Baby boomers brace for longevity risk with guaranteed annuities.

• Author: Ammons, Thomas C.

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The good news for baby boomers has been well documented and heavily publicized: Boomers are going to live for a long time, thanks to medical advances and lifestyle changes. However, this good news carries with it a fundamental challenge: How can boomers continue to increase and protect their lump-sum nest eggs throughout their retirement years without the fear of running out of money?

Insuring Retirement Assets Against Loss

While most people are comfortable insuring homes, cars, life, and income, they are not as comfortable with the concept of insuring retirement assets. The source of this discomfort lies in the type of vehicle that has been developed to address the long-term need of simultaneously increasing and protecting assets. The financial services industry has responded with an array of solutions packaged in a product that has long been maligned and misunderstood: the guaranteed variable annuity with living benefits. A variable annuity is a life insurance contract that provides future payments to the holder, usually at retirement, and usually for life. The payments are not a fixed amount; their size depends on the performance of the assets (usually stocks, bonds, or mutual funds) that the contract has invested in. Gains are not taxed until distributed to the annuitant (but are taxed as ordinary income under Secs. 61(a)(9) and 72(b)(2)). The "living benefits" are guaranteed minimum withdrawals each year, usually a percentage of the annual stepped-up basis. The annual increases are derived from the actual performance of the underlying separate accounts, which are invested aggressively because of the future guarantees. By locking in future annual stock market gains, the increasing guaranteed minimum withdrawals will act as a hedge against bear market cycles.

The Traditional Retirement Planning Paradigm

Most retirees cannot afford to lose capital during retirement because they do not have the time to make it up-e.g., a decline of 25% in value must be followed by a return of 33% to break even and recoup lost capital. Without any financial guarantees of principal or locking in future stock market gains, prudent financial planning would dictate that people become more conservative as they approach retirement and maintain this posture during their retirement years. This common approach translates into a reallocation of equities to bonds or a general strategy of rebalancing variable investments to fixed investments.

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