Envestnet Whitepapers

Annuities as an Asset Class for Fee-Based Advisors l 35 © Envestnet 2022 Filling an Income Gap with an Annuity A common question about annuities is how much should be allocated to them. The question is often framed as though the annuity is another asset class in an asset allocation problem. What is the right asset allocation between stocks, bonds, and annuities? A better way to approach this question is to ask how much annuity income is needed to meet the longevity (and potentially lifestyle) retirement expenses. The Retirement Income Optimization MapTM (RIO MapTM) framework described in Chapter 3 provides a summary for how to approach retirement income. Retirement assets are matched to the liabilities connected to the four L retirement goals (longevity, lifestyle, legacy, and liquidity). Assets are positioned in three general categories: reliable income resources, the diversified portfolio, and reserve assets. Reliable income includes Social Security and pension benefits, individual bonds, and different types of annuities providing lifetime income protections. The diversified portfolio is the traditional investment portfolio and can also include life insurance for matching to a legacy goal or for coordinating with investments to cover spending. Reserves are remaining assets that have not been earmarked to cover other goals and are truly liquid and available to help support retirement contingencies. With this framework, the amount of portfolio assets to earmark as an annuity premium is based on how much is needed to support at least the longevity goals after accounting for the other reliable income resources. For example, suppose an individual reaches retirement with $1 million in an IRA and a $30,000 Social Security benefit. This retiree seeks to spend $70,000 per year, of which $45,000 is deemed as essential expenses. After Social Security, there is a $15,000 gap for reliable income. Suppose the retiree is considering an annuity with a 5.78 percent payout rate for lifetime income. The cost of filling the income gap is the $15,000 gap divided by 0.0578, which is $259,516. This represents 25.9 percent of portfolio assets, and it would serve as the starting point for analyzing the annuity allocation decision. The retiree must evaluate whether this is a reasonable portion of the overall asset base to devote toward an annuity. To make the decision more precise will require tax considerations as well as a strategy for managing inflation for the spending goal. But this process is the easiest and most practical way to think about allocating assets to annuities with income protections. Annuities as an Asset Class for Fee-Based Advisors l 35 © Envestnet 2022

• Cover