section 1 - The American College Online Learning Center

(3) Income rider benefits in a variable or fixed annuityc. Life insurance industry can take the risk of longevity as the risks involved in lifeinsurance and annuities can offset each other.7. How to build an income plana. Must meet basic expenses with lifetime income, which can also include SocialSecurity and company pensionsb. Income annuities remove market risks, deflation risk, order of return risk, andwithdrawal rate riskc. Long-term care risk can be addressed with long-term care insurance and the riskof an early death addressed with life insurance.d. Optimize the rest of the portfolio with a diversified portfolio to address the primaryremaining risk—inflation.e. Inflation can also be addressed by purchasing additional income over time wheninvestment performance is good.f. Another option is to buy inflation-adjusted annuities, but very few use this product.8. Other advantages of annuitization9.a. Peace of mind—can sleep better at night knowing that income needs will be metb. Simplicity—especially important in the later stages of retirementc. Yarri (1965) (using lifecycle theory) showed that annuitization optimized retirementincome over an uncertain life expectancy.LO 6-4-2: The annuity puzzle1. Flooring often comes down to a decision to purchase an annuity product to lock in thefloor for the client’s lifetime.a. Even though a retiree’s objectives will change over time, some basic expenses(e.g., food and rent) must be accounted for each and every month the client lives.2. There is a high degree of aversion to voluntary annuitization among retirees even thoughannuities offer security and sustained income.3. Advantages of annuitizing the floor with a fixed immediate annuitya. Annuities defeat mortality risk. The client is given a stream of income for as longas they live.b. Annuitants might enjoy a “mortality premium”—those who have long lives willbenefit from the pooling of assets with those who have short lives.c. Annuities suit clients with a low level of risk tolerance because they eliminatethe volatility of investing the client’s assets. (Note: this is not true if a variableannuity is used.)d. Annuities may be more desirable if they are framed in a consumption frame asopposed to an investment frame.e. Annuities prevent a client from consuming assets too quickly. They are anexcellent antidote to excess withdrawal risk.4. Disadvantages of annuitizing the floor with a fixed immediate annuitya. Clients lose liquidity because they have given up control and management of thatportion of the assets that are annuitized.b. Clients lose the opportunity to bequest annuitized assets to their heirs.c. They are a poor “investment” if the client dies young.6.22