Annuities sales are soaring to highs not seen since the Great Depression, and the industry is on the verge of successfully lobbying Congress to make annuities an automatic default option in retirement plans.
Even so, Morningstar has released research that says annuities deliver little benefit to investors above certain wealth levels.
The firm says annuities add little upside for investors if their wealth is already more than 36 times their needed annual retirement income. That assertion comes from a report by Morningstar’s Center for Retirement and Policy Studies entitled, “The Retirement Plan Lifetime Income Strategies Assessment.”
For example, the report said, if an investor needs $50,000 a year in retirement and has already accumulated $1.8 million in assets, there are better strategies for maximizing retirement income than annuities.
“We found that the ratio of wealth a participant has to their annual retirement income need is the most important metric for determining the benefits of a lifetime income strategy,” says Spencer Look, Morningstar’s associate director of retirement studies and public policy, in an interview with Financial Advisor. Look co-authored the study with Aron Szapiro, head of retirement studies and public policy at the firm.
“Annuities do not add much value when an investor is already well-prepared for retirement,” Look adds. “They also do not help much when Social Security or other guaranteed income sources already cover the majority of anticipated retirement expenses.”
Overall, Morningstar evaluated how seven different strategies can help retirees reach their income and estate planning goals. If a client has amassed at least 36 times their retirement income needs, one strategy that can serve them better, Morningstar says, is the benefit of “Social Security bridging”—using alternative sources, such as 401(k) assets, to delay claiming Social Security benefits until the maximum possible age.
“Retirees should consider Social Security bridging before other lifetime income strategies,” Look says. “While annuity-based strategies can boost guaranteed income or bequests, none can compete with the Social Security bridge strategy to offer more generous benefits.”
Unlike private annuities, Social Security doesn’t serve a profit margin. Furthermore, the government program’s benefits are based on the life expectancies of the U.S. population, not the above-average life expectancies used by insurance companies. Social Security also offers inflation protection.
“While some private annuities offer a cost-of-living feature, it is not comparable to Social Security, where the benefits are linked to the Consumer Price Index for urban wage earners and clerical workers,” says the report. “Nevertheless, there is still a place for annuities as we find that participants can benefit when annuities are combined with the bridging strategy.”
The analysis also found that while health issues can worsen retirees’ standards of living, “we do not find that they change the relative value of lifetime income strategies as long as the plan participant has the right profile to benefit from annuities to begin with and only uses part of their wealth for the annuity purchase.”
Morningstar surveyed the lifetime income landscape and identified seven distinct strategies that plan sponsors could offer to participants, which includes drawing down from a conventional portfolio.
While the annuities industry has introduced a number of new products with a variety of bells and whistles over the past few years, fixed single-premium immediate annuities (SPIAs), variable SPIAs and deferred income annuities (DIAs) “still provide the most shortfall protection in cases where the portfolio-only strategy falls short of the retirement goal,” the analysis notes.
Strategies that involve using fixed single-premium annuities and dollar-cost averaging into deferred income annuities help retirees dampen market risk and longevity risk “and also tend to outperform bonds over longer time horizons due to mortality credits,” the report says. “Though variable SPIAs do not perform as well in bear markets, they hold their own in cases where the market performs reasonably well despite high inflation or despite the participant living a very long time.”
Morningstar stressed the importance of adjusting asset allocations in other investment products after purchasing an annuity to optimize income and diversification.
The findings “provide rules of thumb and is an important starting point for advisors and investors, who each have different needs and risk tolerances,” Look says.
“Participants can benefit from personalized recommendations on what type of product to use and how much to allocate to the product, given their specific goals and preferences on income stability and bequests,” the study says.