Income Strategy

Debunking Common Annuity Misconceptions

Regardless of how your clients may have come to their opinions, you have the ultimate power to re-educate them

by Chris Conklin

Mr. Conklin is vice president of individual annuities at The Standard where he has full P&L responsibility for the individual annuities line of business. Besides being a Fellow of the Society of Actuaries, Chris is a licensed agent, has sold insurance and annuities, and co-owned a national marketing organization. Visit www.standard.com.

Annuities may or may not have been part of your clients’ financial planning. If not, it may be due to client misconceptions regarding the product itself. But any review of the client’s retirement-income plan provides a perfect opportunity to turn the page.

Regardless of how clients obtained their inaccurate perceptions of annuities, it’s our job, as agents and financial advisors, to correct them. That’s because annuities can be an important tool to help with a client’s overall financial portfolio as they offer advantages, including reducing risk and providing a more predictable future.

Here are a few common misconceptions you may hear and thoughts on how to educate clients:

Misconception #1: Annuities are confusing

A lack of experience with annuities may leave clients feeling confused about them. With their bias that annuities are not a good value, there’s no reason to bother learning about them. While the idea of an annuity may be foreign to your clients, annuities have been around for decades with the same straightforward structure. That structure means that any annuity — regardless of whether it’s fixed, indexed or variable — is built to provide earnings potential as well as some measure of safety to a client. And safety, in my experience, is a very important factor for clients, making annuities fully worth the time to learn what they are and how they work.

In addition to safety, there is another important aspect of an annuity that, once explained, is easier for clients to understand: time commitment. To protect the financial integrity of the annuity carrier, annuities have surrender-charge penalties for accessing money ahead of the scheduled time. Typically, the longer the time commitment your client is willing to make, the greater earnings potential the annuity carrier can provide. Therefore, in order for the annuity to work best for a client, it’s crucial to tailor the choice of timing for an annuity based on a client’s goals and needs.

Misconception #2: Annuities don’t offer the security clients are looking for

Potentially spread by people who had a negative experience with annuities, this misconception could have been avoided with clearer communication from the onset. If a client doesn’t understand what an annuity is or which annuity option is best for their goals, they may choose an option that doesn’t fit their needs, which can lead to frustration. To help overcome this misconception, clearly set expectations with a client about the merits of the different types of annuities and explain how each works.

Consider highlighting these nuances:

  • Fixed annuities have a declared interest rate, and some have an interest rate that is fully guaranteed for the entire surrender charge period — similar to a bank CD
  • Indexed annuities provide interest credits based on a market index. There is usually a minimum and maximum interest credit, where the minimum provides protection against the index’s decrease
  • Variable annuities have subaccounts much like mutual funds. They provide protection against loss via their death benefit feature, plus, they often provide further guarantees through a guaranteed lifetime income rider

Misconception #3: Annuities have high fees

If a client has money in an employer-provided retirement plan — such as a 401(k), 403(b) or 457(b) — or in an existing IRA, those funds can be transferred into an annuity tax-free

On fixed or indexed annuities, critics will sometimes say there are “hidden” fees. That’s because the carrier considers its expenses when setting the interest rates on its annuities. But this is no different than what customers experience with financial products from banks, such as CDs or savings accounts.

With a fixed or indexed annuity, a client would typically only pay a fee in the form of a surrender charge, which is avoidable as long as the client abides by the time commitment. They may also pay a fee associated with an optional rider that provides an additional guarantee, such as a guaranteed lifetime income rider. For a variable annuity, a client could run into three different types of fees: one for investment management, another for the insurance company’s expenses and a third for the guaranteed lifetime income rider.

Because of these potential fees and this misconception, it’s important for you to clearly explain these early in your conversation so your client understands the reasoning behind the fees in each annuity.

Misconception #4: Annuities can create tax problems

Although some may see the taxes around an annuity as confusing, they’re actually set up very similar to other popular retirement savings options. If a client has money in an employer-provided retirement plan — such as a 401(k), 403(b) or 457(b) — or in an existing IRA, those funds can be transferred into an annuity tax-free. As an annuity earns interest, that interest can stay in the annuity tax-deferred. However, as with all non-Roth IRAs and corporate retirement plans, when your client ultimately takes withdrawals, the withdrawals will be taxed as ordinary income.

In a Roth IRA annuity, as long as your client keeps the money in the annuity for at least five years before taking a withdrawal and doesn’t take any withdrawals before age 59½, the withdrawals and interest credits can be completely tax-free.

For regular savings — otherwise known as nonqualified money — annuities offer tax deferral. The advantage of tax deferral is that your clients can control when they are taxed by controlling when they withdraw funds. Unlike direct stock investments, however, annuities do not qualify for capital gains tax treatment.

Bottom line
An annuity may be a great option for your clients and they may be missing out because of simple misconceptions. As advisors, it’s our responsibility to correct these misconceptions so that clients get the retirement savings solution that fits their goals.

Educating clients about annuities’ structures, benefits, fees and taxes are important points to make to help overcome the common misconceptions many have about their merit as a financial tool.

By doing so, you can help make sure your clients are meeting their financial objectives while positioning yourself as a trusted advisor in the new year, and for years to come. ◊