Building A Fixed Solution

How do you integrate uncertainty and volatility into a viable income plan?

by Bernie Casey

Approaching our third year of the COVID-19 pandemic and the uncertainty that has resulted within our lives and communities, and the impact it has had on our loved ones and us makes me stop and think about what I can do to help offset some of this uncertainty. I can’t eliminate COVID-19; however, I can spend my energy assisting financial professionals in understanding why they should integrate annuities into their practices and how Crump can help.

As our world has changed, so has the annuity industry. The certainty, guarantees, predictability, safety, and security of fixed annuities, including fixed index annuities with protected lifetime income options, are product solutions that many of your clients would benefit from and want within their retirement portfolios. A recent study by the Alliance for Lifetime Income indicated, “Investors showed a clear interest in building a retirement portfolio that was protected with an annuity.”

Is It Time To Take Some Gains Off The Table?

While you may be thinking, “why would you present a fixed annuity option to your clients in a low-interest rate environment with increasing inflation and a record stock market?” My answer is that now may be the right time to take some of those gains off the table, reposition and diversify a portion of your client’s portfolio into these guaranteed solutions, and create more certainty, balance, and guarantees, as well as reduce volatility within a client’s portfolio. Fixed annuities fill a particular role and solve a specific need—protecting assets or providing protected lifetime income over one or two people’s entire lives. It’s a tool in the toolbox!

Whether your specialty has been as a traditional life insurance producer, registered representative, property and casualty agent, or registered investment advisor, one commonality is that many of your clients have money and want to know what investment options they have. Some may want to keep a portion of their wealth in a safe position. Whatever your specialty, start the conversation about their concerns, plans for their future, and what matters the most to them. How would they picture a comfortable retirement? How do they plan to maintain their lifestyle? Exploring the answers to these questions through conversation will put you in a better position to educate and inform them about the various options. Fundamentally, people purchase annuities for growth and income accumulation, so let’s take a look.

Fixed Annuities For Growth And Accumulation

When discussing annuities for growth and accumulation, the first focus is where fixed rates are in the market today and the alternatives. For example, a five-year multi-year guarantee annuity for $100,000 can offer a 3% rate locked in for all five years, and a three year can offer 2.5%. These are great safe money CD alternatives and should be considered as bond alternatives. If your clients are looking for more upside potential, a fixed index annuity (FIA) is the next product solution. The value proposition of FIAs is that they offer potential upside growth and downside zero-floor protection. FIAs should be positioned to potentially allow your clients to earn 1%-2% greater than a fixed rate annuity, however, with no guarantee that this will occur. If you invest $100,000 into a five-year index annuity and hold it to term, and the index never has a gain, your client will not get less than the $100,000 based on the contractual guarantee. Zero-floor protection appeals to clients for a portion of their assets, particularly if they are approaching retirement or in retirement, as they know that market losses will not impact this asset. However, the upside is where the opportunity exists. Clients earn interest based on the performance of the indices within the product.

FIAs have evolved over the years. When introduced in the mid-’90s, the primary index was the S&P and the primary crediting strategy was a cap rate; therefore, these were very limiting on the upside. In addition, they were considered complex and hard to explain. Product improvements since then offer the clients the ability to allocate their money in a variety of indices offered by well-known investment firms. In addition, uncapped strategies are more in favor today between participation rates and spread fee crediting methods. A recent example using a seven-year FIA with an A+ carrier and allocating 50% each to a one-year participation rate at 100% and an S&P Risk Control index with a 55 basis points spread fee resulted in a 5.59% average annual return over the most recent ten-year history through 1/1/2022. If you recall, I suggested earlier that the target zone is 1–2% greater than fixed rates, and this historical performance did much better. In addition, with a portfolio that has a 60/40 allocation with equities and bonds, since it is hard to find yield with bonds, financial professionals should consider using an FIA with 20%, thus creating a 60/20/20 asset allocation mix.

Fixed Annuities For Income

Financial professionals should consider this phase as coming down the mountain and converting some of these assets into income when discussing annuities for income. Today’s retirement is much different than years ago when the three-legged stool consisted of social security, pensions, and accumulated assets and provided a solid foundation of income for the golden years. In today’s environment, the challenge for the investor is that without a guaranteed pension income, most people are responsible for managing their savings and creating their pension from the assets they have accumulated to supplement social security and cover their essential expenses during retirement. For those more fortunate, income plans can also be implemented for the discretionary expenses and provide additional income to do the things they want to enjoy in their retirement years.

The concept of getting the most from the least is a phrase I often use when discussing income planning. In other words, how can I generate the most guaranteed income, using the least amount of capital? There are several ways to generate income; however, I will point out that an annuity is the only product that can provide a guaranteed lifetime income for one or two lives. If you think about this, social security is an annuity, as American workers pay in during their working years. At retirement age, they receive a monthly check from the government.

Initially, a review of the available annuity options is analyzed to coincide with getting the most from the least on an income planning case. One of the most basic income annuity products uses a single premium immediate annuity, referred to as an SPIA. The annuity payments are paid under a lifetime income with a cash refund option while the annuitant or joint annuitant is alive. If the annuitants die before the sum of annuity payments paid equals or exceeds the single premium, the beneficiary will receive a commuted lump sum amount. Annuity payments then stop, and no further benefits are payable.

For example, a couple male 65 and female 65, with $1,000,000 could receive a monthly payment of $4,286 per month or $51,432 per year, which is a 5.14% distribution rate. As an alternative, you can also consider using an FIA with an optional benefit called a guaranteed lifetime income rider, which will also provide guaranteed payments for as long as both annuitants are alive. The FIA with income rider would pay $52,500 for joint lives, slightly better with a 5.25% distribution rate. In addition, the FIA will provide for more control and flexibility of the client’s assets, which many annuity buyers may favor, as with the SPIA, the client gives up control of the assets in exchange for guaranteed income. If the client dies while receiving income, the remaining accumulated value is paid to the beneficiary. Most FIAs with income riders have a fee of 1% on average, some less, some more.

Impaired Health Of Compromised Longevity

Since SPIAs and FIAs with lifetime income riders also protect clients from longevity risk by paying as long as they are alive, this may not always be the correct path. Suppose the client’s health is impaired and mortality is compromised or shortened. In that case, an alternative income plan could be reviewed since SPIAs and FIAs with income riders protect against the tail risk or living past their mortality ages. This leads us to a bucket strategy, typically using two or three buckets of money and placing various assets into each bucket. Using the same $1 million investment for a 65-year-old couple, splitting the funds into two buckets:

• Bucket 1: pay $50,000 for a 10-year period, which will require $466,113 of capital
• Bucket 2: purchase a fixed index annuity with guaranteed lifetime income rider for $533,887, start joint income in year 11, and this will pay $58,728 per year GUARANTEED!

The benefit of using a split bucket approach is that not only will the client receive income at a 5% distribution rate for the first ten years, the FIA in Bucket 2 can also grow during this ten-year deferral period while having principal protection along the way. In the event of early death, the beneficiaries would receive the remaining Bucket 1 income payments, as well as the account value of the FIA in Bucket 2.

In summary, as COVID-19 has changed the way we live our lives, the annuity industry has also adjusted and changed over the past several years by designing more simpler products that are easier to understand. Remember that annuities are primarily for either growth or income. The focus within our industry has been to assist financial professionals and consumers with more tools, strategies and solutions, and simplification to understand why and how to integrate all types of fixed annuities into your practice. Education, conversations, and working together will lead to more opportunities that involve an annuity solution.