It is easy and commonplace to misunderstand the value equation offered by guaranteed income options in retirement. And, consequently, seriously undervalue this guarantee.
Perhaps the best way of explaining this is to ask you to think of those people you know in retirement who are in their 90s and have been receiving a state pension.
Ask yourself generically whether you consider if they have had value from this?
The answer must, surely, be ‘yes’.
The state pension offers something more than just money – it provides certainty.
You can be certain you will receive this income year on year however long you live.
This certainty has a value that is best described as a ‘premium’ on top of the monetary value.
It enhances and adds to the monetary value.
And this is true of any retirement product you can access which gives you certainty of income for life.
This means that when you compare ‘certainty of income products’ or ‘longevity insurance’ (more on this shortly) to anything that is uncertain or has no insurance against living a long time, then you have to add significant value to the former.
You cannot compare on a strictly financial basis.
The reason?
Research shows that people in the stage of life, when state pensions are relevant , consistently report that happiness trumps money or assets.
Their primary requirement is happiness.
Almost regardless of net worth, people want to know they are going to be OK and have a reliable income.
Even if they turn into an outlier and live a ridiculously long time, say to one hundred or beyond. In fact, especially if they turn out to be an outlier.
The certainty of income and the stress free nature of lifetime income products lead to making people happier. Fact (as we will evidence shortly).
Remarkably, it also seems to increase the duration of life.
The opposite is true of non-certain and investment led products, which can cause worry and angst as the fluctuating nature of these assets works against the peace of mind angle.
This is also true regardless of someone’s overall wealth.
In other words, someone can have more than enough and can withstand asset downturns quite comfortably but still they will feel worried about the performance and potential losses.
As stated, this is not some whimsical idea, this is borne out by copious research across many retirees across the world.
Certainty of a lifetime income and financial products you can use to generate such income is perhaps best described as ‘longevity insurance’.
Most insurances are difficult to value in advance, you need to be excessively literate in financial matters and equations to apply the value. So, most of us will rely on common sense and instinct, and we get it right some of the time and not others.
The old adage helps here: “you don’t need the insurance until you cannot get it”.
Take, for example ill-health insurance. You might not want to pay the premiums when you are healthy, but boy you are glad you did if you suffer a serious illness and your money problems or worries are alleviated at this time.
The opposite is true, you suffer such an illness with no insurance, then you really wish you had it.
The insurance gives you peace of mind which you can’t value.
You know if your house burns down, you will get a pay-out to get another house. Peace of mind. You know if you write your car off, you will get a new car. Peace of mind. That assumes you have house and car insurance!
So it is with longevity insurance – it provides peace of mind, you know you are covered. You can relax, enjoy yourself and be happy.
If you ever presented with a strict financial comparison between income options from a non-certain investment source, such as a pension drawdown product or an investment portfolio or a buy-to-let property investment versus a certain income from a guaranteed income product, you will not normally be given anything which adds value to the guarantee.
Which makes the strict financial comparison unreliable.
Use the experience of other retirees who have come before you and reported to researchers what works for them, as suggested this research is amazing, consistent and widespread.
Here is just a short round up of some of this research:
- In Great Britain, a Time Magazine headline read, “Lifetime Income Stream Key to Retirement Happiness: A new study in a land of grumps reveals that retirees with a guaranteed lifetime income stream can find true happiness.” They went on to say, “Securing at least a base level of lifetime income should be every retiree’s priority — at least if they want to live happily ever after.”
- Pension specialists Towers Watson produced a report titled “Annuities and Retirement Happiness.” This concluded that retirees were happier if they had a source of guaranteed lifetime income.
- “How Annuities Can Increase Happiness in Retirement” by the American College showed stable income is often the difference between living well and living in a state of perpetual worry. And this truth doesn’t change just because someone retires.”
- Michael Finke and Wade Pfau, both renowned retirement experts, wrote a paper titled “It’s More than Money.” This included the conclusion, “certainty provides confidence. This is one of the reasons that retirees who’ve incorporated income annuities into their retirement planning report higher levels of satisfaction. Income annuities are less expensive and safer for risk-averse retirees whose primary goal is income security in retirement.”
- A University of Chicago study noted that “people who buy annuities tend to live longer – and not just because they are the kind of people that have the money to buy annuities to start with. It’s apparently that little extra incentive of the annuity pay out that keeps people going.”
- In the Journal for Financial Service Professionals titled “Annuities and Moral Hazard, Can Longevity Insurance Increase Longevity?” The author, Patrick C. Tricker, JD, MSF, said, “In the United States, a 65-year-old male who purchases a life annuity can expect to live about 20 percent longer than a 65-year-old male who does not.” The rest of the article went on to explain that people who have guaranteed lifetime income tend to have less stress. They also worry less. Market crashes don’t upset them. And because they are being paid to live, they tend to live differently. They watch what they eat, they exercise a little more, and they see the doctor when they aren’t feeling right. All of these little things tend to cause them to live longer.
(All of the above bullet points are thanks to the work and writing of Tom Hegna, one of the best financial commentators and writers you will encounter anywhere, to find out more about Tom and his work visit www.tomhegna.com)
The certainty/happiness/peace of mind factor is unquantifiable and it could be overstated. It is worth cautioning that just because something makes someone feel better, it doesn’t actually mean it is a better financial option.
Let us therefore look in part two of this article at the strict financial merits of guaranteed lifetime income. Ignoring, entirely, how it makes anyone ‘feel’.
Are the financial merits sometimes misunderstood or misvalued even by some experts?
The answer it appears is likely to be ‘yes’, in many, many cases.
The reason is that the financial products which tend to offer such income are commonly viewed in a strict sense as either ‘investment products’ or ‘income products’ or a combination of both.
They are rarely considered as insurance products.
As soon as they are converted, at least in words, to being considered as insurance and especially longevity insurance, then the measurement of their value can change.
This is partly due to the black swan thinking, that rare events are not to be too concerned about.
For example, if an individual plotting their finances through retirement is going to be “better off” 99 times out of 100 using an investment product or portfolio to generate their income (which is not certain for life) against the 1/100 lifetime income product that is certain, then most reasonable people will take the risk and instinctively plump for the 99/100 option. Even if in the 100th case they will lose everything.
That decision – if presented in that way – taxes most people, and clearly they will need to know more. For example, how much worse off they are in the other 99 cases.
How much does one ‘lose’ by taking the guarenteed income?
That will vary in each of the 99 cases, in some they will lose a lot, in others not very much.
If you want a lifetime income of £30,000 per year (adjusted for inflation) and you can only get this from an investment led and ‘risky’ investment portfolio, how does each of 100 possible future scenarios work out?
Maybe 1 in 100 you lose everything and run out of money.
Maybe in 30 cases you sustain your income for life, but have next to no capital left when you die. In these 30 cases you might arguably be better off than with the alternative of the guaranteed income for life scenario, but if it is only just better off, is the extra risk worth it?
Unless you know the numbers, the prospects and scenarios, in some detail, then the judgement call, the comparison and the risk is not correctly positioned. And your decision making is therefore unreliable.
If the risk of running dry later in life and have seriously depleted income, less than your expenditure, is even higher than 1 in 100, then how much higher, is it 3 in 100 scenarios, 8 in 100? These calculations and estimations are more than important, they can be life changing. They can even effect how long you might live.
Yet, the common practice amongst financial experts is to compare guaranteed income versus non-guaranteed income options, as a straight investment/income comparison.#
This leaves no room for the longevity insurance and non-financial benefits (as outlined above) to be included.
Yet, retirees around the world express that these non-cash benefits (happiness, peace of mind etc.) are exceptionally valuable.
Future scenarios are too often calculated based on a rational of long-term investment returns, which are historic. These are not reliable and do not allow for completely new experiences to occur in your retirement period.
Longevity insurance is not just protecting your finances against living a long life but also against a completely new set of unforeseen circumstances.
If you are planning your finances for retirement, or you are already retired, then exploring the costs and means of building longevity insurance into your plans makes complete sense.