Retirement Assets: Hard to Save, But Harder to Spend?

Retirees, as we reported recently, generally just aren't spending their retirement assets.

And as noted in this report Asset Decumulation or Asset Preservation? What Guides Retirement Spending?, the reasons are many:

First, there are the uncertainties. People don't know how long they are going to live or how long they have to fund their retirement from these assets. Then there are uncertain medical expenses that could be catastrophic if someone has to stay in a long-term care facility for a long time. Of course, if people have to self-insure against these uncertainties, they need to hold onto their assets.

Second, some of these assets are likely to be passed on to their heirs as bequests. But what percentage of actual bequests are planned vs. accidental is an open question.

Third, another possible reason for this slow asset decumulation rate could be lack of financial sophistication. In other words, people don't know what a safe rate for spending down their assets is. So they are erring on the side of caution.

Finally, some of it could be just a behavioral impediment. After building a saving habit throughout their working lives, people find it challenging to shift gears and start spending.

But could the purchase of qualifying longevity annuity contracts (QLACs), deferred-income annuities (DIAs) or any other financial products help retirees and pre-retirees get comfortable with spending down assets during retirement?

What would need to happen to make retirees comfortable with using such products?

Those are the questions retirement experts are discussing now.

But first, some background.

According to Mark Iwry, a nonresident senior fellow at the Brookings Institution and a former senior adviser to the Secretary of the Treasury, the U.S. Treasury developed the QLAC in 2014. At the time, there was little demand for these, because people generally don't like to annuitize. So, what they did instead was create a product to get around that behavior. The QLAC could be used to reduce required minimum distributions (RMDs), and to dedicate a portion of assets to a product that could be used to manage longevity risk, or the risk of outliving one's assets.

You would invest in a QLAC (Read this definition from Investopedia) inside your IRA and 401(k). Under current rules, an individual can spend 25% or $125,000 (whichever is less) of their retirement savings account or IRA to buy a QLAC via a single premium.

The longer an individual lives, the longer a QLAC pays out. QLAC income may be deferred until age 85, according to Investopedia.

"We hoped that the QLAC would be an easier 'value proposition' to sell participants than SPIAs (single-premium immediate annuities)," he says. "It will cost you only roughly 15% of your account balance to buy meaningful protection against burning through your assets if you live past 80 or 85. One result would be less of an inclination by retirees to hoard/underspend."

For his part, Alexander Koury, a certified financial planner with ValuesQuest, says QLACs are a method to help hedge, but not eliminate, longevity risk. "There are also some tax benefits one can realize from deferring a portion of their IRA assets, and therefore many high-net-worth investors are using this strategy as part of their tax planning," he says. "And the nice thing about QLACs is you know exactly what you will get in the future in regard to a reliable stream of income."

One downside, says Koury, is you are sacrificing potential future gains in the market, but again it's only for a portion of one's retirement assets.

Theory vs. Reality

As for whether QLACs would help retirees spend down their assets, that's another story.

"Theoretically, it should help them spend more, but my experience has taught me that people need a plan that will help them spend their assets in retirement," says Koury. "As a financial adviser you must be able to show clients the strategy will work, and it should give them peace of mind knowing they can enjoy themselves without the fear of running out of money."

And indeed, QLACS in the absence of an adviser just might not work.

Consider: Joe Tomlinson, a financial planner, has been working with Steve Vernon and Wade Pfau on something called the Optimal Retirement Income project. "My recollection is that the main problem we had with QLACs involved complexities in coordinating between the deferral and payout phases," says Tomlinson. "Use of the products seemed more appropriate for clients working with competent advisers than for more 'automatic' retirement solutions for 401(k) participants. Also, QLACs didn't seem to provide significant financial benefits over SPIAs."

Vernon also noted research in which he and colleagues examined in detail the potential retirement income solution that uses a systematic withdrawal plan (SWP) with invested assets until age 85, and a QLAC thereafter. "This was in response to people waving their hands saying how great QLACs are, without having any details about how they might actually work in practice," he says.

Vernon and his colleagues examined how much of your assets to devote to a QLAC, and the specific withdrawal methods and asset allocations for the systematic withdrawal plan for the years prior to age 85.

"Our main objection to QLACs is that there will very likely be a large discontinuity at age 85 when you transition from the SWP to the QLAC, at an age when people might be less able to manage this disruption," he says. "If you want a smooth transition, you need to continuously monitor and adjust your asset allocation and withdrawal scheme in the years leading up to age 85. One problem is that this solution shrinks the investment horizon to 15 or 20 years at the outset of retirement, shrinking further each year as you approach age 85. This causes challenges with significant investment in equities."

Vernon and his colleagues also concluded that such a solution needs to be packaged and monitored by an expert. "It doesn't lend itself to being offered in a 401(k) plan or for ordinary consumers," he says.

Read more from the Stanford Center on Longevity: Optimizing Retirement Income Solutions in Defined Contribution Retirement Plans

QLACs and DIAs Need Improvements

Others also note that the QLACs and deferred-income annuities (DIAs) could benefit from some product enhancements. Some things that could make them more appealing:

Variable products with investments in various asset classes: Inflation risk is a big issue, and this would help.

Combination product with long-term care (LTC): LTC seems to appeal to people more, and the right kind of combination might be attractive and also mitigate moral hazard problems with LTC insurance.

Combination product with systematic withdrawal management for the deferral period: Managing money over 20 years isn't that much easier than over a lifetime and people will still not want to spend down.

Standard Life-Cycle Theory Doesn't Apply

Behavioral economists, meanwhile, have another theory why people aren't spending down their assets and why using QLACs and DIAs won't make retirees any more comfortable spending their assets down.

"We are still thinking about the issues within standard life-cycle theory, where people care only about utilitarian benefits of wealth and really mean it when they say that all they want is not to run out of money," says Meir Statman, a professor at Santa Clara University and author of What Investors Really Want and Finance for Normal People. "I don't believe that. If it were so, people would have been eager to buy annuities. We need to think about the issues within behavioral life-cycle theory."

Maybe the problem we are trying to solve with financial instruments is not to be solved with financial instruments, says Statman. "Maybe we should stop banging our heads against the instruments wall and realize that people are not stupid when they reject those instruments."

People, says Statman, care about expressive and emotional benefits of wealth in addition to utilitarian benefits. "We derive social status and pride from looking at an account with a $800,000 balance," he says. "Moreover, people actually have a plan: Spend income first, then dip into regular capital (savings account or IRA, for example) if we need to, then dip into bequest capital, if we must. Then rely on family."

How to Get People to Spend

What might people do if they want to spend more of their assets down in retirement?

From a financial standpoint, the first consideration should be optimizing Social Security (typically by deferred claiming) before considering SPIAs, QLACs, or other products to provide lifetime income," says Tomlinson.

Tomlinson wonders if it might be worth trying to find an effective way to offer inflation-adjusted SPIAs as a way to "buy more Social Security income" if there is a desire for more lifetime income after optimizing Social Security. "That way the annuity decision would fit in more naturally with the focus on increasing lifetime income via Social Security optimization."

Tomlinson, by way of background, is writing an essay for the Society of Actuaries that touches on Social Security deferral, building a better inflation-adjusted SPIA, and the life care annuity. The title: "We Can Build Better Retirement Products, But Will Anyone Buy Them?"

Watch for that paper in the Aging and Post Retirement Research Section at the Society of Actuaries website.

Got questions about the new tax law, Social Security, retirement, investments, or money in general? Want to be considered for a Money Makeover? Email