Curtis Johnston, vice president and wealth advisor at Girard, a wealth management firm in Souderton, Pa., argues that the appropriateness of an annuity can depend largely on the withdrawal rate—and they are not all the same. “If the withdrawal rate is anything less than 5%, I wouldn’t even consider the contract,” he says.
Even if you find a good product—he allows that some fixed annuities are “somewhat attractive”—it should only be used for a portion of a client’s net worth. “Annuities should typically be less than 30% of someone’s portfolio,” says Johnston. But he adds that advisors and clients need to consider the fees, the surrender charges and the length of the surrender period—and if it’s a variable annuity, they should also look at the investment risks. Annuities, he says, “are not an investment vehicle that everyone should own.”
The 4% Rule
Retirees have traditionally been told to withdraw 4% of their assets during the first year of retirement, then adjust that amount for inflation every year afterward. Such a strategy allows them to maintain a good retirement income and not go broke.
But that advice has been based in part on outdated interest-rate assumptions, say critics, since interest rates have been at rock bottom for a long time. Moreover, many retirees’ health-care expenses far outpace inflation.
“It’s probably time to forget the rule,” says Dave Paulsen, senior wealth advisor at Annexus Retirement Solutions in Scottsdale, Ariz.
Another risk of using the 4% rule is when retirees run into a bear market early on after they stop working—in those situations, it’s hard for portfolios to return enough to make up for early losses and still pay out 4%. Annuities can help here, especially if they offer 5% or greater income, says Paulsen. There’s no risk of outliving that benefit or having distributions hurt overall returns.
It’s the changing economic environment that might be driving some of the annuity demand, given the product’s payout advantages. “Their income stream continues even if the annuity is depleted,” observes Paula Nelson, co-head of individual markets at Global Atlantic in Minneapolis.
A Mixed Approach
An annuity can “complement a withdrawal strategy,” says Eric Henderson, president of Nationwide Annuity in Columbus, Ohio. That’s “a better alternative,” he says, than taking on riskier assets to try to boost returns.
Indeed, annuities don’t preclude a multipronged approach to retirement planning. “Look at multiple sources of income, growth and protection to help ensure a complete retirement plan,” suggests Pete Golden, chief sales and distribution officer for individual retirement at Equitable in New York.
Making It Easier
Meanwhile, the annuities market is becoming better regulated. The SECURE Act of 2019 made it easier for workplace retirement plans to include annuities in their options. In June 2020, the SEC established the Regulation Best Interest rule requiring broker-dealers to recommend products—including variable annuities—that are only in their customers’ best interest (and to reveal any potential conflicts they have in the sales). In 2020, the National Association of Insurance Commissioners enacted its own version of Reg BI that extends the protections to fixed annuities.
“Public policy makers are recognizing this need,” says Andrew Melnyk, chief economist and vice president of research at the American Council of Life Insurers, a trade association in Washington, D.C.