By MICHAEL REIDY
When 73% of clients say they like the idea of adding a source of protected monthly income — on top of Social Security — to their retirement income plan, registered investment advisors pay attention.
As traditional pension plans become increasingly rare and an uncertain rate environment jeopardizes the value of many fixed-income investments, clients will likely continue to demand more — and better — guaranteed income strategies. It may be time, then, for RIAs to take a fresh look at integrating annuities into their financial plans for pre-retirees and retirees.
In fact, a 2018 survey by Global Atlantic Financial Group revealed that 56% of financial professionals believe that annuities are an important part of retirement planning. As investment research firm Morningstar noted at the end of 2017, $2 trillion was invested in variable annuity products. And LIMRA reported sales of fee-based variable annuities jumped 43% year-over-year to $800 million in the third quarter of 2018.
Perceived Obstacles To Using Annuities
For years, however, many RIAs have steered clear of annuities because the products were seen as too expensive or complicated. Commission-free options for fee-only RIAs have been introduced as one possible solution to the cost issue and they are often simpler than their traditional annuity counterparts. Although LIMRA reports fee-based variable annuities still represent only 3% of the market, several annuity carriers are getting their fee-only annuity products placed on a variety of wealth platforms, with expectations of significant growth going forward. Theses platforms allow the RIA to integrate annuities with an entire client account.
With regards to their complexity, RIAs would benefit from using plain language to explain annuities, as there is some evidence that consumers are more interested in annuities when financial professionals explain their features without using the product name (keeping in mind that what they may say is limited if they are not also insurance licensed). A National Bureau of Economic Research study found that presenting annuities as income, rather than as an investment, made the retirement tool much more valuable and appealing.
Annuity carriers are resolving the technical barriers that have hindered RIAs from integrating insurance products within their wealth management platforms. Integrating annuity carriers into the RIA’s unified wealth management platform, supporting their clients’ financial planning objectives, is the goal.
Using Annuities To Stand Out In A Crowded Market
Given the disconnect between consumer interest and perceived obstacles to their use, should financial professionals reconsider the role of annuities in their clients’ retirement income portfolios? With optional benefits, including guaranteed income for life over longer retirements, and index-linked interest potential with downside protection, the range of annuities available today may deserve a second look.
RIAs are uniquely positioned to present annuity products alongside investment solutions in one consolidated plan. Annuities can serve to complement overall financial planning strategies, bringing added protection, diversification and the opportunity to meet clients’ retirement income goals. RIAs who combine investment and insurance products may differentiate themselves as market leaders in a highly competitive space and may result in increased assets under management and more satisfied clients.
Specifically, RIAs should consider deploying annuities into client portfolios for these three main reasons.
1. ROBUST INVESTMENT LINE-UPS PAIRED WITH LOWER COST INVESTMENT OPTIONS.
Whether replacing an existing annuity or by establishing a new variable annuity contract, providing clients with powerful investment options at the right price always makes sense for financial professionals. Variable annuity providers continue to deliver more investment options within their annuity contracts, which is good news as market participation means clients have the potential to outpace inflation.
Variable annuities typically offer a variety of subaccounts in various asset classes, including alternative strategies, to help meet retirement goals. And adding a guaranteed income rider — available with some annuities for an additional cost — may enable owners to lock in their gains to increase their payout.
Some advisors are using fixed or fixed indexed annuities as a replacement for bonds and bond funds in client portfolios. Typically, as interest rates rise, bond values may fall, although it is possible that any losses may be short term or eventually recouped. However, if some retirement savings are linked to those declining bonds, the savings value may drop as well. Fixed or fixed indexed annuities can help diminish or eliminate this uncertainty around the fluctuating values of a bond portfolio.
Fixed and fixed indexed annuities can provide the flexibility to avoid market risk, while allowing financial professionals to construct cost-efficient portfolios.
2. RETIREMENT PLANNING WITH GUARANTEED LIFETIME INCOME.
Financial professionals can help provide long-term growth potential, eliminate market-related downside risk, and deliver guaranteed lifetime income with fixed indexed annuities. Fee-only FIAs are just hitting the market. FIAs may be especially interesting for clients who are nearing or in retirement, which is typically the worst time to take on unnecessary risk. Educating advisors on FIA benefits and how they can play a role in their clients’ retirement income goals is paramount.
The decumulation phase may be a more difficult retirement issue to solve than the accumulation phase. RIAs understand that it is how they solve for retirement income that will determine whether they are ultimately successful, and how they will be remembered by clients and their families.
In addition to FIAs that include guaranteed lifetime withdrawal benefits, single-premium immediate annuities can be an extremely useful tool in retirement planning. The client pays a sum of money up front and, in return, they receive a certain amount of money periodically for the rest of their lives, no matter how long they live.
3. PREDICTING RETIREMENT INCOME TAX LIABILITY.
A nonqualified annuity is funded with after-tax dollars, meaning taxes were already paid on the money before it went into the annuity. Upon partial distribution of these annuities, interest credited is taxed on a last-in/first-out basis as ordinary income at the taxpayer’s marginal rate.
Annuity providers may offer an “exclusion ratio” for non-qualified contracts which, from a planning perspective, enables advisors to plan income distribution with the aim of lowering their clients’ upfront tax bills. The annuity exclusion ratio shows how much of a non-qualified annuity’s interest the client will have to pay taxes on for a particular withdrawal (it doesn’t avoid taxes but simply changes the timing of when taxes must be paid).
Because taxes have already been paid on the principal, the annuity exclusion ratio is calculated by dividing the principal paid by the contract’s value.
Once all principal has been received back, the remaining annuity payments are fully taxable.
The age of the annuity owner helps determine the exclusion ratio. It may be a significant number of years before the annuity payments become fully taxable, although this factor should still be included in any retirement income tax planning. For an older annuity buyer, this can provide a significant amount of non-taxable income, based on the amount used to purchase the annuity.
The Bottom Line
Annuities can help RIAs seek opportunities and manage risk throughout the economic cycle. Financial professionals are better able to provide diverse investment options, alternative assets and strategies, expertly constructed portfolios and important tax advantages. It may indeed be time to consider them as a core product offering that can provide the potential for reliable asset growth and guaranteed retirement income — at least for those who wish to differentiate themselves as holistic client advisors.