Anna Rappaport on Annuities and Planning for the Long Term

Anna Rappaport is widely recognized as a leading expert on retirement systems, workforce issues, the impact of changing demographics and women’s retirement security.

After a successful career with Mercer Consulting, Anna founded a consulting firm that specializes in strategies for improving retirement systems.  Anna is a recipient of numerous awards and is a past President of the Society of Actuaries.    

Anna’s current efforts are focused on topics which include the future of employee benefits, strategy for pension benefits, implications of an aging workforce, phased retirement, post-retirement risk, retiree health, Social Security and women’s special retirement challenges.

Annuity Digest: Can you share your views on the role and value of annuities in retirement—are they a good option for retirees and near retirees?

Anna Rappaport: Having lifetime income to meet basic needs is a very important part of retirement.  For some people, Social Security is enough to meet these basic needs, but for many, it is not.

Society of Actuaries research shows a real gap in retirement planning for many people – they often do not focus on the long term.  Focusing on the long term is important for everyone, and for many people that will lead to a focus on annuities.

For those with assets and income needs that range beyond Social Security, however, there is a need to focus on how to add to the basic income provided by Social Security. For this group of people there is a tremendous trade-off between guaranteed lifetime income and liquidity and control of the money. For many people, the best way to buy an annuity is to postpone their Social Security and I recommend that consideration of this strategy is an important first step.

For people whose resources are such that they do not need to spend down assets during retirement, there is no need to buy an annuity.  Annuities are for people who are in the middle, not the very wealthy and not those who are mainly reliant on Social Security.  The very wealthy do not need them, and those mainly reliant on Social Security do not have the resources to buy them.

For people who need more secure lifetime income, the best strategy is very often a mix of annuities and other assets.  There is, however, no scientific formula that determines the optimal mix.  I think longevity insurance and the deferral of annuity payment well into the future is intriguing.

And we need to remember, guaranteed lifetime income is important—particularly for people who do not have traditional defined benefit plans.

The term annuities is used to refer to different types of arrangements – those that provide a guaranteed income for life, and deferred annuities that can primarily be an investment vehicle.  My comments refer to the need for guaranteed life income.  I am not expressing any opinion about alternative investment vehicles during the asset build-up period.

Annuity Digest: What in your opinion is the best use of annuities—how are they most effective?

Anna Rappaport: I want to clarify that I am talking about payout annuities, and a guaranteed income for life.

I am particularly concerned about longevity risk—both for participants and their spouse.

I am also very concerned that four out of ten older women living alone are dependent on Social Security as virtually their only source of income.

Annuity Digest: Is there a mismatch between public and media perception and the importance of annuity products?

Anna Rappaport: There is some disconnect.

The basic disconnect involves planning horizons that are too short and the variability of life-spans.  These are very challenging issues.

In part, there are issues of financial literacy and the way in which people think about planning and the long term.  Long-term planning is really not a part of many people’s life skills.  In addition, financial issues may not match well with many people’s math skills.

Difficulties with long-term planning deficiency may be part of human nature or it may result from how people are trained.  Some people cannot even plan for a year or two from now let alone 30-40 years.

Business faces the same struggles these days.  The financial markets have led to an excessive focus on short-term results at the expense of long-term thinking.

There is another potential area of disconnect.  The term annuity is used for products with several different characteristics and comments about them sometimes do not match to the product intended.  My comments are about lifetime income approaches and not pre-retirement investment products that are a different type of annuities.

Annuity Digest: In your experience, what methods and resources have proven most effective in terms of improving financial education and outcomes?

Anna Rappaport: You need to use language that is kept simple and understandable. We need to understand how people learn because not all people learn the same way.

Centers of influence that people are connected to and trust—employers and other institutions—are very important.

People are more likely to learn and trust outside, impartial, third party sources.  It is critical that these independent resources range beyond that companies that are selling the products.

Annuity Digest: Do the objective and authoritative third party resources that you are referring to exist in the retirement income space?

Anna Rappaport: Yes.

For example, the Department of Labor has published a booklet and has a website titled “Taking the Mystery Out of Retirement Planning.”

I recommend WISER (The Women’s Institute for a Secure Retirement). Working with the Actuarial Foundation, WISER has sponsored a publication “Making your money last a lifetime.”  This publication looks at the pros and cons of choosing guaranteed life income

The Actuarial Foundation has partnered with various parties to focus on impartial consumer education around retirement.

There are good resources.  The communicator needs to be properly connected with people—sometimes that works and sometimes it does not.

The way the information is presented and the credibility and level of trust in the source are important. 

Timing is also important. I would also say that it is critical that information and other resources are available when people are making or close to making decisions.  The point of decision is much better than trying to get people’s attention.  It is very difficult to get people’s attention except at the point at which they are trying to make a decision.  

Annuity Digest: Can you share your thoughts on mandated savings and in-plan annuities?

Anna Rappaport: The United States has Social Security which is a form of mandated or compulsory provision for retirement.  I am not really in favor of mandated savings beyond Social Security.

This is an issue in many countries. Where annuities are not used, there is a lot of concern about adequate income, and where they are mandated, there is a lot of concern about inadequate freedoms.  I would like to recommend papers from the OECD on related topics.  One of several papers is “Forms of Benefit Payment at Retirement” by Pablo Antolin, Colin Pugh and Fiona Stewart. http://econpapers.repec.org/paper/oecdafaab/26-en.htm

With respect to in-plan annuities, there are many pros and cons. There are also many options.  The plans can be mandated to provide an annuity option, mandated to provide annuity payout, enabled to use annuities as a default.  The issues are very complex and I do have a specific opinion. 

I am generally not in favor of mandating in-plan annuities when people have access to defined benefit pension plans.  However, there are more questions with basic defined contribution plans.  I am still listening to the dialogue rather than telling you I know what right answer is.

Where annuitization is used, it is important to accommodate gradual annuitization.

What we really need is a good discussion to consider pros and cons and build consensus.  Just forcing everyone to annuitize is not the right answer at all.  So I am delighted that the Department of Labor and Treasury Department have issued a Request for Information on this topic.

Annuity Digest: What priorities would you counsel a newly retired couple to consider in the current environment?

Anna Rappaport: First, I do not provide personal advice to individuals.  It is important to remember that individual circumstances vary greatly.

That said, I believe it is very important to understand the long-term nature of retirement planning horizons—and what options are available for making retirement resources last.

The Society of Actuaries published “A Guide for Retirement Planning” and it is a great resource to sit down and run through somewhat like a checklist.  There are many large risks in retirement.  People need to be thinking about longevity risk for both members of a couple, long-term care needs, excess medical costs and inflation. Overall, health, levels of engagement and money are key issues.

Some decisions need to be made quickly or within a specific time frame, but in many cases it makes sense to be patient and deliberate with decision making.  An example of a decision with a specific time frame is an election within an employee benefit plan.   There is a specified time for the election.  Buying insurance that depends on health status and insurability also should not be delayed because we never know when health status will change.  But some decisions may well depend on changing circumstances and preferences.

We know that change will come during retirement, but we do not know when and whether it will be gradual or sudden.  Some people have long periods of limitation and others will die suddenly with no limitation along the way.  Part of building a plan is to have adequate resources and the ability to respond to change. 

Having the ability to continue to work, at least on a part-time basis is significant for many people.   Your question indicated “newly retired”, but timing of retirement is a key issue.  For many families, timing of Social Security claiming is also key. 

Retirees need to be thinking about financial resources and engagement with employment, activities, socially, etc. 

Housing is a very important part of the retirement picture for many people.  Society of Actuaries research indicates that on average for middle-income Americans, non-financial wealth, primarily housing is about 70% of their assets at age 55-64.  (Assets do not include the value of Social Security or defined benefit pensions for this purpose.)  Housing and location also define access to family, friends, transportation and housing may be integrated with various services and activities. Thinking about housing and whether and how to use that asset is key for many people.

Much depends on the level of one’s resources.  For the wealthy, much of the focus will be on investments and risk management.  For those with fewer resources, there are a whole different set of issues.

Annuity Digest: What would you counsel a prospective annuity buyer to consider in the current environment?

Anna Rappaport: Always be thinking about timing—is it good to buy and annuity now or is it better to wait?  The general notion of dollar cost averaging is important and I like the idea of buying in pieces.

People need to think long and hard about whether they are prepared to make an irrevocable decision.

It is important to think about the point at which income should start.  Again, the notion of deferred annuities and longevity annuities are interesting.

If people are not totally sure that they are ready, I might suggest waiting a bit or spreading annuity purchases over time through a dollar cost average approach.

Annuity Digest: What are the most interesting developments to watch in 2010?

Anna Rappaport: One of the more important things to watch for this year will be how people made out in light of what has taken place in the financial markets and economy over the past couple of years.  Another key issue will be the employment outlook for those who want to work, often beyond traditional retirement ages.

A lot of the issues we face in the near-term are the same ones that have been around for a number of years.  People are not planning with horizons that are long enough and products are complicated.  However we should look for product developments.

I have recently focused on  how important housing assets are in people’s retirement situation.  The question now is how do we best use those housing-related assets?  Is there, for example, too much money in housing?  How would we approach this issue differently?

The Society of Actuaries research offers a range of interesting resources and information – particularly the longevity report produced in connection with the 2005 Survey of Post Retirement Risks and the 2007 Survey of Post Retirement Risks report on how needs and capabilities change during retirement.  The 2009 survey included a special focus on the impact of the economy and how people are thinking about planning.  Reports on these topics are forthcoming.

And of course, women will continue to have special challenges.  For women, we need to focus more on our own security, and how we plan to widowhood and being alone.

Annuity Digest: Thank you for your time Anna.