Retirement & Income Planning Can Protect Against ‘Shortfalls’

‘Nearing retirement’ comes with a special sense of urgency about the financial security of our retirement years. Worse case, after a portfolio analysis, we see the red flags on the horizon that may point to potential shortfalls in our accumulation strategy.

On the ‘face’ of it…

In fact, a behavioral, financial researcher, Hal Hershfield, from the Anderson School of Management/UCLA studied how our financial decision-making really improves once we begin focusing on our aging. Simply put, the notion of ‘time’ can dramatically “alter the judgments and decisions” of investors, which could have a negative effect on retirement incomes.

“…I have found that looking ahead in time and feeling a sense of connection to one’s future self can impact long-term financial decision-making, converting a consumer into a saver…The scans revealed that some subjects did think of their current and future selves as the same person, and in our asset allocation task, those people were more likely to delay their gains.  (In a 2013 Harvard Business ReviewHershfieldsuggests using a face-aging camera app for a ‘selfie.’

For sure, it’s yet another way to get us thinking about our investment time horizon.

But taking on more investment risk notes Hershfield, is also a common temptation when playing ‘catch up’ in the rush to shore-up looming retirement shortfalls. Worse, investors may entirely push back on any investments that are categorized as “fixed,” such as bonds or annuities.

Fixed-Indexed Annuities

In addition to a pension, Social Security and 401(k)s, a fixed-indexed annuity, can anchor one’s retirement portfolio is to provide a guaranteed income stream.  Such insurance products serve to protect the portfolio’s principal during down markets; they can also provide inflation protection for the long term.

How it works…

The owner of the annuity chooses a stock market index, like the S&P 500, to capture gains when the market goes up—the gains are credited to the annuity contract. During the life of the annuity, the insurance company provides a guaranteed minimum interest rate, for example, to smooth out any market downside.

Fixed-indexed annuity: ‘Return’ calculation

The greater of the annuity’s annual minimum rate (the rate noted in the annuity contract), r the return of the chosen index (S&P 500 ?) is used to calculate the annuity’s overall return. This is done after the deduction of any fees and expenses.

For example, if the annuity that’s aligned with the S&P index delivers a 20% return for the year, the policyholder is credited with a percentage of that return, based on the annuity’s “participation rate.”

To illustrate: A 75% fixed-index annuity will return 75% of the upside of the chosen index: if the S&P goes up 20%, then the investor is credited with a 15% return.

Any ‘downside’ protection?

Generally, and even if their chosen index takes a tumble, the annuity holder is given downside protection. In fact, if the index—S&P, for example—goes up a minimum rate can be triggered, which can be 0% to 2%.

These options make this kind of annuity a go-to investment for retirees: the income can help fill the ever-widening gap between is coming in versus expenses going out over the long haul.

Variable Annuities: A better choice?

The economic debacle of 2008, according to the Wall Street Journal shortly after the stock market ‘crash,’ provided a lot momentum behind variable annuity products. As such, these insurance products can be purchased with a portfolio containing a mix of mutual funds, which has the potential to return additional income over the contract’s life—it will depend on just how these funds perform!

Forbes: Variable annuity fees

An article in Forbes points out the varying degrees of fees that are often associated with annuity contracts. The national average is about 3.61% but can range as high as 5%. Moreover, the mutual funds associated with these contracts can be limited. What’s more, any income rider and death benefits can be subject to change during contract period

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