The New Finance Of Longevity

Making the Case for Annuities

Even in a strong economy, clients may need to make compromises

by Doug Wolff

Mr. Wolff is President, Security Benefit Life Insurance Company, Topeka, KS. Connect with him by e-mail: [email protected]

Clients planning for their retirement are in a new, unpredictable world. After seeing their stock portfolios make roller-coaster moves of late, your clients may wonder whether their retirement strategy needs a serious overhaul. They may tell you that protecting capital now seems a greater priority.

Even in a strong economy, clients need to make compromises. If you lock them into an attractive long-term rate, they forfeit the chance to increase assets’ value should rates rise. If they buy equities to take advantage of stock market booms, they risk their principal in a downturn.

But the current pandemic-related economic turbulence gives many retirement options even greater downsides. Equity investing? That’s putting money in an unsettled stock market that could be rattled further, should the pandemic extend into 2021. As for bonds, the current near-zero interest rate has left this asset class a little flat, as prices will drop as rates rise and stabilize.

Could fixed and fixed index annuities be an option? As a complement to your clients’ broader portfolio strategy, these products offer a unique combination for clients: guaranteed protection in a tough economy, and with fixed index annuities the ability to take advantage of part of the increase in one or more financial indexes.

An Argument For Annuities

Annuities may be a good fit for the late Baby Boom generation or early Generation X—essentially, your clients in the 55-to-67 age range. The current economic crisis is a particular challenge for this generational subset. Younger clients can expect to weather the storm, as they have many years of investing ahead of them. And many retired clients likely have shifted more to income preservation strategies. It’s those who are planning for retirement yet still looking for growth that may be most exposed to the turbulence.

What do fixed and fixed index annuities offer as a retirement strategy? Clients can gain a number of benefits from the products. Among the most appealing in today’s market include:

Principal protection. Whatever happens in the markets, a client’s annuity contract value is always protected and backed by the life insurance provider’s guarantee. This means peace of mind during an unpredictable time.

Income protection. If interest rates sink further, or move into negative territory, an annuity has a floor beneath which it won’t go meaning the income they generate is secure. A fixed annuity, for instance, gives clients this reliability, via a guaranteed interest rate, at a time when that’s a very appealing prospect.

Tax deferral. Taxes are a significant drag on their retirement strategies. Any of their taxable investment accounts, such as brokerage accounts or money market mutual funds, means a yearly tax bill for any interest, dividends, and capital gains earned. Here’s where annuities offer a real difference. An annuity will postpone all payment of taxes on credited interest until the withdrawal date (annuities purchased as IRAs do not provide additional tax benefits versus other assets held in IRAs). This means 100% of the accumulated interest is compounded and won’t be taxed until the client starts to withdraw the money.

Bond replacement. Over the past 30 years, bonds have benefitted from declining interest rates. Given that interest rates are now near zero. Bonds are less likely to take advantage of interest rate decreases going forward. Annuities, particularly Fixed Index Annuities (FIAs), are a compelling alternative to a traditional bond investing strategy, as they offer some accumulation potential but without downside risk. Essentially, they provide stability in a portfolio similar to bonds, but without the same interest rate volatility.

Giving Clients Accumulation Potential And A Shelter In A Storm

Volatile equity markets are a serious concern for your clients that are nearing retirement. Fixed annuities are designed to help them save for retirement and other long-term goals, particularly if they don’t need access to the money to cover living expenses or unexpected emergencies. Their guaranteed fixed rate of interest provides clients with portfolio diversification too.

Annuities offer a range of benefits that could make them the right choice for many of your clients—an appealing combination of reassuring protection, tax deferral, diversification and the flexibility to take advantage of a potential upside in the economy...

Using an FIA is another option for a portion of client retirement portfolios, particularly if they need growth potential, but are concerned about market volatility.

For example, these products offer interest credits determined, in part, by changes in one or more financial market indices rather than interest rates. A broad range of indexes are available along with a variety of crediting choices, so like fixed annuities, FIAs can provide some diversification as well. FIAs offer some interest accumulation potential, but with no downside risk, regardless of how well or poorly the underlying indices perform.

Instead of losing value in a sell-off, an annuity owner’s account value, principal plus growth, is locked in.

Providing Clients Rate Flexibility

Clients can also benefit from how annuities respond to interest rate fluctuations. From the early 1980s through 2015, interest rates progressively declined, hitting what were then-historic lows in the 2008-2009 recession. As rates plummeted, so did the prospects for rate-related savings growth. Holding off and waiting for rates to rise didn’t work, as that only happened modestly in the mid-2010s and again in 2018. With the onset of COVID-19, interest rates again stand at near-zero.

Fixed or fixed index annuities can diminish or eliminate uncertainty around the fluctuating values of a bond portfolio. At the same time, they help financial professionals to build portfolios that offer interest accumulation potential. In this low-rate environment, annuities can provide baseline protection, with a guaranteed annual fixed rate.

Lessening A Client’s Tax Burden

Taxes can be a substantial drag on your clients’ investments. With brokerage accounts, certificates of deposit, and money market funds, even if clients don’t withdraw any interest accrued, they have to pay taxes on it each year. Annuities offer a different strategy. They can enable your client to defer paying all taxes until they withdraw the money later, usually when they retire. And given that upon retirement, they could be in a lower tax bracket, that would cut the amount they owe to the IRS.

This offers more protection and more accumulation potential. Because while your client defers their tax obligations until retirement, all of their portfolio’s credited interest (including what normally would be sent to the IRS each year in a taxable product) compounds over time. This generates higher potential accumulation, and thus more potential retirement income.

Take Advantage Of Innovative Features

The annuity industry has experienced a lot of change in the past decade with providers building innovative features into traditional annuity products. If you want your clients to have the potential to take advantage of changes in interest rates, for example, a floating rate annuity could be a good complement to their current retirement strategy. Automatic credited rate adjustments based on the movement in interest rates allows clients to lock in a competitive rate now, without locking them out of potential rate increases in the future.

Still Offer Freedom Of Movement

Annuities have greater flexibility and wider principal access than clients may realize. Clients can put money in an annuity for a committed amount of time yet still are able to typically withdraw up to 10% each year free of surrender charges. In the event of certain unforeseen health concerns, many annuities allow clients to access their money free of surrender charges. Further, the contract value of their annuity passes directly to their beneficiaries without the delay of probate and without incurring any additional expenses.

Conclusion: Annuities Are A Valuable Piece Of The Arsenal

These are unusual times for clients, particularly for those who have begun cementing their retirement strategies in the face of this unforeseen, troubling economic climate. The economy of the early 2020s could be more challenging than the economy that many prospective retirees have spent their working years in.

Annuities offer a range of benefits that could make them the right choice for many of your clients—an appealing combination of reassuring protection, tax deferral, diversification and the flexibility to take advantage of a potential upside in the economy. Plus, they can help make you better able to manage risk throughout the economic cycle for your clients.

They might be just what a client needs, before and after they retire.