RT65 Annuities 2024

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Rethinking annuities

Annuity Boom

Annuity sales have exploded. Experts say many retirees would benefit from them. Here’s how some advisors are using them.

Dorothy Hinchcliff , Publisher & CEO

Jerilyn Klein , Editorial Director

Contents

This Is Not Your Father's Annuity Industry

Driven by independent agents, annuity sales hit a record $385.5 billion in 2023, but the entry of a defined contribution heavyweight could be a game-changer.

By Ed Prince

The Right Fit?

Annuities are a good fit for many retirees, who need educated advisors to make the best selection, say leading experts.

By Jerilyn Klein

Investigating Income

Rethinking65 writer Paula Green asked six advisors how they successfully used an annuity to address a client’s desire for retirement income. Here’s what they told her.

This is not father’syour annuity industry

Driven by independent agents, annuity sales hit a record $385.5 billion in 2023, but the entry of a defined contribution heavyweight could be a game-changer.

By Ed Prince

What’s new with annuities? Plenty!

The once-sleepy class of financial instruments offered by insurance companies has become a hotbed of growth and change. After two years of record sales fueled by high interest rates, stock market jitters and the silver tsunami of baby boomers heading into retirement, annuities are poised to take off in another direction — embedded in 401(k) plans.

According to the annuity industry organization Limra, total U.S. annuity sales reached a record $385.4 billion in 2023, up 23% from 2022, which set the previous record of $312.8 billion. That trend continued in the first quarter of 2024, when sales hit $113.5 billion, 21% above the results from the first quarter of 2023, Limra reported.

The 2023 boost is due largely to independent agents and broker-dealers, whose sales collectively increased 29% and represented 41% of 2023 sales, according to Limra.

“Rising interest rates have made annuities very attractive to a larger group of investors who are served by independent advisors and broker dealers,” says Bryan Hodgens, head of Limra research.

Fixed annuities, which provide guaranteed fixed payments for a specified period up to the remainder of the investor’s life, recorded $286.6 billion in sales in 2023.

The most popular product by far has been fixed-rate deferred annuities, which totaled $164.9 billion in sales in 2023, up 46% from the

2022 high of $113 billion, Limra reported. Those approaching retirement are the big takers.

“In addition to favorable interest rates, demographics have also played a role in the surge of fixed-rate deferred sales,” says Hodgens. “The number of Americans over age 60 continues to grow, and many more of them will be relying on Social Security and their savings to fund their retirement.”

Lure of the ‘Guaranteed Paycheck’ in Retirement

Annuities can fill a need for many retirees — providing a guaranteed “paycheck” after they stop working, industry insiders and observers say.

For most private-sector workers, defined benefit plans — pensions — are a thing of the past, replaced by defined contribution plans like the 401(k).

“We’ve done a great job of protecting workers in the defined contribution system to make sure that they’re automatically placed into savings accounts,” says Michael Finke, a research fellow at the Alliance for Lifetime Income (ALI) and a professor of wealth management at the American College of Financial Services. “We put them into target-date funds; we put this bubble-wrap protection around them so that they didn’t have to make active decisions about how to invest and how to save.

“And then they get to retirement,” Finke says. “And very often … we’re not giving them very much guidance about how to spend it.”

As a result, many retirees are afraid that they could run out of savings.

“Oftentimes what happens is people just don’t spend the money,” Finke says, noting that a lifetime annuity, which provides guaranteed payments for as long as the investor lives, removes that worry. Such an annuity can take the place of a pension, traditionally considered one of the three “legs” of the retirement income “stool,” which also included Social Security and personal savings, he says.

“So, what we’re trying to do is create a situation that gives people the license to be able to

Rising interest rates have made annuities very attractive to a larger group of investors who are served by independent advisors and broker dealers.”

—Bryan Hodgens

spend the money that they saved by taking a chunk of it and saying, ‘We’re going to buy that third leg of the stool that’s going to give you that lifetime income guarantee,” says Finke.

Stephen Kates, CFP, principal financial analyst with Annuity.org, says the retirement potential of annuities is starting to attract more than just boomers.

Gen X Shows Interest in Annuities

“Retirement is the bread and butter of what annuities are going to be about,” Kates says. “Gen X … they’re starting to think about retirement. They’re showing interest at a much younger age than baby boomers had, and so we’re seeing people buying more annuities earlier, annuitizing annuities earlier.”

“More and more baby boomers are going to keep retiring, and that’s just going to be positive for the industry. So, we’ll likely see another record sale here in 2024,” Kates predicts.

Continuing Concerns About Complexity

Although annuity sales have skyrocketed in

What we’re trying to do is create a situation that gives people the license to be able to spend the money that they saved.”

—Michael Finke

the past two years, proponents have lamented that relatively few people choose them even though surveys have consistently shown that they offer the features retirees want.

“We have this huge disconnect,” says Jason Fichtner, chief economist at the Bipartisan Policy Center and executive director of ALI’s Retirement Income Institute.

“If we talk to people … first we say, ‘Would you like to make sure that you don’t outlive your savings?’ They say, ‘Oh, I’d love that.’ If we say, ‘Would you like to have your own personal pension and get a paycheck for life?’ ‘Oh, I’d love that.’ ‘Would you like an annuity?’ ‘No, I don’t want one of those.’ And we just described what they wanted.”

“A lot of people view annuities as a four-letter word,” says Kates of Annuity.com. “Which is kind of a funny idea, because probably the most popular retirement product of all time is a pension, which is essentially an annuity.”

Cost and complexity are often cited as reasons for annuities’ past lack of popularity.

Finke of the Alliance for Lifetime Income says

that while annuities can be complex, they can also be the opposite. “Simplest products ever — you just pay a certain amount of money, and you get a promise of an income for a lifetime,” he says, adding that some of the features that can make them complex are in response to consumer demand.

Matthew DiGangi, head of annuity and hybrid life-LTC distribution at MassMutual Strategic Distributors, says consumer education is key to increasing acceptance of annuities.

“There is a huge opportunity for education on the latest annuity solutions available in the market and how they fit into a holistic financial plan,” DiGangi says. “We believe that education is the place to start and is key to increasing adoption of annuities. People need help understanding what annuity solutions are available, how they work, pros and cons of each, and how they improve retirement outcomes.”

Unexpected Benefit for Advisors

Financial advisors who educate clients on annuities can reap an unexpected benefit, DiGangi says. The 2023 MassMutual Fixed Annuity Study

found that 85% of consumers who discussed fixed annuities extensively with their advisor are highly likely to recommend their advisor to their friends and family, compared with only 58% who have not had the discussion, he says.

Annuity sales have been up for the past two years, thanks in large part to independent channels, but some observers say another little-used option may be poised for explosive growth: annuities embedded in 401(k) plans.

As Fichtner points out, annuities are not new to workplace retirement plans, going back a century to TIAA, the Teachers Assurance and Annuity Association.

“Annuities are not new to the defined contribution space,” says Hodgens of Limra. “They’ve been around for decades. They’re prevalent in the 403(b) space, but they were not in the 401(k) space.”

A Boost from Secure 1.0

The Secure Act of 2019 (Secure 1.0) eased the rules for 401(k) plan sponsors, making them potentially more viable as a defined contribution plan option.

“(It) allowed the plan sponsor, the employer, the company, to be able to say, ‘If I do a basic amount of due diligence on an insurance company and that insurance company can’t make good on those guarantees and those promises of guaranteed income payment, I won’t be held liable by my plan participant,” says Hodgens

There is a huge opportunity for education on the latest annuity solutions available in the market.”

—Matthew DiGangi

“It created a safe harbor for the plan sponsor, and as long as they’re documenting as a fiduciary how they’re picking the insurance company and picking the products, they’ve got some air cover there. That was a big deal,” he says.

Prior to Secure 1.0, of the approximately 700,000 401(k) plans in the U.S., only about 14% had an annuity option. Since the Secure Acts, there has been an increase, but many annuity proponents say the pace has been slow.

“A lot of big retirement custodians … are taking their time rolling these into plans,” says Kates of Annuities.org. “It’s happening

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Annuity products are issued by Massachusetts Mutual Life Insurance Company (MassMutual) and C.M. Life Insurance Company. C.M. Life Insurance Company, Springfield, MA 01111, is non-admitted in New York and is a subsidiary of MassMutual, Springfield, MA 01111-0001.

Variable annuities offered through registered representatives of MML Investors Services, LLC, Springfield, MA 01111-0001 or a broker-dealer that has a selling agreement with MML Strategic Distributors, LLC, Springfield, MA 01111-0001.

Principal Underwriters: MML Investors Services, LLC (MMLIS), Member SIPC®, and MML Strategic Distributors, LLC (MSD), are both Members FINRA and subsidiaries of Massachusetts Mutual Life Insurance Company, Springfield, MA 01111-0001.

© 2024 Massachusetts Mutual Life Insurance Company (MassMutual®), Springfield, MA 01111-0001. All rights reserved. www.MassMutual.com.

We’re going to start seeing a sea change now that BlackRock is offering.”

—Jason Fichtner

at a bit of a glacial pace, which is just the normal course of action for retirement plans. … They’re taking things very slowly because they have their own responsibility to provide good options for their employees. And people don’t want to make mistakes. You don’t want that bad press saying that you’re pitching bad products to your employees.”

A Heavyweight’s Entry Could be a Game-changer

Now, however, BlackRock, the world’s largest asset manager, has entered the fray, adding an annuitization option to its popular LifePath target-date fund. The new offering, LifePath Paycheck, was introduced in April and is being hailed as a game-changer for the industry that could potentially kick off a wave of such products.

Fichtner agrees that as more people start using BlackRock’s LifePath Paycheck option, demand will increase.

“We’re going to start seeing a sea change now that BlackRock is offering,” Fichtner says. “People are going to start asking, ‘What is that, and why don’t I have it my plan?’ And I think

there’s going to be one of these hockey stickshaped curves.”

The LifePath Paycheck offers annuity contracts issued by two insurers, Equitable and Brighthouse Financial. So far, 14 plan sponsors, with plans totaling $27 billion in target-date assets, are making LifePath Paycheck available to 500,000 employees, with several other large plan sponsors expressing interest, according to BlackRock.

Avangrid, a Connecticut-based energy company, was the first plan sponsor to go live with the program on April 22. Paul Visconti, senior director, total health and retirement programs with Avangrid, says the company wanted to stand out to potential employees.

“We are in the utility industry. It’s a very tough market for highly skilled labor and we’re really trying to differentiate ourselves by having benefits,” Visconti says. “So, we have a very generous 401(k) match. We have a student loan debt program for non-union employees. … This is another tool in the toolbox for more people to come to Avangrid and stay here for the better part of a career.”

LifePath Paycheck also will bolster employee emotional health, Visconti says. “The more financially secure you are, the more mentally secure you are, and if you’re feeling good mentally, you’re going to be a better employee, you’re going to be more productive.”

Avangrid employees in LifePath Paycheck can start contributing to an annuity at age 55 and can begin withdrawals as early as age 59 ½.

Avangrid and BlackRock have undertaken an extensive employee education initiative to introduce and explain the program.

“It’s been mostly very, very positive,” Visconti says of employee reaction, adding that it’s too early to gauge how many will opt into an annuity. “I wouldn’t say there’s any negativity, but there’s obviously some confusion. People want to understand it. They want to make sure that they can take advantage of it. How does it benefit them?”

“And we do make it very clear this is not for everybody. It’s a tool in the toolbox for the

people that need it,” he says. “That’s the key. We’re not trying to sell anything. We’re trying to make sure people are aware of their options when they’re ready to retire.”

DOL Rule Change Adds Uncertainty

Another development in April could potentially have an impact on the annuities industry: the Labor Department’s publication of its new Retirement Security Rule. The rule updates the definition of an investment advice fiduciary under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code. The fiduciary standard would apply “when trusted financial services providers give compensated investment advice to retirement plan participants, individual retirement account owners and plan officials responsible for administering plans and managing their assets,” according to the DOL.

The rule goes into effect on Sept. 23, but several industry observers declined to predict what its effect will be, citing potential legal challenges and the possibility of a change in administration following the November presidential election.

“There’s going to be a lot of debate, a lot of discussion for the rest of the year,” says Hodgens, Limra’s research chief. “We’ll see how the industry reacts to it and where that all falls. I’m not here to make the prediction one way or the other. … It’s going to play itself out in terms of how advisors are going to have to disclose and how they’ll work.”

In a four-decade career in journalism, Ed Prince has served as an editor with many of New Jersey’s leading newspapers, including the Star-Ledger, Asbury Park Press and Home News Tribune.

Annuities: Criticisms and Rebuttals

By Allen Wastler

Annuities, as a whole, often get bad reviews. Money mavens and financial pundits and business publications, love to reel off a list of criticisms about annuities’ suitability and relative value for consumers.

For some clients, sure, these criticisms may have some validity.

But that doesn’t mean annuities aren’t appropriate for anyone. In many cases, annuities may offer clients:

• An answer to worries about longevity and outliving retirement income.

• A way to satisfy a desire to diversify future retirement income streams.

What is one of the more common criticisms aimed at annuities generally — and what makes it off base?

Annuities lag market investments

This criticism is a favorite from those critics who are associated with businesses and interests tied to market investments.

But it misses both a central feature of annuities — the guarantee of income in the future — and the recognition of market risk inherent in other investments.

Sure, an equity portfolio can have impressive gains. But it can also fall flat on its face, depending on the stocks in the portfolio and the overall market.

By comparison, many annuities may offer a lower rate of return, but without the risk that typically underlies investments with higher rates of return. You are giving up the chance for a higher return in exchange for the guarantee.

Now, some annuities tie fund growth and payouts to market investments, introducing

some market risk. Whether that type of annuity is suitable will depend on the unique client need.

Conservative investors looking for stability may benefit from a fixed annuity, while clients who are market-driven may find variable annuities a suitable solution.

In the end, most general criticisms of annuities miss the point that they come in different varieties with different purposes and, as a result, different prices. Some annuities are designed to help you accumulate savings for long-term goals like retirement. Other

annuities focus on providing a guaranteed income stream that begins either immediately or in the future.

Of course, what makes sense for an individual investor will depend on their goals and circumstances.

For more criticisms and rebuttals, you can share with your clients click here.

Call 1-833-607-3025 today to talk to an expert about how MassMutual retirement strategies and solutions can meet your client's needs.

The information provided is not written or intended as specific tax or legal advice. MassMutual, its employees and representatives are not authorized to give tax or legal advice. You are encouraged to seek advice from your own tax or legal counsel. Opinions expressed by those interviewed are their own and do not necessarily represent the views of Massachusetts Mutual Life Insurance Company.

Annuity products are issued by Massachusetts Mutual Life Insurance Company (MassMutual) and C.M. Life Insurance Company. C.M. Life Insurance Company, Springfield, MA 01111, is non-admitted in New York and is a subsidiary of MassMutual, Springfield, MA 01111-0001.

Variable annuities offered through registered representatives of MML Investors Services, LLC, Springfield, MA 011110001or a broker-dealer that has a selling agreement with MML Strategic Distributors, LLC, Springfield, MA 01111-0001.

Principal Underwriters: MML Investors Services, LLC (MMLIS), Member SIPC®, and MML Strategic Distributors, LLC (MSD), are both Members FINRA and subsidiaries of Massachusetts Mutual Life Insurance Company, Springfield, MA01111-0001.

MM202606-309244

THE RIGHT FIT?

Annuities are a good fit for many retirees, who need educated advisors to make the best selection, say leading experts.

By Jerilyn Klein

Americans have long shied away from annuities because of lack of knowledge, high fees and fear of deceptive sales practices. But leading researchers in lifetime income think annuities are right for many retirees at risk of running out of income, and they’d like to see more financial advisors get the word out to clients.

Advisors could find a captive audience: Less than half (47%) of working adults ages 50–75 believe they will be able to cover basic living expenses in retirement using guaranteed income sources, such as Social Security and pensions, according to industry association Limra. That’s an 11 percentage-point drop from 2017.

Then there’s the longevity factor.

“Life expectancy has been going up … but uncertainty about how long you will live has been going up too, says Gal Wettstein, a senior research economist at the Boston College Center for Retirement Research (CRR). “For the general population, that should make annuities more valuable because the risk that they're protecting against is unexpectedly living a long time.”

And people want help. According to a 2023 survey CRR developed with Greenwald Research, half of Americans over age 50 with

financial assets exceeding $100,000 would like to buy a lifetime income product at the prevailing price, yet only 12% own a commercial annuity. The majority of financial advisors (about two-thirds) recommend annuities to fewer than half their clients, another CRR survey found.

A Difference of Opinion

Other research also suggests that advisors are out of touch with what clients want. According to a 2023 Alliance for Lifetime Income/Cannex survey, 50% of investors say they are extremely interested in owning an annuity, although only 19% of advisors think their clients are interested.

Wade Pfau, author of “The Retirement Planning Guidebook” and founder of Retirement Researcher, an educational source for individuals and financial advisors on topics related to retirement income planning, largely attributes the big disconnect to a difference in retirement-income styles.

“Financial advisors who are primarily investment managers are ultimately going to say there's no need for an annuity — you just build your diversified investment portfolio, the stock market will probably perform adequately and you'll be fine,’” he says.

Yet “only about a third of the population at large resonates with this idea that all you need is that diversified investment portfolio and you'll be fine. Two-thirds of the population want protections and commitments to strategies that a pure investment-based approach doesn't provide,” says Pfau. This data comes from the Retirement Income Style Awareness Profile (RISA™) tool he co-founded.

Of course, many advisors whose fee model is based on a percentage of the assets they manage probably don’t want to see a large chunk of those assets squirreled away for years in annuities outside client portfolios. Yet record-breaking annuity sales are being driven by investors served by independent advisors and broker-dealers. [See article “This Is Not Your Father’s Annuity Industry.”].

Financial advisors are ultimately going to say there's no need for an annuity — you just build your diversified investment portfolio, the stock market will probably perform adequately and you'll be fine."

—Wade Pfau

Photo

A Better Explanation

Pfau, also director of research at McLean Asset Management in Tysons Corner, Va., and a professor of practice in the Retirement Income Certified Professional (RICP®) Program at The American College of Financial Services, thinks that more individuals would be interested in annuities if they understood that they are insurance to manage longevity risk, not investments.

Many annuity purchasers have turned to variable annuities for tax deferrals and to invest in their subaccounts, without considering annuitization, “the term for turning on lifetime income,” says Pfau. “I think that's what led us down this path of thinking of annuities as investments.”

But the power of using the insurance component of annuities makes a lot of sense to Pfau. “The longer you live, the more money you'll need to fund your retirement [and] the more payments you'll get from the annuity. And so, in hindsight, the higher its rate of return will be,” he says. “But I think that just causes confusion when people start thinking about it that way.”

A better explanation is, “it's a life-contingent income that does better the longer you live,” says Pfau “It's just harder to frame that as an investment.” Explaining confusing vocabulary and complicated contracts would help too, he adds.

‘A Workhorse for Income’

Boosting bond allocations in retirement is the widely embraced approach for building income. However, “a more efficient way to build a retirement plan is with stocks and annuities, compared to stocks and bonds,” says Pfau. Instead of having to self-manage longevity risk with bonds, the annuity can pool it, he explains.

“The annuity can pay everyone to live to their life expectancy, which by the time you are in your 60s will be your middle 80s. If I'm trying to self-manage that risk, I might have to plan to live into my 90s or beyond, which just means spending less,” says Pfau. But “with the

annuity, the longer I live, the more income it provides relative to bonds. And so, it becomes a workhorse for income.”

Less Costly, Too

The cost of funding a lifetime income stream with an annuity is also less than the cost of funding it with a bond ladder, says Pfau [see chart at right]. Although lower interest rates increase the cost of funding an income stream with an annuity, the cost of funding a bond ladder grows even faster as interest rates decline.

“Annuities are hurt less by lowering interest rates, since the mortality credit component for spending is not impacted by interest rates,” Pfau explains. “The mortality credit is the subsidy from the short-lived to the long-lived customers in the risk pool.”

This credit “helps to raise the standard of living for individuals otherwise worried about outliving their money because they don't know how long they will live,” he says. “With mortality credits, individuals have contractual protections to support spending for their lifetime.”

Additional Advantages

Also with an annuity, “there's less pressure on the rest of the investments outside of the annuity so they have more opportunity for growth over time,” says Pfau. “The foundation of just stocks plus annuities can better support the retirement-spending goal, while at the same time, especially over the long term, preserving more assets for legacy than a stockbond-based approach.”

Pfau thinks a good time for investors to start thinking about annuities is five to 10 years before retirement. “It can make sense to lock things in before retirement so that you are less exposed to sequence-of-return risk in the years just before retiring,” he says.

Disadvantages would include “any loss of liquidity implied by the annuity,” he says, and “potential loss of upside growth opportunities if the alternative is to be more invested in the markets.”

New Kids on the Block

The financial industry has been abuzz about the early rollout of annuity offerings in defined contribution plans. State Street Global Advisors, BlackRock and TIAA are among the financial firms that now have such offerings for employers seeking to help protect their retirees against longevity risk, notes Olivia S. Mitchell, a professor at The Wharton School of the University of Pennsylvania and executive director of its Pension Research Council. [See article “This Is Not Your Father’s Annuity Industry" for more marketplace info.]

Secure 1.0 and Secure 2.0 legislation gave employers some “safe harbor” rules under

Annuities or Bonds?

which plan sponsors can include lifetime income products in their DC plans, says Mitchell, who focuses her research on employers including deferred annuities inside defined contribution plans and has long advocated for this. Secure 2.0 introduced additional flexibility for including annuities in DC plans.

’A Layer of Fiduciary Responsibility’

Through research, “we show that most older individuals would benefit from partial annuitization,” says Mitchell, also director of the Boettner Center for Pensions and Retirement Research at Wharton and a research associate at the National Bureau of Economic Research (NBER).

The annuity can pay everyone to live to their life expectancy, which by the time you are in your 60s will be your middle 80s."

—Wade Pfau

“Specifically, we recommend that it would be roughly optimal to use 10% of the DC account to purchase an annuity payable from age 80 (or 85), for those having at least $65,000 in their account at retirement,” she says. “Smaller amounts are not likely to be sufficient to provide much additional retirement income.”

Purchasing an annuity using IRA assets would also help protect against outliving one’s money in retirement “but having the employer provide the annuity provides a layer of fiduciary responsibility that might not be there outside the DC plan,” says Mitchell.

There are potential tax benefits, too. “Converting a portion of your tax-qualified retirement assets into an annuity can reduce your tax burden, since that money (up to a cap) is no longer subject to required minimum distribution (RMD) amounts,” she says.

Who Benefits Most

Mitchell’s research indicates that persons expected to live a long time would benefit more from buying a deferred annuity using DC plan assets. “In addition, the better educated women would be likely to benefit the most, because of their greater longevity and

higher incomes,” she says.

“Since lower-educated individuals generally have higher mortality, they would tend to do better by drawing down DC assets to live on, while deferring claiming Social Security benefits,” says Mitchell. “This is because lower-paid persons get a far higher replacement rate from the government program, which rises the more they delay.”

In contrast, “the better-paid people get Social Security benefits that are capped due to the payroll tax threshold, so delaying claiming doesn’t boost their benefits as much,” she says. “The latter, of course, can be thought of as ‘buying’ a bigger Social Security annuity from the government.”

No One-Size-Fits-All Solutions

Annuities aren’t just about filling the retirement gap. Some people place a high priority on leaving a bequest to heirs, avoiding market risk, being able to capture some market upside, and/or other factors, says Wettstein of Boston College.

So, with products, “I don't think there's a right answer for everybody,” he says. “Annuities do different things for different people.”

For example, “the standard-vanilla, single-premium, immediate annuity” protects premiums from market fluctuations, says Wettstein. Policyholders always receive the payment contractually agreed upon. “That’s also valuable … you don’t want to have to withdraw money from your brokerage account right after a big market crash.”

But while there’s no downside, “there’s no upside either. And the market generally goes up,” he says. That’s why the insurance industry added variable annuities and indexed annuities — products that can help people with “a better appetite for market risk who still want guarantees of a floor of income,” he adds.

Inflation and Other Fears

Variable annuities can also help investors cope better with inflation because they’re indexed to real assets, says Wettstein. With fixed annuities, inflation is more of a concern.

“Again, it depends on what people are afraid of and what kinds of risks they’re trying to protect against,” he says.

As for who should be looking closest at annuities, “it’s really the people who are middle class or upper-middle class that need to worry because Social Security provides very incomplete protections for people whose earnings were relatively high throughout their life,” says Wettstein. “The replacement rate you get from Social Security is relatively low, because it’s a progressive benefit.”

An Easier Entry Point

“One of the main problems standing in the way of people buying annuities is that it’s hard; it’s administratively hard, it’s bureaucratically hard,” says Wettstein, based on research by his team and others.

“If you stopped a random person on the street and asked them how to buy an annuity, they probably wouldn’t even know what an annuity was. And if they did, they wouldn’t know who to call about getting one,” he says.

Wettstein says he is “cautiously optimistic” about how the financial world is starting to integrate annuities in target-date funds. “It’s not a silver bullet,” he says, because other issues are also preventing people from buying annuities and target-date funds aren’t customed tailored. “But making it as seamless and as effortless as possible would go a long way toward giving people this kind of protection.”

Conversations with clients

How could advisors get annuity conversations rolling? “I’m not a financial advisor, but as a client, I would appreciate knowing the basic options — but not too many,” says Wettstein. “It’s easy to get lost and overwhelmed by all the many variations on annuities that exist.”

Instead, “it would be helpful to present options like an immediate fixed annuity as a touchstone because people are used to getting a paycheck. And that is kind of a way to guarantee that they continue to get that paycheck,” he says.

But he doesn’t think that an annuity is necessarily much help for those who haven’t saved enough to begin with for retirement because they’re not cheap.

“If you are looking at immediate fixed annuities at age 65, a $100,000 premium is going to get you about $500 or $600 a month. It is for the rest of your life, but it’s not a ton of money for that really hefty premium,” says Wettstein.

Another option that he says can be presented to investors who haven’t saved enough for retirement, or feel they don’t have quite enough, is a variable annuity indexed to the S&P 500 or another market performer that may offer returns.

Family Affair

Spouses can choose to get their own annuities or one spouse can get a single annuity with a survivor benefit. It’s more of “a mathematic question; it’s not something that has to do very much with the characteristics of a couple,” says Wettstein. “It’d be pretty

straightforward to calculate at least a present value for those two options and see which one wins out.”

Pfau of Retirement Researcher says an annuity with a living benefit can support lifetime income even without being annuitized. And “it provides flexibility to potentially drop the living benefit if markets are doing well or if health problems develop,” he says. “It's rare to actually annuitize into a SPIA or DIA,” he adds, referring to a single-premium immediate annuity and a deferred income annuity.

For real-life examples on how advisors have used annuities to help clients, see “Investigating Income” article.

An Advisor's Perspective

“Encouraging more widespread use [of annuities] requires better education about the various types of annuities and how they can fit

in a comprehensive financial plan, addressing misconceptions, and promoting their role in retirement income planning,” says Jamie Hopkins, CEO of Bryn Mawr Capital Management in Philadelphia and director of the Private Wealth Management division at Bryn Mawr Trust.

However, “we also need to accept the notion that annuities are not good for everyone and can’t solve every issue. Instead, they need to be used intelligently and strategically in a retirement income plan that is tailor-made to each retiree’s goals and situation,” says Hopkins, a professor of practice at Creighton University’s Heider College of Business.

“The underutilization of annuities can indeed be attributed partially to a lack of understanding among financial advisors,” he says. “However, we also need to address compensation models and compliance.”

He notes that a number of compliance

teams don’t allow advisors to dive into or place clients in annuities. And as mentioned earlier, some advisors stay away from annuities because it would reduce their fees from assets under management. “In some fee-only shops, I have heard this referred to as annuicide — a particularly bad term and name,” says Hopkins.

But “ignoring annuities completely can be just as harmful as overusing annuities,” he says, noting that advisors need to prioritize their clients’ best interests above their own financial gain.

“Greater use of annuities can benefit advisors in several ways,” says Hopkins. First, incorporating annuities into clients’ portfolios can enhance retirement-income planning and thereby strengthen client relationships and trusts, he says. Annuities can also help diversify clients’ assets and protect them from market volatility. And annuities give advisors

an opportunity to earn commissions or fees for their services, complementing their existing fee-based business models, he says.

“By embracing annuities as part of their toolkit, advisors can better meet the evolving needs of their clients and position themselves for long-term success in the financial advisory industry,” says Hopkins.

And if a client tells you they hate annuities, don’t take it literally. “People don’t complain that they have too much Social Security, which again is an annuity, or they never complained in particular about having a defined benefit plan, which is also an annuity,” says Wettstein of Boston College. “Don’t think people don’t like annuities, which is something you sometimes hear – they just have trouble getting them.”

Jerilyn Klein is editorial director of Rethinking65.

By embracing annuities as part of their toolkit, advisors can better meet the evolving needs of their clients and position themselves for long-term success in the financial advisory industry.”

—Jamie Hopkins

Investigating INCOME

RETHINKING65WRITERPAULAGREENASKED SIXADVISORSHOWTHEYSUCCESSFULLYUSED ANANNUITYTOADDRESSACLIENT’SDESIRE FORRETIREMENTINCOME.HERE’SWHATTHEYTOLDHER.

WFinancialAdvantageAssociates Rockville,Maryland WESBATTLE CFP®,ChFEBCSM,AIF®

es Battle helped a client avoid a massive tax bill and reduce annuity expenses by exchanging a nonqualified annuity that was out of its surrender period into a deferred variable annuity. The client, in their late 50s and still working as a federal employee, came to Battle for help with their overall financial picture and guidance on the non-qualified annuity, which had been purchased long before their session. [A nonqualified annuity is funded with post-tax dollars.] The client’s goal: preventing a large tax bill while looking for something that would perform better over the long term.

Battle found a solution: a 1035 exchange, which allows one annuity to be surrendered and the funds moved into another while still deferring taxable gains. He and the client agreed the best choice was a deferred variable annuity that offered many low-cost investment options in the subaccounts.

“We were not starting income at this point; we wanted the funds to grow with continued tax-deferral,” Battle says, adding that the client’s

expenses were reduced by more than 2%.

Annuities are notorious for having multiple internal layers of fees that are not always disclosed to an investor, Battle added. These fees are separate from a surrender charge and stay with the contract the entire time. They can include an administrative charge; a mortality and expense charge; a management fee; subaccount investment fees; and sometimes additional rider fees. The 1035 exchange provided an opportunity to reduce most of these fees.

Battle says it is important to educate a client about the purpose of annuities — many clients believe they are just like an investment account. They are unaware of the tax implications, how fees are calculated and that they are designed to be held for the long term.

“It would not be prudent to just disregard a solution because of the ‘type’ of product it is,” he says. “But you definitely need to do your due diligence in examining all the features and restrictions of the product you are recommending.”

Marguerita Cheng used two annuities to help a 72-year-old divorced client create a comfortable retirement for herself and ensure a son with special needs would remain financially secure after her death. Cheng helped the woman evaluate and navigate her pension benefit options after learning her employer did not permit non-spousal beneficiaries to receive residual pension benefits.

The woman, who was divorced twice, retired at age 67 after reaching her full Social Security retirement age of 66. When she died, the pension through her ex-husband would terminate and she could not leave anything to her 44-year-old son, who has special needs. “This is why the rollover made sense,” Cheng says. So instead of a monthly benefit, the woman selected the lump-sum option.

Cheng invested 20% of the woman’s pension windfall in two deferred variable annuities, purchased five years apart, to provide downside protection and lifetime income, which can supplement her Social Security income. One annuity was purchased from Nationwide and one from Brighthouse Financial.

She can turn income on after the seven-year surrender schedule is satisfied, but to derive the maximum benefit from these contracts, she will wait and earn the market credits for 10 years.

“Both offer downside protection and annual credits if the equity markets underperform,” Cheng says. Her client’s son is the beneficiary of both annuities and upon her death has several options.

Cheng says she also explained to her client, who has an inherited IRA from her mother, the importance of liquidity and access, which her portfolio of exchange-traded funds and mutual funds provide. Cheng also stressed the importance of long-term growth as the client’s mother, who was also a client of Cheng, lived until age 92.

“It is important to take the time to understand the client’s sources of retirement income and retirement plan options,” Cheng says. “Even with a pension, I can’t emphasize the importance of taking the time to thoroughly research matters.”

Marguerita Cheng

Jeremy Keil used annuities to help a 65-yearold couple who were terrified of the stock market to secure income for their retirement years. Receiving all their income from Social Security and pensions, the couple didn’t “need” the money in their 401 (k) plans and only wanted investments that generated interest. “They wanted to avoid market exposure,” he said.

Keil looked at the guaranteed interest rates offered by multi-year guaranteed annuities (MYGA), which offer better rates than U.S. Treasuries or certificate of deposits (CDs). While similar to a CD, a multi-year guaranteed annuity is not issued by a bank or backed by the Federal Deposit Insurance Corporation (FDIC). It is issued by an insurance company and backed by a state life guaranty association.

Investors can gain higher interest and remove 10% a year from the annuity, after the first year, from a multi-year guaranteed annuity. Yet investors removing more than that amount would pay a steep surrender charge and be subject to a market-value adjustment. That means if interest rates increase, the investor might lose a bit of the principal, similar to how bond prices drop when interest rates increase.

Yet this market-value adjustment only applies when more than the “free withdrawal amount” is removed.

“That MYGA made the most sense because it offered the highest rates for the time period,” says Keil. To counter the lower flexibility of the annuity, he made sure the couple had more money invested in a money market than previously.

Noting that many clients or advisors think one particular investment product is the solution, he says a combination of products frequently works best.

“Just as stock and bond investments, you ought to diversify your interest rate investments,” Keil says. “Pay attention to the state life guaranty association amounts so that you can make sure your client is protected and consider annuities as part of the solution, not the only solution.”

Many advisors sell annuities based on “look at this great bonus rate” or “look at this great payout percentage,” as if they are selling the annuity whether needed or not. “First discover the need, then find the cheapest, best way to get it,” Keil adds.

JEREMY KEIL

JJohnR.(Dick) Power CFP®Principal,PowerPlans Walpole,Massachusetts

ohn R. (Dick) Power used a deferred, indexed annuity to help a single woman without a pension generate a reliable income stream to sustain a comfortable retirement that she started at age 63.

Power aims to have 70% to 75% of a client’s income stream generated by “guaranteed” sources like a pension, Social Security or annuity, he believes an annuity offers a reliable income stream to someone without a pension.

“A monthly check one can reasonably expect is a great psychological benefit,” he says. “Coupled with other investments, it provided security and flexibility,” for Power’s client. “It may even allow for more aggressive investing and growth opportunities.”

The client, who owned her condominium outright, had used investment accounts for years and was comfortable with taking a bit of risk, but wanted a buffer to create a loss “floor.” Power used a newer annuity product that offered buffering choices so that the upside could be tailored to gain a bit more, if the client was willing to take a bit more downside risk. The annuity’s payout is for life once it begins without regard to the values in the account, as

long as it hasn’t been drawn down from extraordinary withdrawals.

Power said he would definitely use this type of annuity with other clients. “It provides some opportunity for growth beyond what other products offer, but has the downside protection,” he says.

He urges advisors considering annuities to remember clients want security in retirement.

“Providing 75% of the income needed as a sure thing makes a big difference,” he adds. “Investment performance makes up the difference and provides the opportunity for legacy growth if that is desired. Or for increased spending in a good year!”

Describing this type of annuity as a self-funded pension, he explains to clients that companies often buy policies from insurance companies to meet their pension responsibilities.

“The trade-off is between the owning of the investment assets and their volatility and no guarantees vs. the guarantee of the insurance contract,” Power says. “Almost every client has been a relatively easy prospect to convince, perhaps because we only use the annuities where appropriate.”

Jjohnroland Northwestern Mutual Milwaukee,Wisconsin

ohn P. Roland used an income annuity to let a wealthy married couple enjoy an early retirement at age 55 by delivering a guaranteed lifetime income for part of their income needs. “One of the primary objectives of retirement planning is to never run out of money, and the income annuity provided that for them,” says Roland. “With that in place, it gave the client peace of mind to feel comfortable with an early retirement.”

The client, a 52-year-old attorney with investable assets of $8.5 million, implemented a Portfolio Deferred Income Annuity (PDIA) with Northwestern Mutual for $1.5 million. Income is set to begin at age 65, with the flexibility to advance as early as age 60 or delay to age 70. At age 65, the projected initial monthly payment is $10,200, which can increase with Northwestern Mutual’s dividend payments, thereby acting as a hedge against inflation.

Northwestern’s planning software mathematically revealed a stronger outcome for the client by incorporating an income annuity, rather than a portfolio of just stocks and bonds. The analysis showed the client an

income annuity would be a good addition to his retirement plan. Previously, he wasn’t interested in considering annuities.

“But when done in the right context and design, they can ultimately result in a more confident retirement lifestyle with ‘permission to spend,’ knowing the money will continue to be paid month after month, year after year, for your entire life,” says Roland.

With that piece in place, Roland allocated the client’s remaining retirement assets to more growth-oriented investments that might offer greater overall lifetime returns and a stronger projected outcome, based on a Monte Carlo analysis.

Financial advisors should think of income annuities as a “portion of the portion” of the balance sheet intended for lifetime income. “They are not meant to replace growth assets or equities,” Roland says. Yet when a client has too little retirement income from investments, they may end up selling them at an inopportune time to cover expenses. An income annuity truly acts as a fixed-income component of the plan, he adds, with the guarantee the income will last the client’s entire lifetime.

Rob Schultz used a single-premium immediate annuity (SPIA) to help a 76-year-old widow use the $400,000 from the sale of her home to meet expenses at a senior living facility. With only about $2,500 of the $5,000 in monthly living expenses covered by Social Security, the woman did not want to depend on investments for all of her remaining expenses.

Schultz says he bought an SPIA for the client with $200,000 to provide $1,500 in income each month over a 10-year certain period. Coupled with the $2,500 Social Security payment, the $1,500 annuity payment covers the woman’s most essential expenses. The 10-year guaranteed annuity payments ensure that her heirs would receive the balance if she only lives a few more years.

Because the annuity doesn’t offer inflation protection, he explained to the client that he would invest the $200,000 balance from the home sale in growth investments.

“I explained that the annuity provides a

high level of guaranteed income, although it won’t be an asset that is passed on to the next generation,” says Schultz. He note that leaving money for the client’s two adult children is not a priority as their financial condition is better than hers.

Using this kind of annuity to turn a portion of a client’s assets into a pension can help create financial security. “Retirement isn’t fun if you are watching the market to determine if you can pay your fixed costs,” Schultz says.

He urges advisors contemplating annuities for their clients to consider the client’s reaction to a market correction. “Would they panic and not keep assets invested?” he asks. “Clients like knowing that their basic needs are covered with guarantees, and then they can take market risk for the discretionary expenses.”

He also urges advisors to start with non-retirement assets to fund annuity products because retirement plans already have built-in tax deferral.

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