Guaranteed versus Non–Guaranteed Income Products

Added January 13th, 2009

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As more baby boomers enter retirement, their focus shifts from accumulating retirement assets to drawing on those assets for living expenses. Insurance companies as well as mutual fund companies are competing to offer boomers financial products that address their need for retirement income. In this article we will discuss a crucial difference between many of these products – guaranteed versus non – guaranteed income products. Baby boomers and older non-boomers need to understand this difference as they evaluate available products.

Income Planning Products for the Retirees

Mutual fund companies and insurance companies are competing for your retirement nest egg. As boomers enter retirement, these companies understand that boomers (and older non-boomers!) are concerned with generating sufficient income from their nest egg to live comfortably throughout their retirement.
The process of income planning includes Social Security and pensions. But unlike these fixed sources of income, drawing income from your retirement nest egg raises a number of questions:

Should I turn all or a portion of my nest egg into a regular stream of income by purchasing an annuity?
If I don’t annuitize my nest egg, how much can I safely withdraw and still make sure the money lasts throughout my retirement years?
How should my nest egg be invested once I am retired and drawing income?
How do I keep up with inflation?
How do I plan for large, unexpected expenditures?

Financial services companies understand these concerns and recognize an opportunity. They have created products to assist you with generating income from your nest egg and addressing some of the questions listed above. No one product is right for everyone – in fact you may find that your income plan requires more than one product to help you reach your goals. Alternatively, you may be a “do it yourselfer” who does not need an income product to create your income plan.
Some products are offered with guarantees by insurance companies. Traditional fixed annuities are the best example but newer products include Fixed Index Annuities with Guaranteed Lifetime Withdrawal Benefit riders. Many mutual fund companies are beginning to offer income products but with a crucial difference – the payments are not guaranteed.

It is important that you understand the difference between guaranteed income products and non-guaranteed income products.

Guaranteed income products include traditional annuities sold by insurance companies. Traditional fixed annuities guarantee either fixed monthly income payments or payments that increase with the cost of living. Another type of fixed annuity is the Fixed Indexed Annuity (FIAs) that may offer a guaranteed minimum payment (known as a guaranteed withdrawal living benefits or GWLBs). Fixed annuities and GWLBs each offer some income guarantee to the annuity owner. The guarantee is backed by the financial strength of the insurance company itself. If the insurance company runs into financial difficulty, a state fund may pay policy owners a portion of the guarantee. These funds vary by state so make sure you understand how the fund works in your state.
Non-guaranteed income products are offered by mutual fund companies. The mutual fund company makes recommendations – but no guarantees - as to the amount of income that may be withdrawn each month for the designated number of years. The recommended withdrawal amount is set low enough to provide a high likelihood that the nest egg will last for the period specified (see the example below). Unlike the guaranteed products, the retiree’s nest egg may be depleted before his or her death leaving the retiree no recourse but to live on Social Security and whatever pension income they may have.

Example: A large mutual fund company offers an income replacement fund. An online planning tool asks the site visitor to enter the number of years they wish to draw income from the nest egg and the amount. In this example, we assume a retiree aged 65 entering 30 years (assuming someone in reasonably good health at age 65 would want his or her portfolio to last at least to age 95) and has $100,000 to invest. The program estimates monthly income of $461 or $5,532 annually. The initial portfolio consists of 64% stock and 36% fixed income (bonds and money market funds) at age 65 but will gradually become more conservative (investing less in stocks, more in fixed income) over the years. If the investments do well, the monthly income will increase and should provide protection from inflation. A traditional fixed annuity – with no cost of living adjustment – would pay a 65 year old man $630 monthly for life. Note the fixed annuity payment will not be increased for inflation so each year purchasing power will be lost. (The example is for illustrative purposes only and should not be used for planning purposes – your individual circumstances may differ).

Below is a summary of these differences.

Guaranteed Income Products	Non – Guaranteed Income Products
Issued by an insurance company, sold by an insurance agent licensed to do business in your state.	Offered by a mutual fund company, sold either directly by the company to the consumer or sold through a licensed securities representative.
The insurance company guarantees payment of an income stream under the terms of the policy. The guarantee may take the form of insuring the full payment (e.g., a traditional annuity) or of guaranteeing a minimum payment (e.g., a guaranteed withdrawal living benefit or GWLB). The payment may be for life or for a term of years. The guarantee is backed by the claims paying ability of the insurance company.	The income stream is not guaranteed. The mutual fund company will make a recommendation as to the amount you may withdraw annually with a strong probability (but no guarantee) that withdrawals may continue for the time period specified (e.g., a term of years – usually 30 years but may be shorter such as 10).
Products may be purchased that promise to increase the payment with inflation.	No promise is made that the income payments will keep up with inflation. In general, because the nest egg is invested at least partially in stocks, it is anticipated that over the long run, payments will keep up with increases in the cost of living. The retiree, however, bears the risk that payments will decrease during a sustained bear (down) market.
Premiums paid to the insurance company are invested as part of its general account.	The retiree typically invests in a diversified portfolio established and recommended by the mutual fund companies. Each portfolio contains a mixture of stocks, bonds and money market funds (some newer portfolios include commodities).

Whether a guaranteed income product is important to you is an individual matter. The important point is this: don’t purchase an income product thinking it has a guarantee when it does not and, on the other hand, don’t unknowingly pay for a guarantee you may not want! Always work with a knowledgeable advisor to create your retirement income plan.
In separate articles you will find information on:

How GWLBs work, and;
Variable annuities with GWLBs.

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