of retirement services in the academic, research, medical and cultural fields with more than $436 billion in combined assets under management (12/31/2007).
Please keep in mind that there are risks associated with investing in securities including loss of principal. Both mutual funds and annuity accounts are subject to ongoing fees and expenses.
TIAA-CREF Individual & Institutional Services, LLC, and Teachers Personal Investors Services, Inc., members FINRA, distribute securities products. Annuity products are issued by TIAA (Teachers Insurance and Annuity Association), New York, NY. Advice and Planning Services is a division of TIAA-CREF Individual & Institutional Services, LLC.
Investment products are not FDIC insured, may lose value and are not bank guaranteed. You should consider the investment objectives, risks, charges and expenses carefully before investing. Please call 877 518-9161 or log on to www.tiaa-cref.org for a prospectus that contains this and other information. Please read the prospectus carefully before investing.
1 Guarantees are subject to the claims-paying ability of the issuing company.
2 Returns based on the CREF Stock variable annuity account, a broadly diversified portfolio of common stocks. Assumed $100,000 accumulation. Annuity is at Age 65, Single Life A2000, (2 yr set back), 4% AIR. Life annuity shown after CREF Stock expenses, hypothetical GMWB product shown after expenses, assumed to equal historical CREF Stock expenses over the same period (approximately .40%-.55% a year).
3 Please note that mutual funds do not guarantee principal. Upon redemption the value of your investment may be more or less that the original investment.
© 2009 and prior years, Teachers Insurance and Annuity Association - College Retirement Equities Fund (TIAA-CREF), New York, NY 10017
