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December 9, 2021
Episode 63 of the NewRetirement podcast is an interview with David Blanchett — Managing Director and Head of Retirement Research for PGIM DC Solutions. Steve and David discuss retirement income and go over some listener questions.
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Steve: Welcome to The NewRetirement Podcast. Today, we’re going to be talking with David Blanchett, PhD, CFA, CFP, and Managing Director and Head of Retirement Research for PGIM DC Solutions. PGIM is the global investment management business of Prudential Financial Incorporated. And in his role, he develops research and innovative solutions to help improve retirement outcomes for investors.
Steve: So, we’re going to be talking or we’re going to be discussing retirement income and also take some listener questions. David spent many years at Morningstar and worked closely with Christine Benz, another guest on our podcast, and he joins us from Lexington, Kentucky. So, with that, David, welcome to our show. It’s great to have you join us.
David: Good to be here.
Steve: Yeah, I appreciate your time. So I just thought I’d do a little quick intro. And when we were kind of warming up for this, you mentioned that you have four kids, and I also saw you have three dogs, and your wife is a vet. And so I was wondering if you know other vet households, given your wife does this work? The one veterinarian household we know here, they have five kids and more animals, including a pig in like a suburban environment. So I was just curious if that’s like the norm?
David: So we also have two guinea pigs, so let’s not short-change Curly and Whiskers. I think so. So, when we went to veterinary school, I met, obviously, a lot of my wife Sarah’s friends. And people that want to be veterinarians are not in it for the money. They’re in it because they love creatures big and small. And so I feel like when I think about other families that she went to school with, I feel like there’s definitely a greater than average number of kids and pets when you think about who is a veterinarian out there.
Steve: Yeah, okay. That makes sense to me. Yeah, no, I mean, for sure. I think it’s harder than med school. That’s what I heard. It’s harder to get into, and the study is super difficult.
David: Yeah. There’s fewer veterinary schools than there are medical schools. But yeah, it was a journey for my wife. She actually didn’t want to go until she was older, and so I think she started when she was 29. So she was one of the oldest people in her class when she ended up starting at school.
Steve: Wow. Cool. Well, good for her. Yep, you can reinvent yourself at any point in time, right?
David: That’s right.
Steve: That’s awesome. So, for you, how did you decide to get into retirement research and follow this whole path, and obviously just invested a ton, got several degrees and certifications?
David: Well, the one thing that I always point back to is both of my parents were public school teachers. My mom taught high school math, and my dad taught middle school science. So, that kind of explained my quantitative. And I used to get extra money for the A in math versus the A in social studies.
David: But I’ve been interested in financial planning since I was even in high school. I did a bunch of internships. I did even more in college. And I’ve always really liked the financial planning profession. I used to be a personal financial advisor, and I really enjoyed that. I enjoyed working with people, but what I gravitated towards was the research, is kind of asking those questions. You know, when you work for a company, they tell you to do certain things and you say, “Well, is that really in the best interest of a client? What should I be doing?”
David: And I think that what happened over the last, say, 20 years is I’ve been on this journey where I was mostly doing what someone told me to get to a point where I want to be the one figuring out what I think is best for people. And in theory, I could still be a financial advisor. I may go back and do that one of these days. But I really enjoy the research. I really enjoy looking at creating solutions and strategies that can help lots of people.
Steve: Yeah, that’s awesome. Well, it feels like there should be more work going in here. I mean, there’s you, there’s Wade Pfau, there’s a few other thinkers in this space. But given that it’s such a big problem, everybody who faces retirement has to figure out how they’re going to pay for the rest of their lives, and it’s very complicated. There’s lots of products. There’s lots of solutions. There’s lots of service providers coming at folks, especially if you have money, with different angles. It feels like there should be more work and more publications. Why do you think there’s not as much work going on here?
David: Well, I would agree that we always want more. I think that the profession of financial advice is not rooted in technical knowledge. It’s rooted in sales, right?
David: When I first was doing internships, you’d be called a stock broker, and that meant the same thing as a financial advisor. And I think that we’ve evolved beyond that. People still are stockbrokers. That’s still a very valid profession. But I think that what we’ve seen is this goal to make it more of a professional service industry. Right? So now I literally have a PhD in Personal Financial Planning. But we are minting in the industry probably at least 10 new PhDs a year, and so they’re focused on solving these problems. So, I think that one thing that excites me is that I think we’re trying to evolve as an industry that is much more focused on helping individuals accomplish their financial goals, versus just selling you a certain product.
Steve: Yeah, a hundred percent. I know in the news now, Michael Kitces is out there having a debate discussion around the appropriate titles and just people being clear about how are they paid and what should they call themselves? And so I think that’s good. I mean, it does need to get clearer. And it’s fine. I mean, look, salespeople are in every industry, and then there’s also advisors or fiduciaries in other places too. Just be clear about what folks are doing.
David: And it’s funny, there’s always these big debates about what is the best method of compensation. Right? Do you charge hourly, or fee based, or commission based? And I mean, I have some thoughts there, but the most important thing for me is are you a fiduciary? Do you actually put your client’s best interest first? And I think that a lot of people out there that work with advisors don’t realize that the advisors don’t have to do that. Right? There’s a very different set of thresholds that exists in terms of the quality of advice. And so again, I love the fact that we’re evolving as an industry, but at the same time, you can’t not acknowledge that there’s a wide array of relationships of fiduciary duties and everything else that does often not lead to the best outcomes for clients.
Steve: Yeah, a hundred percent. And so I think for the end user, the end consumer, the best thing to do is ask how is someone paid? Ask if they are a fiduciary. Just be clear about it. And if there’s hesitation, then maybe there’s an issue. But hopefully folks are transparent with how they’re getting compensated.
David: Right. And I always like… And the whole fiduciary thing, it’s like a yes/no answer. When you ask someone that question, they say, “Well, I want to talk about that.” You know? That’s just a no. In my experience, people, they don’t just say, “No, I’m not a fiduciary.” They’ll come up with a fun answer for that question. But it’s a yes or a no question. It’s not like an open-ended question, right?
Steve: Yeah, a hundred percent. All right. Well, before we dive into the whole retirement income topic, anything you want to… I mean, a lot of folks were actually, I think, kind of surprised when you made the move from Morningstar to Prudential. Any color commentary on that, that you want to share? Or we can just move on.
David: No, I mean, I can touch on it. Why not? I mean, I was there for about a decade and I really enjoyed working at Morningstar. I enjoyed the people there. I enjoyed so much about it, but I’d been there for 10 years. And I got an offer to join Prudential, which at the time was a record keeper, an insurance company, and an asset manager. They have since sold their record keeping business. I don’t think that I was the reason they made that sale, but I viewed it as an opportunity to kind of get closer to creating solutions to help people. Right? So, at Morningstar, they’re well known for ratings. There is a small investment management group that does build certain products, but the reach of Prudential is massive. So, the idea of really being more applied in the research and actually creating product solutions, I think for me, was just something that was too good to pass up.
Steve: Okay. Awesome. Well, we have a bunch of user questions for you coming up about the products you’re creating, and the pros and cons of annuities, and different kinds of solutions there. So we’ll dive into that in a second. But first, just touching on retirement income and at a high level, how do you frame up retirement planning overall for retail investors? Like how should they think about this problem and how to approach it?
David: So, if you want to model retirement and you use 10 tools, you’ll get 17 different answers, right? There’s no… It’s kind of a hot mess because no one knows what’s going to happen in the future. Right? It is fundamentally a guess, right? And the question though is, are the inputs to what you are using to make that guess good or bad? And there’s lots of reasons why a bunch of bad assumptions can result in a good plan, and a bunch of good assumptions result in a bad plan. But I think that the key is understanding what are the financial goals I’m trying to accomplish, and then how am I taking in all these different things?
David: Like I think, for example, too many tools today use historical long-term averages as the return assumption of financial planning. Well, the long term average yield on 10-year government bonds is 4.5% or 5%. This hopefully won’t shock any of the listeners at all today, but you can’t get 4.5% today buying a 10-year government bond. And I think that those are the things that might sound small, but when you use assumptions like that, it could lead to really bad decisions around whether or not to delay claiming social security, how much you’re going to save or spend. And so I think that it’s important to kind of be as accurate as you can when it comes to these highly uncertain forecasts.
Steve: Yeah, a hundred percent. And one thing you mentioned when we were in the preamble here, you talked about how do you hedge against true failure, right? Which is like you run out of money, which is, I think, the thing that everyone worries about. And maybe they overemphasize it, but any thoughts on that?
David: Well, so when you think about any kind of financial plan or forecast, there’s two risks that we’re worried about. Right? One is I am broke when I’m alive. Right? And that is the one that everyone is like hyper-focused on. It’s like, “Oh, man, if I’m like 107 years old and still alive, what am I going to do?” And very valid point, okay? The problem that often worries me is that the way we quantify outcomes overemphasizes that versus the other risk that is often even not even discussed. It’s, “I didn’t live the best retirement that I could possibly live. I didn’t go on those cruises when I was 68 and 70 because I was so focused on the possibility, however remote it is, of still being live at some certain point in time.”
David: So the key really is balancing those appropriately, and also acknowledging that, “Hey, I can change if I need to.” So I think that the vast majority of tools out there assume that the retiree makes a set of decisions at 65 and literally does not revisit those at all for like 35 years. And that’s just nuts, right? I mean, what you did last week could change this week. And so I think that, again, you need to make decisions in the context of what you’re modeling, what your assumptions are. But I think that too often we’re way too conservative on the possibility of these kind of bad things happening.
Steve: Yeah, a hundred percent. And people over time, they spend less as they get older. I think the data is like 1% less on a real basis. So, over 10 years, they’ll be spending 10% less every decade. That starts to add up. Yeah, and I think if you step back and look around and say, “Hey, how’s the average 80-year-old doing, and what are they up to?” They’re not doing the same thing that the average 50-year-old or 60-year-old is doing. And really, the scarcest resource is your time. And so I 100% agree. Don’t be afraid of using your money and your human capital, especially when you’re younger, when it’s more accessible. The future isn’t guaranteed, so you don’t want to over index on that like, “Hey, how do I manage that situation for when I’m a hundred?”
Steve: And by the way, related to this, I mean, I think one of the thoughts is: should more folks be buying longevity insurance, a deferred income annuity that kicks in at 85, because it’s low cost and it says, “Okay, there’s a floor of income here on top of social security that’ll keep me from being in the poor house.”
David: Well, you just used the A word. That’s like the danger zone, right? Now it’s going to get to a weird conversation. So I mean, I think whenever I talk about annuities, I’m going to have to like pause and engage the audience, right? Because there’s very, very different opinions about annuities. But here are the facts. Annuities have been available for thousands of years. Right? You cannot guarantee income for life from a portfolio. Your portfolio can go broke, right?
David: And so I think that people need to be thinking about them, right? Now, the question is there’s lots of different structures out there. If you want more guaranteed income without a doubt, the best place to get it is delaying claiming social security. That is like a layup today. Fun fact: Virtually every investment product out there is priced based upon the market. So yields are super low. That means that the payouts are super low. Well, social security doesn’t change like that. Now, I know that there’s issues with funding that will be addressed, in my opinion, but I think that people need to seriously consider them.
David: I know that there’s baggage there. There is a fricking Dateline special on annuities. And when Chris Hansen walks out and starts talking to you, things are not going to go well. Okay? So I get all that. But a lot of advisors that don’t allocate to annuities, they’re all like, “All annuities are terrible.” What I always say is I’m like, “Hey, hold up. Your job, your human capital, what you’re supposed to be good at, is helping your clients accomplish their financial goals. And you mean to tell me that not a single one of your clients, all… Well, let’s assume you have 500 clients. Not a single one of them could benefit from allocating annuity? That’s just not true.”
David: And while I agree that it might be difficult to figure out, I think that it’s incumbent upon advisors especially, and even individuals, to think about how they want to enjoy retirement. And having a portfolio that can go up and down in value can be tough. And knowing that you have this fixed monthly income is pretty fricking awesome. And for those people who want to simplify the whole income process and guessing how long they’re going to live, annuities are definitely worth considering.
Steve: Yeah, yeah. I mean, they’ve done studies to say that people who have pensions are much happier, a lot less stressed, because they’re like, “Hey…” They’ve outsourced the problem. I mean, there’s still risk with a pension, but they keep getting paid like they were getting paid when they were working. And yeah, 100% agree on the social security decision as well. I think there’s a lot of fear mongering like, “Oh, it’s going to run out of money.” The boomers and seniors and older people that are 50-plus are a huge voting block in this country. And I don’t think they’re going to want their social security or healthcare messed with very much, especially since they’ve been paying into it for their working lives. So…
David: Old people vote, right? They’re very good voters. Let me tell you, you cut grandma’s social security check even by like a penny, and she’s coming after you. Right? Now, I mean, maybe there’s like means testing that affects the top one or five percent. But I think that the odds that individuals who are currently or about to receive benefits being affected are pretty close to zero. Now, I just turned 40, right? I think that my benefits will look very different. I think there’s a very good chance that I’ll have to work till 70 to get full benefits so they could be taxed more. And I’m okay with that. I mean, we’re still using mortality tables that are like three decades old at this point. People are living longer. They can work longer. I’m okay with changes. But I would bet a ton of money that individuals who are in or close to retirement will not be affected by a change to the social security system.
Steve: Yeah, yeah. No, good. You know, I think for folks that are 40-plus and kind of thinking about social security, I think it’s good for them to be aware of this. Another group that really should think about this and probably get more educated is millennials and Gen Z, because a lot of these folks are like, “It’s not going to be there. I’m on my own.” And I think it contributes to their thinking about risk and their willingness to be like, “Oh, I’m going to YOLO into these cryptos and whatnot,” and it affects their behavior. They feel like they’re kind of on their own, and maybe they should take more risk earlier. I don’t know. I don’t know if you’ve seen research on this. It’d be interesting to actually see if there’s research on their behavior based on what they’re reading about or their beliefs about social security and Medicare.
David: Well, I mean, technically, if you think it’s going to go away, you should save a lot more for retirement. And let me tell you, if you were into financial planning, you take out social security and things get a lot worse all of a sudden. It looks pretty dire. I think that my pushback would be I think we always have to have a minimum benefit. I mean, I can’t imagine a developed country that says, “You know what, folks? You’re all on your own when you get to retirement.” Now it’s today, “I don’t care, so I’m not going to plan for it,” because it is going to be there. And it’s very valuable. So I wouldn’t just dismiss it outright.
Steve: Yeah, a hundred percent. Okay. So I just want to touch on safe withdrawal rates. Hey, the 4% safe withdrawal rate or 3.5%. Karsten Jeske’s like a 3.5% person. He’s been on our podcast. You know, where do you fall on this?
David: So I think… So, okay, so context again, so people know what this means. But like so 4% is this rule that Bill Bengan kind of came up with. I don’t know, what… It’s almost 30 years ago. And that’s the initial withdrawal rate you take from the portfolio, where that exact amount is assumed to be increased for inflation every year for 30 years. And the bad outcome is that you don’t receive that exact amount of income every year for 30 years. If you happen to fall a dollar short in that 30th year, you will. Right? It does not consider the fact that people don’t tend to need that fixed annual increase with inflation. It does not consider the fact that you could just fall barely short.
David: So, while it’s totally true that if you rerun that original analysis with more realistic return assumptions, so kind of reflecting today those yields, it’s closer to like 2.5% or 3%. I think that 4%, even 5% is great for most people because, I mean, here’s the thing. The portfolio, it’s marginal income, right? So you have social security. You might have a pension. You’ve got this other stuff. This is on top of that. So your question should be, “How much do I need and how can that change over time?” And I think that 5% actually works great for a lot of people, if you can take a nominal withdrawal amount. So, if I just need $50,000 a year, I don’t have to have the increase for inflation because I’ll get that bump from social security. That can actually work great.
David: And so I think this gets to my earlier point about like whether you’re too conservative, too aggressive on how you spend. I just worry that when you start talking about, “Oh, I need a safe initial withdrawal rate of 2.5%,” you’re going to lead to this situation where you’ve massively underspent. You didn’t go on that cruise when you were 68 and you could have actually enjoyed it.
Steve: Right. Yeah. You don’t get the time back. And you know, you can, if things are really going sideways, if you’re younger, you could work part-time or you could withdraw less on a particular year, kind of wait for the market to come back a little bit. And all the data shows that people that have money when they go into retirement die with even more money. So people aren’t spending. I mean, savers keep saving and…
David: Well, that’s another reason to actually annuitize, right? I mean, the thing about this, like we are hard-coded, if you’re good at it, to save money your entire life. Right? You know, “No, you can’t do this stuff. You’ve got to save.” And then all of this sudden you’ve got to do the opposite, right? Where when you retire, you’ve got to go from watching your 401k to depleting that. I mean, how painful is that to pull money out of that thing every month or every quarter, every year, not knowing how long you’re going to live and all this uncertainty, and low interest rates, and increasing mortality, and could… I mean, it just goes on and on and on. And so people are paralyzed by fear. Well, so I think that’s the thing that’s always kind of terrifying, right? Like we are exposed…
David: I mean, people talk about markets being mean reverting, where markets go up, markets go down. That hasn’t happened in Japan, right? And so I think that there is this very real risk that we see a decade of low and negative returns, and you see inflation, all these bad things happen. That’s the problem with defined contribution plans in general, is that it subjects individuals to these risks that they don’t know how to face. Because if you combine low returns with longer life expectancy, that’s a really dangerous combination, right? If you’ve got a low return and a 40-year-time horizon, then your battleshipe gets sunk. And if you are only planning for life expectancy or life expectancy plus a few years, it doesn’t matter as much.
David: And so I think that to me is the issue, is that you don’t know what to do, and we often focus on the bad possible outcomes. And I can’t not acknowledge that I see a very decent chance of really low returns in the foreseeable future, given where interest rates and evaluations are today.
Steve: Yeah. No, someone framed it up really well once when they said what we did by moving from pensions, the DB structure, to defined contribution, the 401k model, where people are now managing their stuff themselves, you made everybody the pension chief investment officer. So everyone had to become their own planner. They had to learn to save, learn to invest, do that for a long time. And some people have done it great. Like a lot of our users in new retirement, they’ve done it. You know, they’re 401k millionaires. They’re like, “Hey, I’ve been doing it. I got it.” But they’re the minority. That’s like 5% of the population, 10% of the population. Everybody else is like, “I can’t think about this. It’s too complicated. I’m not going to do anything.” And then people roll into retirement with an average balance of like $125,000, and they’re looking at 20 years or 30 years of paying for life. That’s the hard part of what we’ve done here.
David: Yeah. I mean, I think that one thing that does excite me is that the defaults in 401k plans are getting smarter. Right? The default savings rate is going up. And so hopefully, the path of least resistance is becoming better for people. So you won’t have to necessarily make a lot of active choices when you’re saving. You can get to a good retirement. The problem is, when you get there, it’s just an absolute hot mess. Right? There are so many choices you have to make. It requires all these decisions, and there’s all these risks out there. And so I don’t know a way to simplify it because it’s very complex. But I think that’s the value of advice for those that need it.
David: To your point, lots of folks can do fine on their own, but I mean, one concern that I always have is that you make a series of quasi irrevocable decisions when you retire and you can’t always take those back. And so if you are a do-it-yourself or you’re keen on doing it all yourself, that’s totally cool. Find an hourly financial planner just before you retire and get a second opinion just to make sure that you’re on the right path. If that’s the only time you ever do it, that would be my kind of spot for someone like that.
Steve: Yeah, a hundred percent. Yeah. And I think more people are looking around for that. I actually talked to one of our users today who was like, “Hey, I’ve been looking for this, kind of get started on my own, but then wrap some services, coaching or advice around it on demand, versus being fully committed to the wealth advisor that’s charging 1.3%, which ends up being a lot of money.”
Steve: So we have another question from Rob Jennings, and it’s: What are the big considerations around whether or not to delay social security? And also, what do you suggest, given this super low, fixed income environment, do bonds have a place today in portfolios?
David: So I’ll take the… I think bonds definitely do. Bonds are that safe balance, right? They have a low or negative correlation to equities. And when markets are going down, government bonds are going up. I don’t see a place for high-yield bonds in a portfolio, just for example, because when the markets go down, they go down. They aren’t safe. I think it’s important to have that safe asset you can draw on to possibly give your equities time to recover in the event of a negative market shop. Now, social security, there’s a lot there. Like the most important question is: How healthy are you, and how long do you think you’re going to live?
David: But a point that I would make is that, honestly, it doesn’t really matter, because here’s my hot take of this. And everyone’s all like, “Oh, if I die, if I wait and I delay claiming social security until I’m 70, and I spend my money down, I might die when I’m 71.” That’s one perspective. But if you die when you’re 71, your kids just won the lottery. You managed to save up a ton of money for retirement and you didn’t retire very long. And so they’re going to get all the money you saved for your entire life. Congrats to them. Okay? However, if you then live for a long time, if you outlive all your planning period, you live to age 105, and you’re getting that big benefit, you’re going to be in much better shape than if you claimed early and then deplete all your savings.
David: And so, from my perspective, if you think about it from like a relative-ish, absolute perspective, it’s like, sure, if you delay claiming social security when you’re in your sixties, your kids might get a little less. You’re going to have to kind of bridge that gap for a few years, whatever works. What you’re ensuring is that 1) if you die early, they’re still taken care of. But 2) I think the worst thing that can happen for those that are really focused on leaving their kids money is the reverse happening, is that they do live a long time. All the savings get depleted. And then it’s the kids that are parents, versus the other way around. So…
Steve: Yeah. I think definitely thinking intergenerationally and being organized that way and getting that visibility is super important. I mean, personally, something that happened that was super sad was that my dad’s partner passed away, and she had done a great job saving her whole life. And she actually… So it actually ties into what you’re sharing, because she was actually using a variable annuity, which I am not a fan of these things because I think they’re complicated and high fees. But it did work. So it was spinning out a material approaching $10,000 a month of income. So it was paying for their lives. They were living great. They had more income in retirement than they had when they were working, or she did. But then she passed away early, much younger. And then a lot of the money did go to the heirs and people in the family. But what’s happening is now we’re thinking about my father’s situation, just planning for care and how we’re going to pay for it and longevity. And you can see that even for me, I am in this business. You can see the complexity and also the need to think about this from another 10, 20 years, right? Because his parents lived a long time.
Steve: So anyway, I just wanted to kind of circle it back since this became real in my life very recently.
David: Well, I was going to say, so it’s funny, I can get a little feisty on social media. And if someone was talking about how retirement is not complex, there’s all these rules of thumb you can follow and you’ll be totally fine. And my response was, yeah, you can follow a number of rules of thumb and most people are going to be okay. Right? But there’s going to be quite a few people that follow those rules of thumb, that make a bunch of decisions that are terrible for them, and then bad things happen. And so I think retirement, I don’t say it’s complex because it gives me a job. I think it’s complex because it’s complex. And I think that for those that are listening, I would say it’s okay to kind of use rules of thumb, but as you move through retirement, you move towards certainty, right? When you first retire, there’s so many paths you could go down. When you eventually die, well, you’ve reached the end of your journey. And you have the most options when you’re younger to choose to annuitize wealth to do things. And I think that’s when understanding this complexity and how to manage it is just so important.
Steve: Yeah, no, exactly.
David: So, anything that you should ensure against. The problem is that it’s not easy to get. It can be very expensive. And we’ve seen big changes in the cost of an insurance over time for those that have it. So I think that it’s definitely worth considering for those that want to help hedge against the risk of an incredibly expensive nursing home, for example.
Steve: And now that rates went up and premiums were changing a lot, and also some carriers just pulled out of the market, do you feel that instability in the markets worked its way out? Or do you think it’s still a big uncertainty?
David: Well, I mean, I think that anything that loads on end-of-life risk and healthcare costs has a lot of uncertainty. Right? So, in theory, it’s good that it’s being pooled, but as anyone knows that’s stayed at a nursing home for a few years, that can be incredibly expensive. Right? So, if the actuaries got it wrong, then we could see more changes there. Now, I mean, the thing about healthcare costs we’re talking about is that they’re actually quite known for most people. There’s actually very few that have that shock. But if you do… And so, I mean, just because there’s a chance that premiums might go up doesn’t mean you shouldn’t buy it. But I mean the important question is what happens if you’ve been paying into the thing for 10 or 15 years and then premiums double? Right? Can you keep affording to keep paying for it without having to receive a benefit? So, to me, it just isn’t as clean as other products. And so I think that for those that can afford it, it should be considered, but it’s tough.
Steve: Yeah. I guess my question would be: why not buy a deferred income annuity that kind of starts when you think you might need it, where you know it’s coming, so then you can bridge yourself? And then the deferred income annuity will kick in and cover additional costs, and then you’re guaranteed to get the money or some kind of benefit.
David: Yeah. I mean, I think any academic out there can talk longingly about deferred income annuities or longevity insurance, or whatever you want to call them. I mean, by definition, it is the most economically efficient way to hedge against longevity risk, right? Because in theory, you don’t need uncertainty about spending today or tomorrow. You need it at some point in time in the future. I need to know at a certain age that I have income from that point on for life. And so I think that is a more efficient structure, for example, to create income. But if you buy one that generates $30,000 a year, but you enter a nursing home and it’s $100,000 a year, there is going to be a gap. But that is way to kind of help create that certainty for income later in life.
Steve: Got it. Okay. Great.
Steve: All right. We’re going to circle back to even more annuity questions because we had a bunch from our users. So, from Brian Walsh, “I’d like to hear a detailed breakdown of scenarios where annuities do not make sense.”
David: Well, I mean, so again, there’s all these different types of annuities, right? So it’s funny that people… So I understand that there’s bad products out there. I totally get that. Okay? There’s bad products in any category in life. Let’s just call it. Maybe there’s more bad annuities than, say, like bad life insurance policies. I don’t know. But it’s just insurance. Right? So you’re buying insurance. And so the question is expected value versus the cost. Right? So, certain products don’t have a large expected benefit, but they have a huge cost. Okay? So, how do you quantify that? Well, the biggest thing for most annuities is just how long do you think you’re going to live? Right? I mean, if you buy it and you’ve got cancer, then you’re not going to be well off. But you can include provisions, like a 20-year period certain or a cash refund provision, that always ensures you at least get your money back.
David: So, from my perspective, those that shouldn’t necessarily buy are those that aren’t going to need it. Right? If you’re not at risk for depleting your savings, then you don’t buy insurance. Right? If you can totally self-insure the risk, you don’t need to do it. And then also those that wouldn’t think it’s necessarily economically advantageous. But one spin on that for me is that even if you don’t think you’re going to live more than average, it really can radically improve how you perceive your savings in retirement.
David: I did some research. It’s called a license to spend. It gives you certainty about how much you can spend from your portfolio. So it doesn’t do you any good, if you want to enjoy retirement, you don’t have any kind of motive to not spend your savings because you’re worried about how long you’re going to live. Annuities can give you that sense of freedom. And you mentioned variable annuities. There’s super simple annuities. They’re like single premium annuities, or SPIAs, are a great way to get guaranteed income. Again, delaying claiming social security is better than buying a SPIA for most people on average, but I wouldn’t dismiss annuities because some are complex. Some are actually incredibly simple in the scheme of things.
Steve: Yeah. Now I’ll point to one of the podcasts that we did with this Glen Nakamoto, who’s a member of our community. He basically bought a series of annuities to create his own pension. And he looked around and actually couldn’t get traditional financial advisors, wealth managers, anyone to say this might be a good idea. And he thought it was because they are all paid on his total assets under management. So there’s also…
David: Weird, right? I mean, it’s weird.
Steve: You know, delaying social security has a cost. You’re going to spend money to get that additional income.
David: That’s actually the only insurance that has a positive economic value on average. Other forms of insurance, by definition, should have a negative economic value or the insured is going to lose money on the policy sold. And that’s what happened for like long-term care, so they jacked up the premium. So they never actually lose money in the grand scheme of things.
Steve: Yep, yep. Okay. Well, that was super helpful.
Steve: Okay. So here’s another question from Jeff Clark: With the threat of inflation potentially eating way annuities in real dollar terms, what options exist with protection against inflation over the long term? And what are the payout rates? I mean, are there annuities that actually are indexed to inflation?
David: Well, Principal had the last annuity with a benefit rider that was explicitly linked to inflation. Now, some will say, “Oh, well, if the markets go up, your payment goes up.” But that is not an explicit inflation link. So there is not, today, a single product that I’m aware of… And I ask this question regularly to anyone that I talk to, that has an explicit link to inflation. Now, again, super asterisk here: social securities is. And so that creates a huge value for that as a sort of guaranteed income. But like right now, if you want to get more income later, it requires… I don’t know what it’s called. A cost of moving adjustments. You can buy a policy where your benefits increase by, say, 2% a year, but that’s fixed. And so that doesn’t necessarily protect you against this idea of hyperinflation.
David: Now, to be fair, while Principal did have this annuity that was available previously, it wasn’t priced very attractively. Like the implied inflation rate on the policy was like 3.5% or 4% versus a fixed cost. You could literally buy a 4% fixed Cola that had the same kind of expected payout as this CPI policy. So again, even if there are products available that provide that hedge, it’s always worth understanding what is the economic value of that protection?
Steve: Got it. Yep. All right. It’ll be interesting.
Steve: And so, actually, last question I have on this topic is: Do you look at tontines versus annuities? And do you see them as… Is it something you look at, at all? And do you think they’re going to be around?
David: I do. So there’s one in Canada now. Like the Collective DC plan is taking over in the UK. So it’s just a spectrum, right? So, at one end of like the lifetime income guaranteed-ish spectrum is social security. It’s an immediate annuity. You get effectively a fixed-ish payment for life, end of story. Okay? What we’re seeing though is more advances… You mentioned tontines. Where you get together with a group of people, for example, and based upon market returns and mortality experience, that defines the payout. I think it’s great. Right? There’s not one… I am certain that there is not one annuity strike that’s optimal for everyone when you incorporate unique preferences and product designs and everything else. And so having more options available, I think, is a huge advantage for retirees in the industry at large.
Steve: Got it. Yeah. Well, we’ll see if they emerge. I know there’s some people doing research on it.
Steve: Okay. Last user question. Justin Perchard, he noted you’ve been doing some research on buffer ETFs and similar products, and he just wanted to kind of get your take on those products, what they are, and how they’re evolving.
David: Sure. So, these exist in ETFs. These exist in annuities. And so this idea… And so, long story short, when interest rates are low, you can’t create an attractive upside with no downside, right? So I want a product that doesn’t lose money. Well, historically, that’s been what’s called a fixed index annuity where you can’t lose money unless the insurance company goes out of business, but you have some upside. Well, those don’t look all that great today when interest rates are super low. And so I think what we’re seeing this emerging class of product are, are products that have like buffers and floors. And I don’t know if we have time to get through all the stuff there, but you can build these yourself. Right? So one, you can buy ETF, you can just go out and… I have level-three options clearance at Schwab. I can sell all day. I don’t do it, but you can do it yourself. So just always start there, okay? You can build these yourself, or you can buy a product that does it for you. Do they make sense? Well, they can. There’s some interesting dynamics historically about implied volatility and options that make buffers a little bit attractive. But, I mean, I like them most from the perspective of…
Steve: You know, your portfolio construction or combining social security annuities for some guaranteed stuff, some highly risky stuff, whatever. You can put this together. And I think in general, less complexity, lower fees usually wins. And then consistent saving for a long period of time, it usually wins the day.
Steve: Okay. So, as we wrap up here, I don’t know if you want to give any color commentary on the state of the economy, markets and taxes. I mean, this might be out of your wheelhouse, but I think a lot of folks are rolling around there, “Okay, the market seems to be just kind of marching up and to the right, but there’s the great resignation. We’ve got supply chain issues, boats parked off of the coast, not going anywhere. A bunch of tax uncertainty and changes. Big national debt.” Yeah. Any color commentary? Or do you have a point of view on this? Or…
David: Well, so I think, I mean… This will be easy. I think taxes will go up for wealthier Americans, not just now, but again in the future. But there’s always going to be uncertainty, right? And there’s always going to be… I am concerned about the equity markets. I mean, they’ve literally gone straight up for like 12 or 13 years. That just doesn’t happen without a correction. I mean, trust me, I would love it if the markets just went up 10% a year, every year, for the entire future. Then everyone will accomplish all their financial goals. It’ll make… Maybe I’m out the job, but I’ll be just fine because I’m making tons of money in my 401k, whatever. I am worried about a shock today with respect to the market, just because, again, we’ve had this sort of massive run-up.
David: And again, this all gets back to this question: How does this certainty affect you, the listener, and your strategy? And the more the uncertainty is going to affect you… And this is not just economically, it’s also psychologically. Right? Like if you cannot sleep because you’re so worried about markets going down, you should probably do something else. And so I think that the hard thing for me is I’m often very focus on assuming that retirees are rational, utility-maximizing people, when they’re not. And I think that’s where this uncertainty can really throw a loop in someone’s plan or strategy, where you have to figure out what makes sense for you given this uncertainty. And I think we’re going to have a lot of uncertainty going forward. So, if you can’t deal with uncertainty, then you probably shouldn’t be invested much at all in the markets. And that has negative implications as well because you’ll have a very low expected return.
Steve: Right. I think that’s the challenge for everybody. It’s like where are the returns? The returns are in the equity markets. They’re not in fixed income right now. I mean, I guess you can go to real estate, or you can have a small business, but you pretty much need to participate in the markets. But yeah, what you’re describing is a lot of folks are engaged in market timing by not being in the market. So they’re waiting, and then that costs them. And if you do take like a long-term view, if you take a 20-year view, you can kind of expect a 6%, 7% rate of return and relatively low chances that you’re actually going to lose money over that, or almost no chance you’re going to lose money over that time period.
Steve: Now, maybe we are an uncharted territories because we have gone straight up much more aggressively than that over the last 12 to 13 years. So, the whole “it’s going to revert to the mean” does tend to happen. And so, is it going to be flat for some period of time? Or is it going to go down and then start growing again? Nobody knows. So, I mean, my last thought here is the way to hedge this is you just have to keep saving, investing consistently, kind of dollar cost average in for a long period of time, and keep doing it and not think about it.
David: I mean, I am worried that people are going to risk on. Right? You know, they’re going to look at low bond returns and juice things up. And to your point, if you can literally not… in long term, you don’t need the money, I think that you’re going to be just fine. I worry about the folks that are more behavioral that will react to the market, and those that have got to take money from their portfolio, because that’s when you’re going to experience a loss that you just sometimes can’t recover from.
Steve: Right, right. Okay. Well, that’s super helpful.
Steve: Okay. Well, as we wrap up, any final thoughts about for as you do your professional work and you look forward to kind of how retirement planning and retirement income’s going to change over the next 10 years that maybe you’ll do at Prudential?
David: Well, I mean, I’m just excited that we’re seeing more of a focus of… I mean, this might seem biased because I work for the group that’s focused on defined contribution wise. But more of a focus among plan sponsors to help participants get through retirement. Because again, I love advisors. I think that they can do a great a job. But they aren’t all professional fiduciaries. I think that the idea of especially larger 401k DC plans that have economies of scale, that can offer first-in-class investments and everything else, helping middle America get through retirement, I think that’s awesome. Right? Because then you’ve got a situation. You’ve got low-cost investments, high-quality advice, professional fiduciary. That to me is pretty exciting. So I mean, I think that and just the growing interest among advisors to be retirement income planning specialists or having that knowledge is important, because I think that a lot of folks have focused on getting people to retirement, but it’s through retirement that I think is most important. And so I think that we are going to see this increased focus on building better retirement strategies in the future. And that to me is just pretty exciting.
Steve: Yeah. No, it’s awesome. Yeah, no, I think there’s a lot of reason to be hopeful that the state of better products, better solutions, more aligned advice, economy is still… We’re still innovating like crazy and good things are happening. So I don’t think the wheels are coming off the US economy anytime soon.
Steve: Okay. So, great. Well, with that, thanks, David, for being on our show. And Davorin Robison, thanks for being our sound engineer. For the folks that are listening, appreciate your time, and hopefully you found this useful. And if you’ve made it this far, definitely check out David’s research. You can see it at DavidBlanchett.com/research. We’ll also point to that. Go ahead, David.
Steve: All right. Thank you. DavidMBlanchett.com. And then also check out our site for retirement planning. Anyone can create a plan. And we have a Facebook community where people are asking these questions and piling in. So we could ask experts like David their opinion and kind of share it with folks. And then the last bit would be any reviews are totally welcome, and sharing is totally welcome. So, with that, thank you and have a great day.
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