What is an ANNUITY?
An annuity is a contract from an insurance company that offers to pay income to you at regular intervals, for a period of time you specify, all in exchange for your contribution (premium). These contracts may contain other features as well.
Why buy the ELM INCOME ANNUITY?
This contract, issued by Principal Life Insurance Company, is for your consideration…
Why buy the ELM INDEX ANNUITY?
This contract is for your consideration if you are not yet ready to turn your assets…
Sensitivity to Loss —
Where does it come from?
As young workers, we put money away for retirement, expecting to leave it alone for many years. If negative returns drag down our assets, we have time to wait for a rebound. The good investment years can make up for the bad ones.
For example, a loss of 20% in one year can be made up by a gain of 25% in the next year. $100 - $20 (20% loss) = $80; $80 + $20 (25% gain) = $100. Making up for the earnings we counted on receiving, which were also wiped out by the loss, would require an even greater gain.
As we near retirement, however, the time that our assets can remain untouched becomes shorter and this causes our vulnerability to losses to become greater. When favorable experience does arrive, it may apply to assets which have been reduced by withdrawals, as well as by negative returns. This means that the favorable experience needs to be that much greater to make up for the poor returns.
A retirement income plan that might have to last for 30 or more years, with increases for inflation, is especially vulnerable to losses. This is because each year that goes by more savings are withdrawn to meet expenses, leaving a smaller amount available for investment.
» View/Hide Case Study Illustrating this Information
Consider, for example, how the timing of changes (volatility) in the market could affect a hypothetical couple, John and Kathy, who decided to retire in 1971, then both age 62. They wanted their income to last for 35 years because of the odds at least one of them would live that long (see Longevity section).
John and Kathy planned to withdraw $15,000 a year from their savings of $300,000, (5% of their savings). In addition they planned to increase their annual withdrawals by 3% each year to allow for inflation during their retirement. So, in year two their withdrawal would be 103% of $15,000, or $15,450, etc.
Here’s what happened:
The two lines on the graph show the assets remaining at the end of each year, after taking into account withdrawals and earnings experience.
Green Line: If John and Kathy’s assets could earn a net return of 7.7% each year (the average return of the S&P 500 Composite Stock Index over the last 35 years), the green line above shows this plan would work well. These earnings would provide the planned income amount each year without even dipping into their $300,000 starting balance before the end of the 35 years.
Red Line: The red line shows what happens if the annual net returns on John and Kathy’s assets exactly matched the actual annual returns of the S&P 500 Composite Stock Index from 1971 through 2005. During that time, the annual return of the Index was volatile and included many years of loss as well as many years of gain. The outcome here, for Kathy and John, is much worse, even though both the red line and the green line have the same average annual return of 7.7%! The early losses and withdrawals, which caused the red line to decrease so much in the early years, could not be made up later, and John and Kathy’s assets are depleted after just 22 years.
Their sensitivity to loss, in short, meant that John and Kathy ran out of retirement assets many years before they had expected and while they still needed the income.