Shedding Some Light on Annuities

In today’s instant information-rich world, annuities have a reputation as one of the most misunderstood investment products out there. Annuities are still a mystery to many of my clients, and frankly still with too many insurance agents.Why? First, I believe many agents and advisors still have not taken the time to understand annuities to fully explain them to their clients correctly. And, second, annuities are easy targets for bashing by companies with ulterior motives like Fisher Investments with their simplistic catchy slogan “I Hate Annuities and You Should Too.”

As a fiduciary investment advisor and also a licensed insurance agent, I have the great opportunity to see a range of clients and have been able to see which clients are best suited for variable investments orfixed products. I am a huge fan of annuities, for the right client and the right scenario. Like every industry, some bad apples have made anti-annuity bashing easy. In this article, I am hoping to shed some light on the different types to help you feel more comfortable about annuities, how they can better fit in your practice and how to help make more suitable recommendations for your client.

According to LIMRA, in the year 2000, total annuity sales reached $190 billion with $137 billion of that in variable annuities and $53 billion for all fixed annuity sales. Nineteen years later, and despite the low-rate environment, total annuity sales increased by 27% to $242 billion in 2019. However, the roles slowly reversed. Fixed annuity sales nearly tripled to $140 billion and variable sales dropped 25% to $102 billion. No surprise—total annuity sales dipped about 10% in 2020 mainly due to the pandemic.

FIXED ANNUITIES

Although variable annuities continue to be a huge part of the annuity market, fixed annuity products will be my focus as they have been on a steady rise for decades and don’t have as many advocates as the variable annuity.

Fixed Annuities are contracts that offer principal protection and better upside return than a bank. I like to tell my clients, “if you know what a bank certificate of deposit (CD) is, then I can more easily explain what a fixed annuity is. A fixed annuity is like a CD onsteroids.”

A CD is a contract with a bank, usually with a 6-month to a 5-year contract, a fixed rate and comes with penalties for earlywithdrawal. The fixed annuity is a contract with an insurance company, not a bank. Unlike a CD, where clients pay taxes on the interest gained annually, taxes on gains in annuities are deferred until withdrawn. The danger for younger clients placed in non-qualified annuities is that gains are subject to taxes for early withdrawals, but also be subject to a 10% IRS penalty of the gains, if taken prior to age 59 1/2.

There are up to 5 different types of fixed annuities and knowing them will help you recommend the most suitable one for your client.

TRADITIONAL FIXED ANNUITIES (TFA): Although the contract could be for several years, the rate can change up or down each year. Today’s 5-year plan rates arestarting at 1.9%.

Multi-year Guaranteed Annuities (MYGA): These function a lot like a CD’s in that they lock in the advertised rate for the duration of the term. Today’s lock in rate for a 5-year plan is averaging about 2.6%.

Single Premium Immediate Annuity (SPIA): This a single deposit that starts a monthly income to last 10, 20 years or lifetime—creating a potential lifetime income stream. Although SPIA’s account for 6% of fixed sales, the annuity bashers love talking about how annuities “lock up your money” forever, and the bad old insurance company will keep your remaining money if you die. It’s rare that agents wouldoffer a SPIA, but some unique cases will require a SPIA.

Deferred Income Annuities (DIA): Also known as longevity annuities, DIA’s in essence are like a SPIA but you can postpone turning on a lifetime income to a date in the future.

Fixed Indexed Annuities (FIA): This is one of the fastest growing of all of the fixed annuity options, but frankly the most confusing. An FIA is like a hybrid between a bank CD and a mutual fund. Like a CD, the principal is protected in a downward market after an anniversaryperiod. However in a good market year, if the index has a positive gain for that period, your client’s credit for that period would match some or all of those index gains. Every insurance company has different “crediting” strategies, but the good news is that clients have the ability to earn more, over time than a regular fixed rate annuity.

Fisher Investments and other naysayers would have you believe that all annuities have “fees.” While variable annuities do charge asset fees, mortality expense and other fees, the above fixed annuities have ZERO management fees.

WHY OFFER RIDERS?

An agent can offer a “rider” with a fee to a fixed indexed annuity or a variable annuity for about 1-1.5%. The more popular rider is the “income for life” rider which if added on, can create a single or joint lifetime income stream with a fixed payment, without the need to a lifetime annuitization.

For example, a 55-year-old client with a $100,000 IRA rollover who is planning to retire in 10 years, can add a lifetime rider. They will know exactly what the future predetermined “guaranteed” income stream will be, without any worries about stock market or index future performance. Similar to delaying Social Security, the clients “monthly income” value grows each year it’s delayed. I just ran this illustration, and  one top A rated carrier would guarantee this client $10,021 a year for life starting at age 65. Can a Fisher advisor guarantee this?

There are at least six reasons why I believe fixed annuities growth has outpaced variable sales:

1. Fixed annuity contracts have become more popular with retirees in the last 20 years. Baby Boomers are retiring in large numbers, which means that they’re not sure whether to buy stocks left and right like they did before, or take a smaller return of 3-5% over time knowing their principal is safe from market.
2. The dramatic decrease of pensions plans in the private sector is increasing American’s reliance on Social Security. The concept of a principal protected account that can create a monthly “guaranteed” income stream makes sense to plan for the future.

3. Insurance companies are becoming more creative with new features, new crediting strategies and hybrids that are filling in gaps in the market place like Long Term Care hybrid annuities.

4. Many younger and older conservative investors are open to “contracts” of five, seven or 10 years, knowing that they will be saving up to 2% a year that would have gone to a broker for management and asset-based fees.

5. Clients liked that they have up to 10% penalty-free withdrawal access to their account value per year. If retirees are still in the annuity contract, they still can follow the 4% rule and make systematic withdrawals without the fear of a withdrawal.
6. And finally, over the last ten years, I have seen more agents taking an active interest in learning more about annuities, turning to mentors, contacting their IMO’s or agencies for assistance in helping them be better prepared to educate their clients on a great option they may have never heard of before.

Although some variable annuities carriers are able to offer plans with contracts, fixed annuities do have contracts with sliding surrender fees. Any client that has risk a profile of aggressive or has short time horizon liquidity needs is likely not a good candidatefor an annuity.

Fixed annuities have been around since the Roman Empire, and it seems like they are finally getting the respect they deserve. I only foresee increased sales as more clients and agents understand that fixed annuities may actually fit in the financial portfolio they have had for decades. Fixed annuities give agents and client guarantees and predictabilities that other products can’t offer.

ALVIN PARRA is the founder and a general agent for Strategic Choices Financial & Insurance Solutions, and the COO of Strategic Choices Wealth Advisors. He is also NAIFA-Los Angeles’ president-elect for 2022.
Reach him at alvin@strategicchoices.