In the face of market volatility, disappearing pensions and low interest rates, advisors can look to guaranteed-income products to give Generation X clients secure retirements.
Members of that 30-to-49-year-old cohort are getting serious about retirement needs earlier than boomers did, says Susan St.Amand, president of Sirius Financial Services in Ottawa, Ont. and past CALU chair. Many started investing in time for the rockiness of the past six years, missing the gains of previous years. Others were rattled by the financial crisis, and have retrenched with more conservative outlooks. On average, they have less spending power and are more risk-averse than baby boomers when they were at the same age. Meanwhile, they’re contending with large mortgages, trying to save for kids’ educations and worried about outliving their savings, say observers. There are ways to help.
Are annuities worth it?
Annuities are simple to explain to clients and can provide a base income, says Julia Chung, practice leader of wealth strategies at Facet Advisors in Langley, B.C.
In particular, adds St.Amand, life annuities could become popular with Gen X clients who see their parents living longer, and want to ensure their own incomes will last to the end. But the non-traditional way this generation approaches work will cause them to purchase guaranteed income products, such as annuities, even later. Some take years off work to go back to school or to travel, and she says many say they’ll work past 65.
For such clients, firms have designed products that guarantee principal while offering earning potential. One product mixes aspects of deferred annuities with a mutual fund to compensate for the current low return on fixed-income investments. It has two phases: five years of accumulation and 20 years of payments. The client makes a deposit, and the money is invested in a mutual fund for five years.
If it gains, the payout rises. If not, her initial investment is protected, and she gets the principal back in monthly installments over two decades. Such products “guarantee you’ll be no worse off than had you had it in cash, but if there’s growth, you get to keep it,” explains Jason Pereira, financial consultant at Bennett March and IPC Investment Corp. in Toronto.
But clients should only buy five years before retirement, he says. For a Gen X client to commit now is to potentially forfeit decades of investment earnings. “Losing a couple of percentage points every year for a feeling of security, over the course of 20 years, is huge.”
Plus, the investment can only grow during the first five years, albeit with no limit. The client misses out on further gains.
The guarantee of principal is similar to market-linked GICs, principal-protected notes and variable annuities, he adds. Another drawback: guaranteed income tends to cost more than many mutual funds or pure fixed-
Insurers offer variations on this product. There are segregated funds that guarantee return of principal and have the option to convert investments to annuities. And some annuities recalculate payouts every three years to account for investment gains.
As interest rates rise, so should the value of the policies. But if rates don’t rise soon, the client gains little or nothing while committing for the long term. If a client is open to investing in the market, “you can make better money somewhere else and then put it into an immediate annuity closer to retirement,” says Chung.
Again, these policies have higher costs than non-guaranteed products, but your client may decide the security is worth it, says St.Amand. She says the decision is like buying shoes for a marathon—buy the pair that will help finish the race. So, she tells clients to focus on the results they want to achieve more than product costs.
In theory, a broker could build his own guaranteed product with Treasury bills and 20 years of call options on indexes similar to his client’s portfolio, says Pereira. A call option gives the client the right to any gains in the underlying index, while protecting principal. But the cost of the options would likely exceed the Treasury bills’ returns, he says.
Insured retirement plans
While it may be too soon for an annuity-style product, the time is right for Gen X to buy insured retirement plans, Chung says.
These plans work when clients over-fund the cash surrender value of whole life policies to access returns from the investment components. “A lot of them have had a 5% to 7% regular return. You don’t get the volatility that scares people,” she says.
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They’re particularly useful for clients without dependants. Such people pay lower premiums, so they have more cash available to over fund the policy, says St.Amand.
Gen Xers who are 20 to 25 years away from retirement are best positioned to take advantage of these policies, says Chung, because they require years of consistent contributions. But clients may find it difficult to make steady payments as years pass and unexpected life events occur, she says.
Missing an installment could provoke the insurer to re-underwrite, she adds. Worse, some products could revoke the ability to over fund the policy if clients miss payments.
Universal life policies have more contribution flexibility. Clients can also actively manage their investments. But Chung says many policies are complicated. She adds some insurers raised their UL premiums in the wake of the financial crisis, and as a result, net returns have dropped.
Insurers suffered when interest rates, and the market, dropped, leaving them holding the bag on guaranteed minimum withdrawal benefit products, says Pereira. For the few GMWB products still standing, “the benefits aren’t as good as they used to be, and the costs are higher,” he says.
But GMWB policies were popular, proving there’s wide appetite for guaranteed income, says Pereira. “Everybody is trying to find something that will be the next GMWB and bring in the billions of dollars that product was bringing in, but no one has got it yet,” he says. Even if interest rates rise dramatically, Chung says the glory days of high returns and low costs won’t be back. “Being bitten, the insurance companies are still not going to go for it.”
New guaranteed income products are designed with the goal of sharing both interest rate risk and potential upside with the client, says Steve Parker, AVP of guaranteed investment products at Manulife.
“You don’t lock into your rates today, but if you believe interest rates are going to rise,” then you have the potential to gain.
The variability also makes it simpler for advisors, as they won’t have to endure product closures whenever the insurer wants to change prices to follow interest rates. Now, the re-pricing mechanism is built in.
They’ll be ok
Gen X clients are resilient and self-reliant, says St.Amand.
Chung agrees. They feel they can’t count on government benefits like OAS supporting them, as boomers have. Chung, a Gen X member herself, has noticed her clients are skeptical that insurers will extend the same guarantees as they have to boomers after that generation cashes in on policies.
If Gen X clients are worried about retirement security, the best strategy is to manage their portfolios more conservatively, says Pereira.
“The industry tells young people they’ve got all this time [to] recover from market cycles,” he says. “From a behavioural finance standpoint, it’s just not true. If someone gets burned, they’re going to be twice shy.”
Conservative clients may panic if their portfolios are too risky and their investments are down. They could stop investing entirely, he says.
If a client’s retirement ambitions and investment style are irreconcilable, he says, don’t persuade him to take on more risk. Instead, be clear that, currently, a conservative portfolio’s low returns make it difficult to fund retirement plans. He can then decide to take on slightly more risk or increase savings. Otherwise, he may have to re-imagine retirement. Pereira also gives risk-averse clients a five- to 10-year view of the markets.
“If you’re in a well-managed, broadly diversified portfolio, there hasn’t been a single five-year period on record when someone didn’t at least break even,” he tells them.