Opening The Annuity Portfolio

How to help your clients choose the right products for them

by Rich Lane

In today’s economic uncertainty, annuities can provide a more stable investment. But many clients may not understand how annuities differ and the benefits that each type offer. Advisors are in the position to help clients understand the key differences and benefits to guide their clients toward a decision based on their stage of life, their risk tolerance and their investment experience.

If clients want to build and protect their assets, annuities are a great option. However, annuities may have a negative connotation in some clients’ minds, as they are often associated with high expenses and fees. These general perceptions are outdated and most were associated with variable annuities, which used to be more common and contain hidden fees, but this has changed over the years. When beginning an annuity conversation with clients, advisors should first position their features and benefits, perhaps before even mentioning the product name — to keep the focus on how the product can support their investments needs.

Even in a low-interest rate environment, an annuity’s compounded growth and tax-deferral can grow clients’ savings faster than they may think while protecting their investment from market volatility. There are two primary types of annuities: variable, which pay an amount dependent upon the investment performance of the investments held by the particular annuity; and fixed, which have an underlying guarantee and pay a stated or guaranteed amount. Because a fixed annuity often provides principal protection, there are few taxable investments that can compete with this blend of safety, growth and flexibility. This type of annuity also has its own options — immediate and deferred. Advisors can help clients better understand each type in order to pick one that works best for their needs.

Understanding Fixed Annuities Benefits

There are many ways that buying fixed annuities can benefit clients. Most importantly, they offer multiple guarantees, through principal and interest rates. For estate planning purposes, proceeds are paid directly to the named beneficiary, which may avoid the delay and expense of probate.

Advisors can help demonstrate that fixed annuities are a long-term savings plan for clients, with a built-in future income stream that can supplement retirement income. There are a variety of contribution and payout options available, with flexible access to funds and a variety of surrender-charge free withdrawal options. Plus, 100% of the premium can earn interest.

Tax benefits also provide an advantage. Earnings won’t be taxed until withdrawals are made or clients begin taking regular distributions. Clients additionally benefit from triple-compounding: earning interest on the principal, interest on the interest and interest on what would have been paid to taxes.

In addition to choosing an annuity based on when payments will begin, and the guarantees a client can expect, clients also have a wealth of choices to customize ‘safe money’ for their unique needs, including their contribution and payout options. Clients’ needs may either match with a fixed immediate or a fixed deferred annuity — with deferred having an option for multi-year guarantee annuities (MYGA) or fixed-index annuities. By thinking about each of these as matching a target client, advisors can better identify which annuities pair best with a particular client’s situation.

Fixed Immediate Annuities

Target clients: Clients who are likely a fit for a fixed immediate annuity are over the age of 60, who want a predictable income stream that can start immediately, and are the most adverse to risk.

Few taxable investments can compete with the blend of safety, growth and flexibility provided by an annuity. With an immediate annuity, clients receive a structured payout, similar to a pension, for a lifetime income stream or for a set period of time for them and their spouse. They are designed to insure against clients outliving their income, with flexible lump-sum payment options. This annuity is an excellent way to maintain an income stream matched to personal financial needs.

These steady and predictable payments provide clients with security, regardless of fluctuations in the market, and are a great way to complement a 401k.

Fixed Deferred Annuities

Like immediate annuities, fixed deferred annuities are issued by insurance companies, which offloads the interest rate risk to the insurance provider. For annuities issued by insurance companies, confirm the financial strength of providers by checking their financial ratings.

Fixed deferred annuities often provide principal protection, no matter what is happening in the market. These types of annuities also have competitive returns and the advantages of tax deferral and compounded growth with flexible access to money along the way. They are designed to help clients accumulate money for retirement, or protect what they’ve already saved, and can be more flexible in terms of access. Fixed deferred annuities also provide a guaranteed minimum interest rate, regardless of market conditions. What’s important to remember is that with these types of annuities, clients are deferring the ability to have a lifetime income stream.

There are many types of fixed annuities, but the two most popular are multi-year guarantee annuities and fixed-index annuities.

Multi-year Guarantee Annuity (MYGA)
Target Clients: Clients who are likely a fit for MYGAs are a first-time annuity buyer, and seek a guarantee of investment return, or clients looking for predictable rates of return for a period of time. They are a long-term saver who likes the benefits of tax-deferred growth and protection as part of their retirement strategy.

MYGAs offer a guaranteed fixed interest rate for a certain period, usually from three to 10 years — a potentially safer way to grow money that does not accumulate tax until the client begins taking payments. The length at which the contract guarantees the fixed interest rate is the primary difference between traditional fixed annuities and MYGAs, which is an important aspect to help clients understand when they are choosing which option is best for them.

As MYGAs are not subject to market volatility, they will accumulate interest over a set period of time, and certain providers can provide penalty-free withdrawals during the surrender period. This can be beneficial if the client needs to take money out for emergencies and does not want to take a loan against their 401k.

When the initial interest rate period is over, clients can choose to renew, though it may be done at a different interest rate depending on the insurance company. Or, the funds may be transferred to a different type of annuity.

Fixed-Index Annuities
Target Clients: Clients who are likely a fit for a fixed-index deferred annuity are over the age of 60, a more advanced buyer who understands how annuities work, and wants to participate in market gain, which may include more risk. They like the benefits of tax-deferred growth with upside potential based on market performance.

Fixed-index annuities are deferred annuities that credit interest at a rate based on returns of an index. Interest rates are linked to the performance of an index, such as the S&P 500 index, but the returns are limited by a cap, participation rate or spread. By tying an annuity’s interest crediting to the performance of an index, the funds can participate in general market gains. At the same time, they are protected from downturns.

Clients earn interest based on the growth of the index each year, up to the annual index rate cap. Funds in this account will participate in 100% of the percentage growth in the index up to the rate cap. Interest is based on the growth of the index from the beginning to the end of the index term, which is 12 months. As interest is credited, the earnings are locked into the index interest account value. Funds in the index interest account will never decrease even if the market goes down.

By positioning annuities as sound investment options, advisors can help their clients understand how annuities fit their needs — and still remain as valuable and stable as they were decades ago. It’s important to remember that different annuities have different benefits, which will appeal to clients for personal reasons. When advisors understand clients’ long-term goals, their aversion to risk tolerance and other considerations, they can help clients build confidence in their portfolio through a balanced approach that meets their financial goals.