Retirement income for life

By Brian Hufford, CPA, CFP®

How does a dentist create a confident strategy for maintaining retirement income for a long retirement?

This question has been front and center for my research this year simply because it is the dominant question for an aging dental profession. Many late-career dentists greatly reduced their stock exposure after 2008, preferring the lower volatility of bonds. With the challenging bond markets of 2013, it seems that the final pillar of a confident source of income with lower volatility is at risk.

Dentists have reacted to this lack of confidence for a stable retirement income in a variety of ways. The most common way has been to work five to 10 years longer than expected. While working longer has helped to defer the problem, it has not solved it.

I see an almost infinite variety of implausible solutions to the retirement income challenge: purchasing rental houses, buying high-dividend-paying stocks, purchasing farmland, or purchasing fast-food franchises. I could fill the rest of this column with similar strategies that dentists use.

My research has taken a different tack. What dentists need is an income guarantee for their retirement that will weather the volatility of our muddle-through economy and the potential uncertainty of traditional stock, bond, and cash portfolios. It is not unlike fire insurance for one's house. We hope to enjoy our home throughout retirement, but purchase fire insurance to replace it in the unlikely event of a devastating fire.

I have previously written about Single Premium Immediate Annuities, which are attractive guaranteed sources of income for life. The problem with these types of insurance products is the loss of control of one's savings. The annuitant receives guaranteed income for life, but access to all of the savings no longer exists. With my home metaphor, full annuities have some of the characteristics of reverse mortgages. With a reverse mortgage, the home equity is converted to cash in exchange for future control of the home equity.

New products from insurance companies are coming to the marketplace, intended to guarantee an income stream during retirement while offering the annuitant more control of the underlying savings. This relatively new insurance product is called a Contingent Deferred Annuity. Imagine a retirement solution that offers a retiree control over the retirement portfolio allocation among stocks, bonds, and cash while insuring an income stream of between 4% to 8% of the "wrapped account."

Suppose the value of the wrapped portfolio was $1 million a year ago, and the market has dropped substantially this year so that the portfolio is only worth $750,000. The 4% to 8% income stream would be guaranteed by the insurance company on the higher year ago $1 million wrapped-account value.

With this income guarantee, an investor approaching or in retirement would be more confident pursuing potentially higher-return equity investments knowing that the insurance company is guaranteeing an income floor. Volatility risk would be lessened due to the income guarantee from the insurance company on the portfolio value. If the investments in the wrapped portfolio were entirely depleted, the income guarantee from the insurance company would continue the retirement income throughout the retiree's lifetime.

Assume an opposite outcome. Suppose that, unexpectedly, the growth in our economy and investment returns in stocks and bonds revert to better-than-normal levels. The wrapped account investments have grown much more than anticipated, and you have not needed the insurance company income guarantee, having attained a healthy 80 years of age. You have withdrawn retirement income from your investments throughout retirement, but due to better-than-expected investment returns, there no longer is any perceived need for the insurance company income guarantee.

In this case, the portfolio account still belongs to you, and you may simply discontinue the Contingent Deferred Annuity feature and retain the portfolio. Unlike traditional annuities, the wrapped savings account always belongs to you. The insurance company is merely charging a separate premium for the income guarantee.

This briefly is a synopsis of the features of Contingent Deferred Annuities as one approach to providing more confident retirement income for a long-life expectancy. If you wish a much deeper analysis of this topic, type "Contingent Deferred Annuity Millman Study" into an Internet search engine.

As with any insurance product, it is important to understand the risks stated in the product prospectus, the applicability of state insurance laws, and the suitability of the product for your situation. It is also important to examine the financial strength of the insurance company offering the product.

Brian Hufford, CPA, CFP®, is CEO of Hufford Financial Advisors, LLC, an independent, fee-only planning firm that helps dentists achieve financial peace of mind. Contact Hufford at (888) 470-3064 or [email protected].