That may be sound advice as a general rule, but annuitization as a tool for reducing or delaying taxes may still be preferable for some wealthy clients with retirement accounts that are set to trigger a taxable event. Renn points out that the recently introduced option of allowing the direct conversion of some or all of a 401(k) plan into an annuity when an employee retires can be an attractive strategy—especially if assets in the account are substantial and have a high amount of embedded capital gains. In that case, annuitization is a tempting alternative to the standard option of rolling the money from a 401(k) at retirement into, say, mutual funds—a choice that can incur a hefty tax bite.
Another twist on annuities for high-net-worth individuals as a retirement-planning tool: private placement life insurance (PPLI), a specialized form of variable universal life policies. For some clients, a customized PPLI solution can provide substantial tax advantages for managing investment-related capital gains.
The ability to select investments and wrap them in a life insurance policy while gains accrue on a tax-deferred basis is a “big advantage,” says Richard Bernstein of New York City-based Richard S. Bernstein & Associates. “The investment income is not subject to income tax as long as the policy is in force.”
The downside is that setting up a PPLI can be expensive. But the price tag may be worthwhile for wealthy clients because of their ability to customize the investment mix. A standard variable life policy offers similar tax advantages but without the control of the portfolio holdings.
Even if you’re skeptical of annuities, it’s still useful to review the numbers for perspective. Hull recommends exploring the possibilities at immediateannuities.com, a free website that provides quotes from multiple insurers. For instance, the site recently quoted a preliminary “estimate” of $5,500 in monthly income for an immediate annuity for a 65-year-old male based on a $1 million investment—the equivalent of an annual 6.6% withdrawal rate relative to the principal.
2. TIPS
Inflation-protected Treasurys (aka TIPS) are another benchmark for estimating a “safe” income stream. Their lack of credit risk plus their inflation hedge puts these securities in a class of their own.
But there are two issues to consider. One is that the longest maturity for these bonds is 30 years, which means that TIPS may not be a one-purchase solution for funding long retirements. One way around this is setting up a ladder strategy that holds bonds with a spectrum of maturity dates.
The bigger problem is that yields for TIPS are relatively paltry these days, even by the standards of recent history. The real yield on a 30-year inflation-indexed Treasury is currently in the 1% area.
As a result, TIPS aren’t a viable alternative for most retirement strategies at this point, although these bonds can be used in concert with other securities. Of course, if inflation soared in the not-so-distant future, the guaranteed real yield for TIPS would be more attractive.
In any case, the low risk aspect of these bonds make TIPS a natural benchmark, albeit an unusually low-yielding one at the moment.
3. DCDB Benchmark
Another useful yardstick is the Allianz Defined Contribution Decumulation Benchmark (DCDB). This index tracks the estimated payout of a low-risk strategy that blends a laddered TIPS portfolio out to the longest maturity with a deferred annuity that kicks in when the payout from the TIPS ladder ends. The underlying strategy is designed to offer protection against longevity risk and inflation.
Monthly updates based on current market data are available at www.dcdbbenchmark.com.
For the estimate as of June 2015, the strategy’s estimated payout in the first year is nearly 4.5%, which rises to 6.6% in the 20th year and beyond.