Annuities are not right for every client, advisors say. But when they are right, they can be the perfect financial planning solution.
Here are some real-life stories that advisors say demonstrate the potential power of an annuity to solve particularly knotty problems.
Retirement Income
Mike Salierno, an advisor for Northwestern Mutual who founded Eterna Generational Planners in Clearwater, Fla., had a client who was “preparing for retirement,” he said. After reviewing her entire financial situation, he determined that, even with Social Security, her potential monthly retirement income would fall some $2,000 short of what she needed for necessary and discretionary spending.
“Our belief is that fixed, non-negotiable expenses need to be covered by fixed, guaranteed income,” he explained. That guaranteed income may come from a pension and Social Security, he said, but if they aren’t enough, an income annuity can be the perfect solution.
He showed the client how putting some of her IRA savings into a fixed annuity would give her the dependable monthly income she needed to cover the shortfall, without affecting other portfolio assets. A fixed annuity, he said, as opposed to a variable annuity with a lifetime income rider, suited the client’s aversion to volatility where her income needs were concerned. “She didn’t want to have to worry about market conditions on a monthly basis to know that she would be able to pay her bills on time,” he said.
Another advantage of an income annuity for this client, he continued, was the easy, set-it-and-forget-it factor. The income stream is “as automated as possible,” he said, which suits clients who “never had to manage their finances. … Once issued, this annuity cannot be terminated [or] surrendered, and the premium paid for the annuity is not refundable and cannot be withdrawn” without penalty.
Reduced RMDs And Taxes
A different type of annuity proved the ideal solution for another client, a man in his 70s whose required minimum distributions from retirement accounts were much higher than his retirement-income needs.
Moreover, Salierno said, the RMDs were so high that they caused “a large tax issue,” pushing him into a higher tax bracket. Worse still, they forced him to take distributions regardless of market conditions, depleting his portfolio’s potential.
A qualified longevity annuity contract (QLAC) proved to be the perfect answer. These contracts are deferred income annuities funded by a qualified retirement plan or IRA. They are exempt from required minimum distributions until the account holder reaches age 85. Up to $200,000 per person can be converted from a retirement plan or IRA into a QLAC, either all at once or over time (these contracts have the option of naming a spouse as a joint annuitant, raising the total investment limit to $400,000). Since they’re deferred annuities, the guaranteed monthly income stream must start at a future date.
This solution “drastically helped [the client’s] RMD calculation, as well as helped him take some assets off the roller coaster of the market,” said Salierno.
Guarantees Allow More Aggressive Investing
Scott Stolz at iCapital in St. Petersburg, Fla., has a longtime client who purchased a variable annuity back in the 1990s, when the yield on 10-year Treasurys was about 8.5% and the insurance companies assumed clients would have shorter lifespans, he said, and these factors led to an increased payout rate for the annuity. Consequently, for most of the time that the client had owned it, the income it generated was higher than any other annuity he could buy in later years—especially when interest rates were near 0%.
In addition, the underlying account value’s compounded and tax-deferred growth over the decades produced an average annual return of roughly 10.25%, he said.
According to Stolz, the client asked to review how his old annuity compared to the new ones today to assess options currently available in the rising interest rate environment. He said it was never worth changing the old annuity, however, until about three months ago. The client asked again to review the annuity situation, and Stolz found a new annuity with an income rider that would actually increase the client's guaranteed income by roughly 20% (because of the new terms, fee schedule, etc.).
As interest rates have moved up, “several insurance companies began to offer very competitive income options on their fixed-indexed annuities,” he said. Fixed-indexed annuities (FIAs) provide a fixed rate of income, with account values that are linked to a market index. They offer downside protection on the account value in exchange for limiting upside potential.
The guaranteed income from the FIA allowed the client and his wife to “leave their remaining retirement assets relatively aggressively invested,” said Stolz.
But that’s not the end of the story. The client did not move all of the money from the old annuity to the new one. He kept $75,000 in the 30-year-old variable annuity.
“One potential long-term problem with the new policy was that the income doesn’t increase over time,” said Stolz. “Therefore, the income will be slowly eroded by inflation.” The old variable annuity, on the other hand, offers the option of getting a variable annuitization, which differs from a fixed annuitization in that, if the account value rises with the market, the annuitization amount increases, too. “Of course, variable annuitization is a two-way street,” he acknowledged. “Income payments will decrease if there are insufficient returns on the investment account.”
Inheritability
Last year, a woman with a terminal illness approached Danielle Darling, an LPL Financial advisor at Resource One Advisors in St. Albans, Mo. The woman was worried about leaving her loved ones financially secure, especially since she could no longer qualify for life insurance. “We explored annuities as a tool to help her achieve her goal of leaving a lasting legacy,” Darling recalled.
The client had worked hard to build wealth, she said, and was concerned about not just her children’s future but also protecting her wealth no matter how the markets performed. So Darling suggested a variable annuity with an enhanced death benefit. It would “not only guarantee her family a substantial payout but also provide the potential for some market-linked growth during her remaining life,” she said.
This solution helped reduce the client’s anxiety about leaving her loved ones without financial support. Even if she passed away during a market downturn, her family would still receive the guaranteed benefit amount, which was much more than what her investments alone could have yielded at that point, said Darling.
“By choosing an annuity, she could focus on spending her final days with her loved ones, knowing she had secured their financial future,” Darling reflected. The experience, she added, highlighted the unique ability of annuities to offer asset protection, growth potential, and wealth transfer capabilities even when “life and market circumstances may otherwise pose a challenge.”
Asset Protection
Asset protection is another key benefit that many annuity supporters point to. For example, when Anthony Williams, an LPL Financial advisor and co-founder of Galene Financial in Houston, had a client pass away with very little of his retirement portfolio left, an annuity provided a nice surprise for the client’s widow.
“He was withdrawing over 10% annually just to keep afloat,” said Williams. “One by one, his investments were drained.”
Naturally, the client’s widow expected a terrible inheritance. She had seen her late husband’s savings pounded by market volatility and excessive withdrawals. But it turned out that, years earlier, he had purchased a $50,000 variable annuity with a living income benefit. She was entitled to 100% of the original $50,000 investment.
“That was when I had my aha moment!” said Williams. “If more of [the husband’s] retirement savings had been in that annuity or something similar, he could’ve avoided much of the market risk [and] might have enjoyed a guaranteed income he couldn’t outlive, potentially leaving a much larger legacy for his wife.”