Capitalizing on the tax-deferral advantage of a variable annuity
Learn how sheltering investment growth in tax-deferred accounts over the long-term may result in more wealth for retirement.
When it comes to retirement planning, the greatest investment tools investors can exploit are diversification and annuitization.
Annuities have become an essential slice of the retirement pie for Americans approaching and living in retirement. As part of a retirement income solution, annuities also can be an ideal complement to other portfolios.
We believe they are very well positioned in today’s uncertain market environment. Unlike other financial instruments, these contracts issued by insurance companies combine the features of investing and insurance in a single solution. They offer a range of flexible benefits, including:
Using annuities to solve the most common retirement challenges
Problem 1: Income Generation
Between a rock and a hard place
The dilemma for retirement investors today is that, while they may have accumulated a sizeable nest egg, thanks to remarkable asset growth over the last two or three decades, they’re unable to generate income from those assets. Low interest rates and market volatility have made retirement income planning more challenging than ever. It is precisely because interest rates are so low that your clients likely will need more than what they can reasonably generate from dividends and interest—and will need to access capital gains as well as some principal. Advisors and their clients will have to create a systematic withdrawal plan, taking some income from dividends and coupon payments, as well as from capital gains, while easing into principal. That’s where annuities can play a beneficial role.
Problem 2: Life Expectancy
The annuity advantage
Insurance companies that issue annuity contracts deal in statistics that calculate the life expectancy for people at different ages and the probability of surviving past certain ages. They rely on the law of large numbers. By pooling and managing investor assets, insurers are inherently able to provide higher income streams—and with higher certainty that payments will last a lifetime—than the average investor could do on their own.
Individuals approaching retirement who have a family history of longevity and who are in excellent health are likely to experience above average life expectancy. If they haven’t saved enough to achieve their desired retirement spending goal with a high level of confidence, they need to maximize the amount of income their wealth can provide for life—however long that may be. These individuals or households are excellent candidates for an annuity—preferably one that enables them to benefit from mortality credits to maximize their income at an appropriate level.
Problem 3: Emotional Biases
Stick to a plan
Constant headlines about market volatility can fuel investor fears. Many pay a heavy cost when their feelings dictate (often poorly timed) investment-related decisions. With built-in features, including withdrawal penalties, annuities can help inhibit investors from making emotional decisions. Research shows that the longer clients remain invested, the less variable their returns. And, because insurance companies aggregate the assets of thousands of investors, they can afford to stay fully invested through multiple market cycles. In addition, these insurance contracts also offer optional riders for a fee, to protect assets from market risk.
This slide from our 2020 Guide to the Markets illustrates why it’s important to stay invested. It shows historical returns by holding period for stocks, bonds and a 50/50 portfolio, rebalanced annually, over different time horizons. It demonstrates the importance of a balanced portfolio, and an appropriate time horizon.
Problem 4: Market Returns
Timing your clients’ retirement
Your clients might be able to control when they retire, but they rarely can control what market they retire into.
For these households, a dynamic withdrawal strategy that many variable annuities can offer may be an attractive solution to help mitigate this risk. Investors considering an annuity purchase should carefully review its benefits, trade-offs and fees to make an informed decision about how it supports their overall retirement income strategy.
This slide from our 2020 Guide to Retirement illustrates what can happen when clients retire at the beginning of a declining or bear market. Poor market returns at the beginning of retirement can negatively impact their financial situation. The bottom chart shows the returns experienced from 1966 to 1995, with below average and negative returns in the first 10 years, resulting in the accelerated depletion of assets by the age of 89.