Reuters Money
Structured products still should be avoided by yield chasers
Regulators have finally gotten the message that structured products can be hazardous to your wealth .
Structured products are notes that promise a high yield and are linked to derivatives sold by a bank or broker. After I wrote a column based on a study I conducted for The Nation Institute on May 17 exposing the dangers of these vehicles, the SEC and industry regulator FINRA issued two warnings.
The SEC followed up with a sweeps probe of brokers selling these products and released the results July 27. The agency found evidence of unsuitable recommendations, omission of material facts and “questionable sales practices.”
Why are regulators finally telling you to stay away from retail structured products? They carry embedded risks and high costs that brokers and banks are not clearly disclosing to you. Since the sales commissions on these notes are high, many brokers are aggressively selling them.
The Georgia Secretary of State, for example, is probing the sale of reverse convertible notes, which are bets tied to underlying stocks. The state has subpoenaed UBS AG, Morgan Stanley and Ameriprise seeking information on product sales and customers. The companies have denied wrongdoing.
Watchdogs have reason to be concerned as structured products are now finding their way into variable annuities. The pitch is beguiling: Do you want market gains with downside protection? Sounds pretty sweet, doesn’t it?
A structured product will pair an options contract linked to a securities index or zero-coupon bond. Of course, it’s rarely disclosed in plain language how those options are priced or how much the note will cost you. While at first blush it sounds like a good deal, when you add up the commissions and internal costs, it’s usually a dubious investment in which you’re stuck for a few years. And you could lose principal, so nothing is guaranteed.
How to generate retirement income the TIAA-CREF way
How to generate reliable income in retirement? It’s becoming the new holy grail for the financial services industry in the wake of the 2008 crash.
But if your workplace retirement plan is handled through a mutual fund, brokerage firm or bank, the retirement income solutions offered most often are simply strategies for decumulation of your savings. They’re not designed to provide lifetime income, which is the only way to protect yourself from longevity risk – the risk of outliving your money.
In order to get lifetime income, you need the benefits of annuitization, which can be found only via a defined benefit pension or insurance product – both of which pool mortality risk. Many of the big retirement platform companies are starting to partner with insurance companies to sell income annuities to workers upon retirement, and industry initiatives have proposed ways to make defined contribution plans more like pensions. But the role model for success actually has been around since 1918.
That would be the TIAA Traditional Annuity, which is offered by TIAA-CREF, the nonprofit retirement solutions provider that serves academic, medical, cultural and research institutions. TIAA is the insurance side of the company; Traditional is a guaranteed fixed annuity product offered through workplace plans and or a retail IRA.
TIAA Traditional is structured to provide a guaranteed rate of return during workers’ accumulation phase, and for optional conversion of all or part of the account to a lifetime income annuity upon retirement. Traditional’s principal is guaranteed, and so is a minimum interest rate during accumulation – generally 3 percent. But additional returns have been awarded every year since 1948, averaging 7.51 percent. In 2010, it returned 4 percent.
Just as significant, Traditional guarantees a minimum interest during the payout phase to participants who annuitize, with the potential for additional amounts depending on the fund’s portfolio performance.
“It’s not a mutual fund,” says Brett Hammond, managing director and senior economist at TIAA-CREF. “In effect, you’re buying the ability of TIAA to make promises and deliver returns that meet those promises. That determines how we invest, which for Traditional is more conservative than if it were a stock fund.”
A few observations about TIAA Traditional. Yes the Traditional is “guaranteed” but that means the same thing as for any corporation, i.e., the assets of the organization are pledged. Secondly, the minimum interest rate depends on when your contract was issued, as pointed out by others the additional amount changes yearly and could be zero. Third, TIAA uses “vintages” which depend on when the monies were contributed to the account, in turn these determine the actual rate of interest you will receive. Although if pressed they will tell you how much you have in each vintage at any given time, they don’t regularly report this to participants and the amounts you have in each vintage will change even if you are no longer contributing. Finally it is possible to withdraw funds from the Traditional if you are 70 or over by using Required Minimum Distribution. If you are retired and not yet 70 you can use the Interest Only Option. After you retire most likely you can “rollover” your retirement investments to an IRA BUT you can’t rollover the TIAA Traditional except over the ten years using a Transfer Payout Annuity. Moreover if you use this route, you will earn less interest once it is in an IRA. You do have to pay attention to the details in the contract between your employer and TIAA-CREF, some contracts have more benefits for participants than others, some are more restrictive than others, there isn’t just one uniform contract. Just this summer the Arizona Board of Regents severely limited the investment choices excluding TIAA Real Estate, Social Choice, Global Equities, Growth & Income, Equities Index, almost all of the TIAA-CREF mutual funds and almost all of the “outside” mutual funds putting much of the emphasis on LifeStyle funds
Should the U.S. Treasury sell annuities?
Here’s an out-there idea whose time has probably not come, at least not yet: What if, instead of (or in addition to) floating bonds, the federal government sold retirement annuities?
That may sound like a wild idea, especially in an era when policymakers are talking about privatizing Medicare. But it has advocates within the retirement industry. The upside, according to Martha Tejera, a veteran retirement plan consultant, is that retirees who bought annuities guaranteed by Uncle Sam would feel like their retirement funds were secure. They wouldn’t have to worry about managing their own nest egg, running out of money, or handing their funds over to a Madoff-style crook.
“I think we are creating a whole generation of retirees who are just going to be preyed upon, by both legitimate and non-legitimate sellers of financial products and advice,” she says.
I spoke to Tejera while I was researching today’s Stern Advice column about the changing debate surrounding 401(k) accounts. Instead of focusing on the ability of workers to build enough savings in those accounts, retirement industry experts like Tejera are starting to focus on what happens to that money when workers retire. Asking individuals who aren’t financial professionals to manage their nest egg for a lifetime might be asking a lot. “If you hand them $200,000 all at once, it can go poof! pretty quickly,” she says.
The government-as-annuity-seller idea was raised recently by a couple of well-known professors in a New York Times opinion piece. University of Texas Law School professor Henry T. C. Hu and University of California Berkeley finance professor Terrance Odean argued that having the federal government guarantee inflation-adjusted annuities would help people cope with the possibility of outliving their savings, and would also earn the Treasury some tidy deficit-reducing profits.
In their view, having the federal government guarantee annuities will reassure workers that the insurance companies selling them lifelong income streams will still be around when the money is needed. It will allow the insurance industry to create and manage the annuities, so it won”t wipe out that sector altogether”. It would reduce federal reliance on Chinese (and other foreign) bond buyers. “Our proposal is a winner for everyone,” they said.
Of course, a few questions remain. One that springs to mind is: Isn’t that what Social Security already is? Not exactly, as Social Security is not a self-funded and dedicated annuity, but a more broad-based pay-as-you-go retirement security program. The annuity plan could be invested by the insurance industry in instruments yielding more than the Treasury bonds that the Social Security program relies on.
I am disappointed that the only 3 comments so far, have uniquely panned this clever, simple idea. The majority of respondents have voted in favor of offering an annuity option sponsored by the US Treasury. This annuity concept would be beneficial and give people security. Yes it is like social security only different. I am a long term financial planner and have been concerned that the IRA/401k/403b/annuity industry is established for the financial industry benefit instead of for the benefit of the tens of millions of potential retirees. Less than 25% of Americans are saving any where near enough to retire. Also, Social Security is being reduced in importance as the years go on. My grandmother lived almost exclusively from her social security check. Now that is more difficult. All of the financial industry products are fine for those who can afford them. But the majority of Americans need to be able to have something simpler and safer.
If the US Treasury allowed people to convert some of their savings to an annuity, the Treasury could benefit by having more debt financed by Americans, reminiscent of the War Bonds of the two World Wars.
These annuities would have to be offered by an independent commission who should structure the payout as a function of long term US Treasury current interest rates, current mortality tables and some kind of modest profit which would cover all costs, sales and otherwise, and then some. Other annuities might pay a better rate, but a US Treasury annuity would at least offer a stable reliable alternative. Chile and the United Kingdom currently require that their citizens purchase an annuity with at least a portion of their retirement savings. I believe that the USA would be best off if Americans understood better the risk of running out of money. We have definitely not thought through the options for the 3 to 4 million people annually who will be facing retirement. This annuity could be handled as a “Social Security buy extra”. Say the US Treasury’s independent commission forecast a Treasury bond rate to be 1.0% greater than inflation. A person who purchased an extra $100,000 of social security income at age 66 would be entitled to an extra $500 (woman)to $640 (man)per month in social security income. This could then be inflation adjusted over time.
The allure of dying broke
With the economy still struggling, unemployment still lofty, and retirement savings lacking, more Americans than ever are terrified of the idea of dying penniless.
Financial adviser and author Stephen Pollan wants to remind you: That’s the whole idea. Not the prospect of outliving your cash; no one wants that. But the idea of using up all of your savings while you’re still here to enjoy it? That’s the mark of a well-lived life. Says Pollan, always outspoken: “You’re a jerk if you leave a single penny.”
First published almost 15 years ago, Pollan’s book Die Broke seemed like pure heresy at the time, overturning just about every accepted tenet of personal finance. The old model of success: Work yourself to the bone, and scrimp and save every nickel in order to leave a vast estate to your heirs.
Poppycock, says Pollan. The new model: Use your money to build a great life while you’re still around. Whether you’re Paul Allen collecting sports teams and Jimi Hendrix memorabilia, or Bill Gates trying to cure malaria — put your money to work while you’re still above ground.
“You’re stupid to die with any money left over, because the amount of your estate is not the measure of your worth,” says Pollan. “People have realized that there’s nothing shameful about not having anything when you leave the Earth. The message of Die Broke used to be counter cultural – but now it’s become mainstream.”
That message appeals to people like Bonnie Russell. The Del Mar, California-based owner of Personal Public Relations grew up in tony Marin County, and she developed her own die-broke philosophy after seeing the corrosive effects of inherited wealth. “I met so many trust-fund babies who were so screwed up because they never had to earn a living,” says Russell. “That’s why if I plan it right, the last check I ever write will bounce. And I’ll leave behind nothing but a great tan.”
But that doesn’t mean Russell is selfish — far from it. In fact she donates much of her time and money to her favorite charitable causes, so she can enjoy that fulfillment while she’s still around, instead of just bequeathing a dollar amount in a will. Russell doesn’t plan to pass on a bundle to her children and has no designs on her parents’ wealth, either. “I don’t expect any largesse, and I’m so cool with that,” she says. “It’s their money and they can do whatever they want with it.”
Someone once said that dying broke means you consumed more during your lifetime (moneywise) than you paid out. I find this concept to be very true, albeit repugnant.
Pension annuity or lump sum? Don’t take it with you
When it comes to pensions, the advice of playwrights George S. Kaufman and Moss Hart doesn’t apply – you can, in fact, take it with you.
About one-third of private sector workers who have traditional defined benefit pensions are given a choice at retirement between a monthly annuity-style payment or a lump sum. Most retirees choose the lump sum – even though it’s rarely the smartest move.
Most retirees will come out ahead over the course of retirement with an annuity. And, lump sums are getting to be an even worse deal due to recent pension reform legislation that mandates changes in the way lump sum payments are calculated.
Under federal law, pension plan sponsors calculate lump sums using longevity and interest-rate statistics, aiming to match the amount you’d need to invest to match the annuity-style checks you’d receive from your normal retirement age. In that sense, the choice between lump sum and annuity should be neutral, producing the same result over time.
But that’s not the case. While the outcome depends on a number of factors —how you invest the money, whether you’re a male or female, and whether you’re married—most people will come out ahead with an annuitized pension. Here’s why:
Lower lifetime income. Say you’re entitled to a monthly pension of $1,000 at age 65, payable for life. That converts to a lump sum of about $140,000. Of course, that sounds like a lot more than $1,000 – and that’s why so many retirees take the lump sum if they’re offered a choice. But the $1,000 comes every month of your life, in good times or bad. And if you’re married, you could elect a joint-and-survivor benefit with a slightly lower monthly payment around $850. If you go first, that payment continues until the death of your spouse.
The lump sum? You’ll need to invest it to generate lifetime retirement income, and you run the risk that you’ll withdraw too much, suffer market setbacks or live much longer than average – creating the need to stretch your nest egg much further. Actuaries say the odds of success with a monthly payment are much higher.
Pensions are fine until the company executives finish looting the treasury and go Chapter 11. I’d take the lump sum and buy my own damned annuity from a AAA outfit.
Do you need longevity insurance?
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We insure our homes against the risk of theft and fire, and our cars for the risk of an accident. But how about insuring ourselves for the risk of living too long?
The odds are rising that more Americans will run out of money in old age. Average longevity is rising dramatically at a time when many older Americans are struggling with damaged retirement accounts, unemployment and rising expenses for healthcare.
Meanwhile, Social Security is on track to replace less pre-retirement income in the years ahead, due to a higher full retirement age mandated back in 1983 and Medicare Part B premiums; any further cuts implemented now as part of deficit-cutting would erode Social Security’s value even further.
Earlier this year, the Employee Benefit Research Institute (EBRI) reported that many American households in all income brackets won’t have enough cash in retirement to meet expenses in retirement. EBRI’s 2010 Retirement Readiness Rating study projected that almost one-third of Americans in the second-highest income bracket will run out money after 10 to 20 years in retirement. And, nearly two-thirds (64 percent) of Americans in the two lowest pre-retirement income brackets will run short 10 years out.
Think longevity insurance sounds like a good idea? If so, you’re in league with a handful of major insurance companies who have started offering such policies in the past few years. Longevity insurance policies are deferred income annuities that issue payments only when – and if — you hit an advanced age. It’s a variation on the plain-vanilla single premium immediate annuity (SPIA), wherein you fork over a chunk of cash to an insurance company at retirement, in return for lifetime checks that start immediately.
Longevity policies are much less expensive than SPIAs because of the deferred benefit feature – the insurance company gets to invest your money for a longer period, and if you don’t hit the target age you’ll never collect. For example, Hartford Financial Services Group quotes a joint and survivor longevity policy for a married 65-year-old couple at $49,779, which would pay a $1,500 monthly benefit when they reach age 85. That’s far less than the $314,913 it would charge that same couple for an immediate annuity offering the same monthly payout.
The idea is to insure that couple’s income in the event of advanced age. But they would also gain more flexibility in the way they spend down their assets in the intervening years.
That few people do it means 1)it’s a very bad idea 2)it’s a very good idea. I vote for #2. Of course, we had life insurance and house insurance and, now, flood insurance. Insuring against running out of money in advanced old age makes sense IF the insurance company doesn’t go broke or renege, IF rampant inflation doesn’t diminish the buying power of future benefits, and IF you/your spouse lives long enough. But then, don’t put all your eggs in this basket either.
