A Good Match: Managed Payout Funds and Annuities

Combining a managed payout mutual fund with a deferred immediate annuity may be a simple way to help clients plan for retirement.

PIMCO and MetLife last March began teaming up to allow your clients to purchase both of these at once. In the PIMCO Real Income Fund, clients get a managed payout mutual fund designed to keep pace with inflation. When funds in the mutual fund are exhausted, the MetLife Longevity Income Guarantee (LIG) annuity kicks in to provide lifetime income.

Research by Anthony Webb, professor at Boston University’s Center for Retirement Research, shows that PIMCO and MetLife could be on the right track by combining products.

His study, published in the 2009 edition of “Insurance, Mathematics and Economics,” found that using an advance life deferred annuity to pay income starting at an older age is a less costly form of longevity insurance than an immediate annuity. The study, “Evaluating the Advance Life Deferred Annuity,” recommends that people who expect to start receiving advanced life deferred annuity payments at age 85 should put 12 percent to 14 percent of their wealth into the annuity product.

The PIMCO-MetLife strategy works this way: A retiring client could invest a portion of his or her retirement savings in a choice of two managed payout funds—the PIMCO Real Income 2019 or 2029 Fund. Both are liquid, open-end mutual funds investing primarily in laddered U.S. Treasury Inflation-Protected Securities (TIPS).

The client also purchases separately the MetLife Longevity Income Guarantee (LIG), an advanced life deferred annuity. This annuity provides guaranteed lifetime income later in his or her retirement years.

Clients can invest a single premium or make periodic investments into the “Longevity Income Guarantee” annuity. With each premium payment, the client buys a future income stream at market interest rates, set by the insurance company. So if interest rates rise over the years, the client should get more income. This lets clients determine upfront how much monthly income to receive beginning at a specific time in the future, based on how much they put into the contract and when, MetLife says.

The PIMCO inflation-adjusted mutual funds seek to continually maintain purchasing power during the distribution period. The fund distributions are made monthly until all assets have been distributed, either by October 2019 or October 2029, depending on the fund selected by the client.
Meanwhile, clients can begin to take income from MetLife’s deferred immediate annuity in as little as two years after signing the contract, provided that they are between the ages of 50 and 85.

For example, a 65 year-old male who put a $50,000 lump sum into a MetLife annuity to obtain monthly income at age 85, would get $15,439 annually to replace the mutual fund income starting at that age. A female would get $14,854 annually.

However, there is no free lunch with this strategy. An analysis of the PIMCO-MetLife products by Michael Edesess, Ph.D. partner with the wealth management firm, Fair Advisors, Denver, says PIMCO’s method of managing Treasury Inflation Protection Securities is costly. He illustrates, in a study published in the April issue of Advisor Perspectives, (www.advisorperspectives.com), how advisors could ladder inflation-indexed Treasury bonds for managed payouts for less than annual expense ratio charged by the PIMCO Real Income Fund. Both the Real Income 2019 class A shares and 2029 class A shares mutual funds have annual expense ratios of 79 basis points, according to Morningstar.

He also has reservations about immediate annuities due to inflation. At a 3 percent annual inflation rate, immediate annuity income in 20 years would be worth about one-half as much as it is today, he says.

“Although the PIMCO fund that invests in TIPS offers inflation protection, MetLife’s (Longevity Income Guarantee) does not,” he says. “Investors may underestimate the purchasing power of the income they get from the annuity 20 years into the future.”

MetLife’s Longevity Income Guarantee, he adds, should be used to cover expenses that don’t track inflation.
Webb, of the Center for Retirement Research, also cited drawbacks to this type of annuity:

· People in their working years may not want to contribute to an annuity that begins to pay off at old age.
· The administrative cost of selling the annuity in small installments is high.
· The insurance company is exposing itself to greater mortality risk.
· There is a shortage of long-term interest rate hedges that insurance companies can use to limit their risk and pay claims.

Advisors note that there are other ways to insure that client money lasts and maintains purchasing power. Rick Carey, principal with the consulting firm/ publisher, Retirement Income Solutions Enterprise, Roswell, Ga., says an attractive alternative to cover basic expenses, such as food, clothing, housing and medical, may be an immediate annuity indexed to inflation.

A study by Phillip Cooley, Ph.D., finance professor at Trinity University, Hartford, and others, says systematic withdrawals may be all your client needs. The study, in the April 2011 issue of the Journal of Financial Planning (wwww.FPAnet.org/journal), evaluated retirement portfolio success rates by withdrawal rates, portfolio composition and payout periods.

The researchers looked at rolling returns on stocks and bonds from 1926 through 2009. They found that retirement portfolios made up of at least 50 percent large company stocks and 50 percent bonds supported withdrawal rates up to 7 percent with a high probability of success.

For example, a portfolio with a 75 percent stock and 25 percent bond mix had a 91 percent success rate over thirty years using a 7 percent annual withdrawal rate, while a portfolio with 50 percent in stocks and 50 percent bonds had a 100 percent success rate over 30 years using a 4 percent withdrawal rate.

The study also shows that success rates decline if more than 50 percent is invested in bonds. Portfolios with lower withdrawal rates and a higher stock allocation have better success rates over the long term.

Adjusting withdrawal rates based on inflation have better success rates if the investor starts with initially lower withdrawal rates, the study, “Portfolio Success Rates: Where to Draw the Line,” also notes.