How is this possible—a retirement pension that you can undo?
Most lifetime annuities are irrevocable. But three months ago a Canadian company, Purpose Investments, began offering the Purpose Longevity Pension Fund, a lifetime annuity with an exit door. You can put your money in now, start collecting a monthly income, and then change your mind later, retrieving what’s left of your principal.
Yikes. Doesn’t a redemption right destroy the economics of longevity pooling?
That would seem to be the case, and yet there’s a decent chance that this new way of financing retirement will take off. For now, U.S. citizens can’t participate, but I think it’s only a matter of time before this product, or something like it, is offered here.
The entrepreneur behind the novel fund is Som Seif, a veteran of the exchange-traded fund industry who founded Purpose nine years ago and has put some unusual products on its shelf. Among them: a bitcoin ETF, something not available in the U.S. (for instructions on how to sneak across the border, go here), a climate opportunities fund and a marijuana fund.
Retirees need to insure against the risk of outliving their savings, Seif says from his Toronto office, and the longevity fund might be just what it takes to get them to take the plunge into annuitizing: “People are living longer. This is going to be a social issue.”
Simon Barcelon, the Purpose executive who designed the new product, explains the gulf between the theoretical advantage of a traditional annuity and its sales appeal: “It’s a beautiful product but people don’t buy it. It’s a behavioral thing. Being irrevocable is what turns people off.”
To understand what is unusual about the Purpose offering, consider how annuities are usually structured.
Harry, 67, has $100,000 for retirement and wants to be sure the money will last until he’s 100. To be safe, he could put the money in the bank and take out $3,000 a year. He could also collect a bit of interest, but to keep things simple we’ll ignore that.
Now let’s suppose the average lifespan of 67-year-olds is 20 years. Then an insurance company could offer a large pool of people like Harry a lifetime $5,000 annual payout, $2,000 more than they could safely get on their own. For simplicity we’ll ignore, along with the interest income, the insurance company’s overhead.
Some Harrys will collect for 10 years, a $50,000 total; some for 20 years, or $100,000; some for 30 years, or $150,000. The average customer will get back $100,000. The insurance company will break even.
What would happen if buyers could change their minds? If, after two years, Harry could back out, getting a refund of the $90,000 he hadn’t yet recovered? Then all the buyers who turned sick early on would be asking for refunds. The insurer would be left with a cohort of unusually long-lived customers. It would go bust.
In short, a refundable lifetime annuity sounds about as likely as a flying pig. How does Purpose Longevity work?
Despite the right of withdrawal, the fund does benefit from mortality pooling. That’s because the buyers who decamp or die leave money on the table: They (or their heirs) get back principal but not earnings. Over time, those earnings accumulate and will, it is hoped, make possible generous payouts to a dwindling population of aged annuitants.
The Purpose product, structured as a mutual fund rather than as an insurance policy, closely resembles the College Retirement Equities Fund that TIAA has made available in the U.S. since 1952. Cref annuities, though, have nothing close to the permanent withdrawal option Purpose is offering.
In the Purpose fund, buyers are grouped by age (there’s no gender division). A customer now 67 would start out with a 6.15% annual payout, or $6,150 for a $100,000 investment. That’s a bit less than what Cref offers.
The money goes into a portfolio invested 47% in stocks, 38% in bonds and the balance in alternative holdings like precious metals. Just as in any mutual fund, a buyer’s shares go up and down in value with the returns on the portfolio and down by the amount of distributions.
Someone voluntarily exiting (or his heirs, if he dies) gets the lesser of two sums: (a) the value of the shares or (b) net investment (amount invested minus cumulative payouts).
Scenario 1: Jane Doe buys $100,000 of the fund, takes $6,150 in distributions during the first year, and then the stock and bond markets crash 50%. Her shares are worth $93,850 before the crash and $46,925 after. Following the crash, the fund managers will probably choose to drastically cut the monthly distribution. Jane can either hang in there, hoping for a rebound, or call it quits and walk away with $46,925.
Scenario 2, more likely: Jane collects $6,150 annual distributions for 10 years while her piece of the fund earns an average $4,000 annual return (appreciation plus interest and dividends). With payouts exceeding earnings, fund shares fall in price; Jane’s stake declines to $78,500 in 2031. If she dies that year, her heirs will be entitled to a refund of $38,500 ($100,000 invested less $61,500 received). The other $40,000 stays with the fund, boosting the account value of the survivors.
Scenario 2 is pretty much what goes on at TIAA’s Cref, the equity-based annuity for teachers, except that in the standard Cref option there is no refund going to either the participant or an heir, so the entire $78,500 would remain inside for the benefit of surviving customers.
At Purpose Investments, as at Cref, there is no guarantee and the vendor has no need to set aside a reserve to cover unpleasant surprises in returns or mortality. At both institutions the management can adjust payouts to reflect what’s happening to the fund’s value. At both, the vendor is entitled to pocket for itself only a fixed expense ratio (0.23% annually at Cref, 0.73% at Purpose).
Cref has demonstrated that an equity portfolio can, over a long stretch, deliver payout gains that outstrip inflation. Purpose has yet to prove itself, but it’s reasonable to expect that it will eventually raise payouts for the oldsters. The increments at Purpose, though, are likely to be modest because its fund is invested conservatively and it picks up smaller windfalls from early demises.
Will something like Purpose Longevity come to the U.S.? Probably. Something rather like it was the subject of a prospectus filed last year by Stone Ridge Asset Management in New York City. The paperwork cited an ambitious $240 million sales target for a closed-end fund designed to give holders a certain annual payout for life. Pricing was keyed to age and gender. There was a vague prospect of liquidity via opportunities to sell shares, albeit at at less than net asset value, back to the fund.
A pandemic is not a great time to be selling annuities and, as far as I can tell, the offering fizzled. I can find no trace of it on the Stone Ridge website; the company did not respond to a query.
Apart from the timing, the Stone Ridge longevity fund suffered from a lack of excitement. Assets were to be invested in zero-coupon Treasuries. The resulting payment stream would be not very different from what you would get, in a far more dependable fashion, from a vendor of fixed monthly annuities, like New York Life.
TIAA and Purpose have creatively demonstrated that the two big roadblocks to using annuities for lifetime income, the fear of inflation and the fear of irrevocability, can be overcome. But what do you do if you are neither eligible for TIAA nor residing in Canada? Create your own income stream. See Do-It-Yourself Income For Life.