Annuities: A conversation about more than just money

An interview with Sri Reddy from Principal®

Sri Reddy is the senior vice president of Retirement & Income Solutions at the Principal Financial Group®. Principal helps businesses, institutional investors, and individuals prepare for the future by providing best-in-class retirement services, insurance solutions, and asset management services through their member companies. Founded in 1879 as an insurance company, Principal is now a member of the FORTUNE 500® and a global investment management leader.
Sri has more than 20 years in the retirement services industry at companies including Prudential, USAA, and ING. He recently sat down to discuss research that Principal presented about annuities and the people who buy and use them. He shared insights on how annuities mean more to customers than just regular income.
Sri has more than 20 years in the retirement services industry at companies including Prudential, USAA, and ING. He recently sat down to discuss research that Principal presented about annuities and the people who buy and use them. He shared insights on how annuities mean more to customers than just regular income.

Q: Why do annuities belong in the retirement income discussion?

A: The reason stems from a positive demographic trend—people are living longer. Data from the Society of Actuaries shows that the average joint longevity of a healthy American couple is upwards of 93 years. So how much money does it take to fund almost 30 years in retirement? In the past, you might have pointed a retired couple towards a portfolio of mostly bonds. But with interest rates as low as they’ve been, there’s a strong likelihood of depleting that savings before age 95. Another major investment option is equities, but that’s a more volatile asset class. If you’re going to take more risk with your savings, you want the potential for living better in retirement. And a big stock market downturn early in retirement could really raise the risk of running out of money.

That’s where annuities can help. Rather than any one person facing the risk of outliving their assets alone, with an annuity, they pool the risk and the entire group benefits. Annuities can provide a higher, guaranteed level of income and reduce the risk of outliving your retirement savings.

Q: What drove the need for this research into annuities?

A: Very simply, we wanted to better understand our customers, and there are two parts to that investigation. We wanted to quantify the financial benefits that the guaranteed income from annuities brings. That’s a mathematical exercise—risk pooling can allow retirees a 100% chance for success in retirement because the annuity payments can last as long as the retiree does. Here success is defined as the ability to support a spending goal and reach age 95 without depleting retirement savings. We handled this by developing some case studies. The other factor is understanding the mindset of our annuity owners and how annuities affected their lives and emotional well-being. For this, we conducted detailed interviews.

We partnered with Michael Finke Ph.D., CFP® and Wade Pfau, Ph.D., CFA® to look more closely at how income annuities improved financial outcomes and to see if there were any psychological benefits for annuity owners.

Q: What did you learn from the research?

A: We confirmed that talking about annuities is more than just talking about money. On the qualitative side, we found that annuities can provide retirees with more confidence and help counteract anxiety. In the quantitative research, we found that income annuities can lead to better financial outcomes than an approach that relies only on investments, with considerable differences in many cases.

It was very instructive for us. You think about customers who have saved for decades to build a nest egg that needs to last their entire post-work lives. They enter retirement, which we typically believe is a lower-stress time than when we’re working. But, in fact, it can be just as stressful if not more. Your lifestyle is now tied to that retirement savings. And with people living longer these days, the question becomes how long will that nest egg last? Retirees are asking themselves if they need to cut back on spending to make it last longer. That’s stressful.

Q: Why do retirees like annuities?

A: Three things: confidence, freedom, and the ability to leave a legacy. These were the most interesting psychological benefits we heard. As part of the research, Finke and Pfau conducted interviews with retirees who owned annuities, so these aren’t hypotheticals. The interviews pointed at an added sense of confidence that the guaranteed income conferred.

Retirees worry about covering their basic expenses. Those who owned annuities said that having the guaranteed income reduced their anxiety; they were less worried that a market downturn could hamper their ability to cover their basic expenses.

And because they felt that their basic expenses were taken care of, they had a greater sense of freedom to spend. Many retirees viewed their annuity payment and Social Security benefit like a monthly “budget.” They know that money is coming every month, and so they feel free to spend it.

Similarly, retirees who have the certainty of an income annuity reported feeling comfortable taking on more investment risk with their remaining retirement savings. That makes sense. If your entire lifestyle in retirement depends on the performance of the stock and bond markets, it can be stressful when market drops take away a chunk of your savings. With guaranteed income, the annuity owners said they felt better about investing and worried less, even when the market was down.

The other big topic that annuity owners talked about was the ability to leave a legacy. If you run out of money in retirement, there’s nothing left for your family or favorite charity. This was interesting, particularly because that’s one of the common misconceptions about annuities—the idea that getting the annuity locks up the principal, and you won’t be able to pass something along. With the benefit options available today, that’s not the case. Again, the interviews showed us that when retirees know their basic expenses are covered, they felt more comfortable giving away wealth.

Q: How do income annuities lead to better outcomes?

A: With retirement outcomes, the first thing to do is define “success.” Since the key variables are the amount of money you have and the length of your retirement, we defined success as having a 90% chance of reaching age 95 without running out of money.

We then created three case studies, each starting with $100,000 of assets. One for a couple who had 10 years until retirement. A second where the couple was just at retirement age. And a third where the retiree had been living in retirement for a decade. Our goal was to determine the benefits of adding guaranteed income to a holistic retirement solution that includes investments. We then compared outcomes in all three cases between an investments-only portfolio and a combination portfolio—one that dedicates half of the assets to an income annuity and the remainder to an investment portfolio. To add more richness to the simulation, Finke and Pfau used thousands of probability calculations to simulate good, average, and poor market scenarios.

What we found was powerful. In all three cases, the probability of success with the combined annuity-and-investment approach was significantly higher than the investments-only approach. The differences were sometimes stark. In the example of the couple at retirement, with good market returns, the combination approach showed more than $690,000 of remaining assets at age 95. The investments-only approach had $250,000 of legacy assets. With average market returns, the combined approach would leave the couple with more than $90,000 to pass along or donate to charity. But the investments-only approach had less than $5,000 with the same returns. And in all cases, when market returns were poor, the investments-only approach had almost no chance of success.

Q: Why should advisors look at adding income annuities to their clients’ retirement strategies?

A: The research shows us that there’s a solid mathematical reason for including guaranteed income. Your clients will see better rates of success in retirement with lower risk. That’s just more efficient.

But peace of mind is the real benefit you’re going to bring to your clients. Imagine sitting down with a client to tell them: “I want you to worry less and enjoy life more—and I can help you do that with a guaranteed income annuity.”

Retirement is seen as a more relaxed phase of life, but that doesn’t mean that financial stress and anxiety melt away when you retire. Your clients approaching retirement may not be thinking about the emotional side of retirement. Help them understand how combining an income annuity with investments can bring stability to their monthly income.

This can help put more focus on life, friends, and family, rather than on the stock market’s ups and downs.

If you’re interested in learning more, you can download the full white paper at Here, you’ll be able to view the full case studies and see the success rates of a combined annuities-and-investments approach to retirement. You can also read quotes from annuity owners interviewed for the study.

Drs. Finke and Pfau are not affiliated with Principal. Results are hypothetical, and past performance is no guarantee of future results. Illustrations utilized in the case study are based on rates available at the time of publication but could vary based on the date quotes are sought and individual client situations and purchase amounts.