Michael E. Kitces, MSFS, MTAX, CFP®, CLU, ChFC, RHU, REBC, CASL, Partner and the Director of Wealth Management for
Pinnacle Advisory Group, Columbia, Maryland
The longevity annuity has become increasingly popular in recent years as a potential new vehicle for retirement income, as its ability to delay payments to an advanced age like 85 allows for a significant accumulation of mortality credits. And since the introduction of Treasury Regulations in 2014, a so-called “qualified longevity annuity contract” (QLAC) can even be purchased inside of an IRA or other retirement account, allowing a portion of a retiree’s RMDs to be deferred from 70½ to as late as age 85. However, as it turns out the unique nature of a longevity annuity’s payment structure is not very hospitable as an RMD deferral strategy. The fact that it can take until a retiree’s late 80s just to break even and recover principal means the retiree risks significant forgone growth by trying to merely defer RMDs through the use of a QLAC. And of course, the RMDs will still eventually happen anyway, as the QLAC merely defers when payments begin. In fact, ironically, if the retiree does live, the accelerated payments of a QLAC in the later years can actually deplete an IRA even faster than normal IRA RMDs. Ultimately, this doesn’t mean that the longevity annuity (or a QLAC inside an IRA) is a bad deal. The ability to accumulate mortality credits still means it can be very effective as a fixed income alternative for those who fear they may not have enough money to fund a retirement well beyond their life expectancy. And if a retiree intends to spend all of his/her assets anyway, and the only available dollars for retirement are held in an IRA or other retirement account, the QLAC is an effective means to engage in such a strategy. Nonetheless, the bottom line is that while a QLAC may be a valid way to use a retirement account to hedge against longevity—and defer RMDs along the way—it’s still not very effective as an RMD avoidance or deferral strategy. Just because you can buy a longevity annuity inside a retirement account as a QLAC doesn’t mean you should.
Is Deferring Social Security the Lowest Cost Option for Adding Guaranteed Income?..…………………………………………69
David A. Littell, JD, ChFC, Chairholder of the Joseph E. Boettner Chair in Research, Co-Director of the New York Life
Center for Retirement Income, The American College of Financial Services, Bryn Mawr, PA
Kirk S. Okumura, MSFS, ChFC, Academic Director of the Financial Services Certifi ed Professional® (FSCP®) Program, The
American College of Financial Services, Bryn Mawr, PA
Editor’s Note: Although the Journal of Personal Finance is a refereed, research journal that targets the practitioner market, the editors believe there is a role in the literature for complex cases that are instructive or allow practitioners to compare their insights into a planning scenario with how others would approach the same situation. In last year’s Fall Issue, we published the winning case for the IARFC National Financial Plan Competition, which was a multifaceted planning case. In this issue, we are delighted to present an analysis of a retirement planning issue involving Social Security that is extremely important in today’s world where so many people are now having to make decisions about when to start the Social Security retirement benefits. The selection and publication of cases is on an editorial basis rather than a refereed basis. We would like to publish one case with each issue, and welcome submissions of any planning situations our readers have encountered such that they feel the cases would provide a beneficial learning opportunity for others in the profession. We also invite readers to submit comments on any of the case presentations.
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Welcome to the Fall issue of the Journal of Personal Finance. We are excited to bring you six articles representing cutting edge research in the field of personal finance.
What’s Your Risk Appetite? Helping Financial Advisors Better Serve Clients (by Quantifying
Kahneman-Tversky’s Value Function)……………………………………20
Sid Muralidhar, Grade 11, Thomas Jeff erson High School for Science and Technology, Great Falls, Virginia
Emerson Berlik, Grade 11, Thomas Jeff erson High School for Science and Technology, Round Hill, Virginia
This paper presents a methodology to allow advisors to quantify risk tolerance of clients, over gains and losses, based on the Kahneman-Tversky survey. Once a formal and quantitative estimate of an individual’s risk appetite can be determined, and its evolution tracked over time, advisors can design eff ective investment portfolios to cater to the client’s specifi c risk tolerance. The paper extends this individual-level risk diagnostic and applies it over various subgroups and demonstrates that (a) teens are more risk-seeking than adults when it pertains to losses; (b) among investment professionals, women are more conservative than men when it pertains to gains; and (c) even within these subgroups, every individual is unique and neither expected utility theory nor prospect theory appropriately capture the diversity in risk tolerance. This paper seeks to make Kahneman-Tversky’s research on prospect theory/behavioral economics, and their value function practical and user-friendly, thus improving investment decision making.
Dominique Gehy Outlaw, PhD , Hofstra University
Jesse Outlaw, CPA, Outlaw, Bruno, and Associates, Family Offi ce
Individuals are living longer due to the advancement of medical technology and nutrition quality. Are the elderly enjoying retirement in those extended years with good quality of life or are they simply alive? Using data from the Health and Retirement Study (HRS) and the Consumption and Activities Mail Survey (CAMS), this study contributes to the literature by presenting empirical evidence on how individuals spend time in retirement. The results show that retirees on average do not spend their time significantly different throughout retirement. Most life tasks such as reading the paper or magazines, listening to music, playing sports or exercising, visiting others, and house cleaning are similar among retirees in different age groups. We also present evidence that retirees on average experience a spike in medical expenses late in retirement. We compare systematic withdrawal strategies with and without health costs risk quantifying the impact on portfolio sustainability.
Jacob Lumby, Texas Tech University, Lubbock, Texas
Christopher Browning, PhD, BS Program Co-Director, Assistant Professor of Personal Financial Planning, Texas Tech
University, Lubbock, Texas
Michael S. Finke, PhD, Dean and Chief Academic Offi cer, The American College of Financial Services, Bryn Mawr, PA
Using a unique module in the Health and Retirement Study (HRS), this paper considers three important factors that may influence consumer demand for long-term care insurance (LTCI): preference for high quality care, potential costs, and knowledge. In addition, this paper proposes a new method for examining insurance demand. Only those individuals who are considering purchasing LTCI in the near future (who don’t currently own a LTCI policy) are included in the analysis. By focusing on this group, this paper attempts to determine the factors that are most relevant to the LTCI purchase decision when the consumer is most heavily considering it. Our findings imply that consumers deeply care about the provision for high quality long-term care, and suggest that widespread informational deficiencies currently suppress the demand for private long-term care insurance.
Gui Jeong Kim, PhD, Senior Researcher, Samsung Life Insurance, Seoul, Korea
Sherman D. Hanna, PhD, Professor, Department of Human Sciences, The Ohio State University, Columbus, OH
We examine the effects of self-control mechanisms on saving behavior using the 2013 Survey of Consumer Finances (SCF), following the assumptions of research that analyzed the 1998 SCF. Self-control mechanisms include saving goals, foreseeable expenses, and saving rules. We find a positive effect of having one or more saving rules on the likelihood of saving, and weak effects of having retirement as a saving goal and of having children/family as a saving goal on saving. However, it is not clear that the measures of self-control reported in previous research really provide useful ways to increase the likelihood of saving. We discuss implications for financial planning advice.
Journal of personal finance