Thinking about emergency planning for retirement portfolios leads to an unexpected conclusion.

    In 1974, I was a crew member of a Lufthansa 747 that crashed upon takeoff from Nairobi Airport in Kenya. The disaster claimed 59 lives but thanks to airline planning and training, I was able to think rationally and help save 90 passengers.

After we plunged into a hillside, the bottom of the first-class cabin collapsed. I unbuckled and began helping passengers evacuate. When I could see no one else, I made one last, hurried trip up the aisle to make sure I hadn't missed anyone. I was about to evacuate when I heard a cry from beneath an overturned seat. I pulled away some rubble and found a bleeding, elderly man gasping for breath. I yanked him down the aisle and as we struggled out the emergency exit. An explosion that followed appeared to doom anyone still trapped in the wreckage.
    However, once we reached an area about a hundred yards away from the wreckage where the evacuated passengers and crew had gathered, a woman appeared in the exit doorway I had just left, waving frantically and screaming. It turned out her husband was lying next to her, seriously injured, and unable to get up and out the exit. As I ran back toward the plane to help the couple, I yelled back at the others to help, but no one joined me. I can't say I blamed them; they were terribly frightened and most lacked the emergency training I had received.

I managed to get to the woman, and together we dragged her semiconscious husband down the chute and off the plane. We were no more than 30 yards away, still dragging the poor fellow, when a final series of explosions consumed the cabin in flames. We were lucky to be alive.
    Today, as principal of a financial advisory firm in Irvine, Calif., I see many people approach retirement planning as they would a commercial flight. They tell themselves that everything will be fine. But while the chances of an airline crash are remote, the odds of a retirement ending in a crash are considerably greater. Many retirees are ill-prepared for the transition from earned income to portfolio income, and those lacking adequate planning may not survive a financial emergency.

I try to get my clients to discuss "emergency planning for their retirement portfolios." What will happen to their retirement if there's a severe market downturn? What if it's prolonged? Will they have to change their lifestyle or return to the workforce?

Optimism Is Not A Strategy
    As advisors, how can we best assure our clients will have an adequate income stream for their lifetimes? Whatever investment products or asset allocation is chosen, we can't predict future market performance or client life spans. Do we simply chose an appropriate investment strategy and hope clients don't outlive it? Can't we do better?

An investment product I never thought I would be recommending is one that guarantees clients won't outlive their retirement income. It's a new generation of variable annuities.

Hold on. I know the negative reaction most advisors have to the use of variable annuities in retirement planning. In the past, the only time variable annuities made sense was for high-tax-bracket clients with maxed-out contribution plans. It was positively obscene to have a variable annuity inside a qualified account.

That environment has changed completely. When guaranteed income for life is the objective, the new variable annuities actually are more appropriate in a qualified retirement account. Consider that the explosion of variable annuity sales is being driven by guaranteed income benefits, most occurring in retirement accounts. The reason is that using these vehicles to generate income in a nonqualified account, as opposed to buying mutual funds or stocks, creates the potential for converting long-term capital gains treatment into ordinary income. Qualified accounts are now the most efficient and appropriate vehicle for variable annuities with guaranteed income benefits, since distributions are treated as ordinary income anyway.
Change Of Heart
    In the mid-90s Dr. Moshe Milevsky, a finance professor at York University in Toronto, and Steven Posner, a derivatives quant expert with Goldman Sachs, published a widely cited research study that concluded the typical variable annuity policyholder was being "grossly overcharged for the so-called protection and peace of mind."

But in his article, "Confessions of a VA Critic," in the January 2007 issue of Research Magazine, Milevsky does an about-face on variable annuities in light of the new guaranteed benefit riders: "Regardless of what you want to call these increasingly heterogeneous products, it seems the relative value pendulum has swung in the opposite direction ... the annuity has finally returned to its roots; it is providing longevity insurance."

In fact, Milevsky suggests that some insurance companies may not be charging enough for their annuities, adding that "the same mathematical models that told us a decade ago that basic death benefit guarantees were overpriced are now telling us that many living benefits are underpriced."
    That's quite a reversal of opinion by an expert on the subject.

Whatever combination of investment vehicles is chosen for retirement portfolios, uncertainty prevails as to whether they will generate an income stream sufficient to last the client's lifetime. Debate the merits of one asset allocation strategy against another, but what is most important to retirees is that their income stream is guaranteed for as long as they live. That's one reason why I find the new variable annuities with guaranteed income benefits so compelling as a retirement planning tool.

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