A new role for credit unions

Census data indicates that approximately 10,000 people will turn 65 every day for the next 10 years. More than half of them are worried about the prospect of outliving their money. Credit unions should be at the forefront of institutions meeting this need, but the reality is that they have little to offer members who are or are about to retire.

The critical need for retirees who fear running out of money is a retirement plan. This would show them the usable funds that they can expect to have every month for the rest of their life. While such a plan may require modifications over time, the ability to make such modifications would be built into the plan.

A viable retirement plan has three main components: financial asset management, annuities, and (for homeowners) reverse mortgages. The challenge is to group them together in a cohesive way to maximize benefits for retirees. The following sections present the main characteristics of pension plans that would meet this requirement.

Coordination of liquidation of assets and annuities

The optimal retirement plan is to use a portion of the retiree’s financial assets to purchase a deferred annuity, using the remainder to provide usable funds to be withdrawn during the deferment period. The challenge is to find the asset allocation between monthly withdrawals and annuity purchase that provides the greatest amount of usable funds. This is illustrated in the table, which shows that the highest amount of fund available varies depending on the asset carryover period, asset performance and age of the retiree.

Downside Risk Protection

The higher the assumed rate of return on financial assets, the greater the risk that the realized return will be lower. A good retirement plan has two features that can be used to neutralize this risk. The retiree who owns a home can add a HECM reverse mortgage to the plan and draw a line of credit that can be drawn down for any purpose. If the return on assets is insufficient, the retiree can draw on the line of credit as needed.

The second feature to deal with downside risk is to segregate a portion of the retiree’s financial assets, called a “set aside,” which is not used in the calculation of available funds. If all goes as planned, the amount set aside, along with the related income, will go to the estate. However, the plan may stipulate that if the pay rate used in the calculation of available funds is insufficient, the set aside may be used as compensation. Indeed, the pensioner declares: “I want to leave this money to my heirs, but not at the cost of impoverishment in my last years.

Competitive price assurance

A significant challenge facing non-affluent retirees is that the two markets that target them, reverse mortgages and especially annuities, are extremely inefficient. The annuity amounts in the table above are the highest of those obtained by shopping a large number of annuity providers, all of which are rated A or higher by AM Best. The reality, however, is that most annuitants aren’t getting the best price available.

To show how imperfect this market is, I compared some of the best quotes shown on the chart with the worst quote for the same trade. For example, the 72-year-old man with assets of $500,000 earning 5%, who would receive $3,181 per month based on the best price on an annuity with a 5-year deferment, would only get $2,711 if the annuity price on the same transaction was the worst instead of the best. That’s a 15% difference. With a deferment of 10 years the difference was 21% and with a deferment of 15 years it was 29%.

If I did the same exercise with HECM reverse mortgages, the results would be similar.

The way to protect the retired member against the risk of overpaying is to act as the client’s agent, selecting the best terms for the annuity and reverse mortgage. They can do it the same way I did, which is to access the available networks of annuities and reverse mortgage quotes. The worst thing the credit union can do, from the retiree’s perspective, is to enter into agreements with sole service providers, which would leave pricing untested.

The education of the retiree

Perhaps the most difficult challenge facing the credit union in meeting the retirement needs of its members is educating them about pension plans. I have found that the best way to achieve this is to divide the educational process into two phases. Phase 1 is the provision of self-help materials that allow the retiree to learn how a pension plan works in general and what their own plan might look like. In Phase 2, the retiree, in consultation with a credit union advisor, develops a detailed plan tailored to the individual’s needs, abilities and preferences.

Concluding Comment

Many credit unions are successful in meeting the needs of their members in the accumulation phase of their retirement, but they do little for members who have transitioned from accumulation to liquidation. The main obstacle is that pension plan components are offered separately by other institutions, and credit unions are understandably reluctant to compete with them. But it creates a huge opportunity to act as integrators, certifying the offerings of these other companies and advising on how best to bring them together to meet member needs. There would be several ways to generate income from this process.