It’s a Wonderful Life (Income)

by Chris Kite

September is Life Insurance Awareness Month. It’s also time for a financial rendition of a classic Hollywood film. Remember (if you’re not a millennial), the 1946 drama, It’s a Wonderful Life? The main character, George Bailey, loses all his business’ money when his Uncle Billy unsuccessfully tries to deposit it in the bank.

Mr. Potter, the film’s antagonist, finds the misplaced money and hides it from George. In short, George ends up contemplating suicide until an angel (Clarence) shows him what life would be like if he was never born. He realized all the people he’s touched, and how his life is truly wonderful. Flash-forward to George’s retirement…

George could not relax and enjoy New Year’s Eve. He and Mary had just retired and put $600,000 into life annuities–60% of their retirement assets. Their financial adviser, Mr. Potter’s grandson, said it was a good way to protect them against outliving their assets. They put in $300,000 on Mary’s life and $300,000 on George’s life. Each annuity would provide monthly income for as long as that person lived.

George now worried about what would happen if he didn’t live a long life. His $300,000 would be gone. He better not stay up late partying. He told Mary he was going to work out and then go to bed early. Mary urged him to relax and enjoy the party, but George had his mind set.

When Uncle Billy lost the bank deposit on Christmas Eve 30 years ago, George was tempted to use his life insurance policy in the wrong way. Mr. Potter—a stubborn old soul—told George he was worth more dead than alive. Now, Mr. Potter’s grandson was completely different, friendly, and trustworthy. George trusted his advice on life annuities and was determined to maximize his return by living a long life. He was now worth more alive than dead, but he worried about not getting payback for his $300,000.

George pushed himself on the exercise bike, lifted weights, and even did aerobics. He worked up a good sweat when Clarence (the angel) came to visit. At first, George thought the custodian was coming, but Clarence was easy to recognize. He looked the same as he did 30 years ago. Clarence explained that angels only aged a day for every thousand years on earth and were thus not allowed to buy life annuities.

Clarence commended George’s exercise and told him he could relax and go to the party with Mary, but George was too pumped up to relax. So, Clarence fiddled with the TV dials and took them back in time five years. Clarence showed how George could ease into the life annuities and not fret so much about losing money if he dies.

Five years ago, George and Mary had about $700,000 saved for retirement, 70% of their goal. They would have these assets along with Social Security and their home equity. Since this would be enough for one person to live on, they could start moving future retirement contributions and growth into life annuities or other longevity products. They could start taking income right away or commit the assets now and wait until about age 80 to take income. The latter approach would greatly leverage income in case of a long life. George and Mary would not have a dramatic drop in assets with this gradual move. They could continue this gradual movement after retirement until they got to the mix that Mr. Potter’s grandson advised.

Did you know a 2005 research study, Asset Allocation with Annuities for Retirement Income Management by Dr. Paul Kaplan of Morningstarshowed how life annuities may be a potential substitute for bonds and cash in a retirement portfolio?

Life annuities protect against outliving income while a portion of assets in equities give higher potential for growth. The study dynamically-modeled inflation and mortality. It also considered trade-offs with estate values and income. It measured success at supporting a 5% withdrawal of initial assets, then adjusted by inflation. It did a Monte Carlo analysis of success and looked at the residual estate value.

The study only tested these mixes and factors with a fixed immediate annuity on one life. It would be good to expand the study to two lives and test products such as variable annuities with guaranteed income, longevity insurance, and long-term care insurance (LTC). A joint first-to-die product may be ideal.

For the current study, the highest success rate of 94.7% came with 70% in fixed annuities, and 21% in equities and the balance in bonds and cash. The highest success rate without annuities was 92.6% with a mix of 40% in equities, with the balance mainly in bonds.

In general, higher success rates came with higher annuity percentages and an appropriate balance of equities. However, is a success rate increase of 2.1% (94.7% – 92.6%) significant? This increase of 2.1% can be viewed as significant since the most you could increase the success rate would be 7.4% to bring the 92.6% success up to 100%. The biggest factor of success is living within the 5% withdrawal rate with its adjustments for inflation. Higher withdrawal rates dramatically decrease the success rates no matter what the mix of equities, annuities, and bonds.

This withdrawal rate factor relates to the psychology of learning to live within a budget.

Lifetime income removes most of the temptation to use up assets faster than is appropriate. A high percentage of assets put into lifetime income may provide substantial pay even if the income is below a target rate. Clarence and Mr. Potter’s grandson can help George and Mary make a gradual transition into income planning. Hopefully, Uncle Sam will also give some better tax advantages to this need for lifetime income.

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