InsuranceNewsNet Magazine January 2011 : Page 32
THE CASE AGAINST A s a result of the recent economic collapse, inflation rates have tumbled downward and inter-est rates are at historical lows. Inflation is said to be running well below the Fed-eral Reserve’s targets. And the Federal Reserve has even expressed concern about the risks of a deflationary spiral. Given this backdrop, are advisors unconcerned about inflation? Certainly not! As federal spending achieves record levels and as the Federal Reserve pumps unprecedented liquidity into the mon-etary system, advisors and their cli-ents are worried that inflation will not only accelerate, but also may be diffi-cult to contain. At the same time, many investors have reduced their appetite for investment risk out of concern that they may lose principal. The result is that retirees and those nearing retire-ment want guarantees of both principal and income in retirement. So what should advisors do to deliver guaranteed income solutions that can address increased e x p e c t ation s of inflation, as well as fears of loss of principal? O n e s o lu -tion that a large number of advi-sors have success-fully deployed is an indexed annu-ity (IA) with an i n c o me r i de r that can provide 32 InsuranceNewsNet Magazine January 2011 INFLATION Preserve your client’s retirement with a smart annuity mix. B Y GARTH BE R N AR D guaranteed withdrawals for life. The indexed annuity is also appealing because it contains a minimum guaran-tee on the amount of principal and inter-est that will be available for distribution. However, the guaranteed withdraw-als of the IA with an income rider are not directly related to inflation. Further-more, in order to keep up with annual inflation, the interest credited to the account value would have to replace the prior withdrawals, plus cover inflation after any fee for the rider is taken into account. So let’s assume that the fee for the rider is 0.4 percent, withdrawals are guaranteed at an annual rate of 5 per-cent and annual inflation expectations are 3 percent. This means that interest credited to the FIA would have to con-sistently meet or exceed 8.4 percent (0.4 + 5 + 3) per year once withdrawals begin. This would be a very unrealistic expec-tation given the methods used to deter-mine interest credits on IAs. How then should an advisor deal with inflation? The answer lies in the man-ner in which retirement income needs are determined for a typical retiree. In particular, the income needed by the retiree can be separated into two parts: an essential income need and a discre-tionary income need. It is the essential income need—the income that is nec-essary to cover the essential expenses of living—that is exposed to inflation. As the essential expenses increase, the essential income needed to offset them also increases. An additional consid-eration is that most retirees will also qualify for a Social Security retirement
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