When it comes to financial planning, it’s difficult to find guarantees. Still, that’s exactly what lots of baby boomers are hoping for today. Though the stock market has made a spectacular rebound since the depths of the economic crisis in 2009, the effects of the crash linger and many baby boomers remain fearful, seeking out steady income.
Those who witnessed their retirement nest eggs implode are still viewing annuities and the income guarantees they provide in a more favorable light. As they leave the accumulative phase of their lives and put more stress on financial planning, they have more regard for safety and some form of guaranteed income. It’s not so much return on their investment as return of their investment, or at least a minimum amount of it, advisors point out.
“Baby boomers are no longer willing to gamble in the market,” says Elizabeth Ruch, a CFP licensee and a veteran advisor with Waddell & Reed in San Diego. “They are looking for guarantees. At the same time, they like the flexibility and growth in the market and want to participate.”
Annuities are filling some gaps in retirement planning, playing a more pension-like role today, providing needed supplemental income for Social Security and dwindling pension programs.
Fixed And Variable Annuities
Structures for both of the primary types of annuities, fixed and variable, have been upended by the post-financial crisis world. With fixed annuities, guaranteed payments to the owner are set in advance, eliminating most investment risk. But ultra-low interest rates have forced insurers to offer meager returns.
With a variable annuity contract, however, some of the risk shifts to the buyer, and payments vary according to the performance of the underlying assets. The stock market has rebounded since 2009, but that does not calm people’s memories of a decade that witnessed two 50% corrections. Before the financial crisis, many insurers offered principal protection guarantees and automatic increases in the value of clients’ original investments over time that forced the companies to absorb huge losses and raise additional capital in 2008 and 2009.
Many leading insurers, including The Hartford and Sun Life, have exited the business entirely, while others have placed strict dollar-value limits on the amount of variable annuities they sell. The upshot is that today’s guarantees are much less attractive to clients than the previous generation of annuities.
This changing environment is forcing advisors to find annuities that must be right for the clients. “Just like any other financial instrument, an annuity should be a proper fit for a client’s portfolio, based on their age, net worth, retirement needs and their financial goals,” says planner Philip H. Miller, vice president of Asset Marketplace LLC in Wilton, Conn.
Annuities have their proponents and detractors. “It’s easy to get burned,” warns Larry Luxenberg, a financial advisor at Lexington Avenue Capital Management in New City, N.Y., who has largely avoided annuities for his clients.
“Some have high costs,” he says. “Some have a lack of flexibility. You may have to stay in them for seven years or more before redemption fees totally go away. You can also have less-than-optimum tax consequences. In some cases, you’re converting capital gains to ordinary income tax rates.”
Up until recently, many advisors have held back recommending annuities to clients, citing their complexity and high costs. Variable annuity providers in particular have been pummeled for imposing high fees while curtailing benefits to stay profitable.
Lately, sales have bounced all over the place. Variable annuity sales totaled $147.4 billion in 2012—down 7% from 2011—while sales of fixed annuities totaled $72 billion in 2012, off 11% from the previous year, according to Limra, an insurance industry research firm.
Yet in an environment where fewer clients are retiring with pensions and the bond market offers miniscule returns and potential losses, advisors aren’t turning their backs anymore. In a 2011 Limra study, the number of advisors who thought that a guaranteed income product was an important part of a retirement plan grew by 25% over a two-year period.
By 2020, Limra estimates that Americans age 55 and older will have $22 trillion in investable assets for retirement income products.
Ruch has stayed an enthusiast through the good times and the bad. “There’s not an annuity I don’t like, but not all annuities are right for all clients,” she says. “The majority of my clients nearing retirement have an annuity in their investment portfolios.”
Catherine Theroux, a spokesperson for Limra, says annuities are a lot more flexible now than they have been in the past in letting clients get access to their assets and income.
“Insurers are recognizing there has been some reticence by consumers in investing their money in a situation where they’d be unable to access it,” she says. “So depending on the contracts, there is more flexibility if you decide to annuitize the process.
“Based on our consumer research,” Theroux adds, “people are very interested in that guaranteed income.”
Insurance companies almost on cue have widened product lines and are rolling out different variations of annuities. AnnuityAdvantage.com, an online service that allows investors to compare annuity products, says they can get a five-year contract whose rates are higher than those of current bank CDs. Investors can also get, guaranteed, a lifetime of income, to be used now or deferred into their retirement. Or they can use annuities to create a tax-deferred account that mimics their IRA or 401(k) to create a nest egg for retirement. There are also multiyear fixed annuity products.
Among the more popular products today are deferred-income annuities and single-premium immediate annuities. Fixed-indexed annuities are also growing in popularity.
One reason fixed annuity products might be more attractive is that their rates have recently crept up. That rise has followed the increase in U.S. Treasury yields after they bottomed out earlier this year, according to wealth manager Gregory L. Olsen, a partner at Lenox Advisors in New York. “This has given deferred income products even a more attractive rate of return,” he says. Many investors are using single-premium immediate annuities to fund life insurance and long-term care insurance, Olsen says.
But it’s not all peaches and cream. Recently, variable annuities have come under close scrutiny by state insurance regulators. The cost of hedging the downside protection, commonly known as “the floor,” has become more expensive for the annuity issuers than actuaries originally calculated, says Miller, prompting restrictions to most product lines.
“The variable annuities that had allowed 100% participation for an indexed strategy with downside protection greatly shifts the risk of profitability of that annuity to the insurer issuing the annuity,” he says.
“Margins for variable annuities are tight in a low-return world,” says Luxenberg. “People are craving guarantees, but with many annuities they give up a lot of flexibility for that.”
One class of products, deferred-income annuities, are resonating with consumers seeking guaranteed income.
In the past, these annuities were referred to as “longevity insurance.” They are a type of fixed annuity allowing the owner to defer the start of guaranteed income payments until a later date. Today, a consumer would buy one at age 6o for payments to begin at age 70, when he or she plans to retire. This quasi-pension product is designed to take the place of dwindling employer-sponsored defined benefit plans.
The deferred-income annuity market has grown substantially in a very short time—sales increased a whopping 147% from the first quarter of 2012 to the first quarter of 2013, according to Limra.
The No. 1 seller of these “DIA” annuities is New York Life. Its new product, the “Guaranteed Future Income Annuity,” passed the $1 billion mark in sales earlier this year, the firm says. New York Life reports that consumers are purchasing these annuities at younger ages; the firm is eyeing Generations X and Y for this product and has dropped the premiums on it for these groups as a lure.
Other companies are getting on the bandwagon, too. Northwestern Mutual Life has a new deferred-income product whose dividends can be used over time to increase the guaranteed lifetime payments, the firm says. Guardian Life also has a new deferred-income product on the market, as does MassMutual.
Another product starting to make inroads with consumers is fixed-indexed annuities.
Adherents speak of these products in the same breath as single-premium immediate annuities and deferred income annuities. Fixed-index annuities, which are tied to different benchmarks, produce high levels of guaranteed income like their fixed siblings, but some people say they have the advantage of better liquidity and that investors have more control over their income than they do with other vehicles.
Doug Wolff, president of Security Benefit Life, says more advisors are purchasing fixed-index annuities for clients today. These products can be offered with a guaranteed lifetime withdrawal benefit and then coupled with a mutual fund spend-down strategy, and this “can allow for both market participation and security,” Wolff says. He adds that the account values in fixed-indexed annuities are less volatile, so they can be ideal for those who need income growth potential but can’t afford to sacrifice principal protection.
Miller says the majority of his clients are looking at indexed annuities with a 0% to 2% floor and a 4% to 6% participation in an indexed strategy with locked-in annual gains.
Matching Products To Clients
Putting the right product to the right client can be a challenge, since annuities come in all sizes and shapes.
Ruch recently worked with a widow in her 70s. “She was very nervous about the market and wanted to make sure her income would be guaranteed,” says the advisor. “Based on all other factors in her financial plan, I advised her to invest a portion of her inheritance in a fixed annuity that would cover her fixed expenses for the foreseeable future. In addition, I advised her to use a variable annuity that will guarantee her a lifetime income regardless of investment performance. This annuity in her plan is set to be triggered in about 10 years that could provide her with additional guaranteed lifetime income due to the [guaranteed lifetime withdrawal benefit] rider.”
In another example, Ruch advised a pre-retiree at age 55 who wanted to retire at 65 to invest in a variable annuity that gave her the opportunity to participate in the market and also have a benefit enhancement rider that guaranteed her interest over that same time period. “At retirement,” she says, “our client could receive through a [guaranteed lifetime withdrawal benefit] rider income for the remainder of her life based on the higher account value or guaranteed income benefit base.”
Olsen says the annuities he has put clients into, especially in the years before the stock market meltdown, “were an absolute home run for clients, so much so that companies are either offering to buy clients out for more than their existing account balance or contemplating doing so in the future.” Indeed, they were such big home runs that those structures and guarantees are no longer available.
But don’t be fooled. Annuities are complex and an ever-changing species of the investment world. “You need to understand their restrictions, the impact of additional fees, surrender charges and other contract restrictions,” says Ruch.