Annuities: An essential slice of the retirement pie

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 investment 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:

• Lifetime income: Annuities offer a variety of guaranteed income options that can start immediately or at a future date.
• Growth potential: The earlier your clients invest, the more opportunity they’ll have for long-term growth potential from a broad range of investment choices. Growth will vary depending on the performance of the investment options you choose.
• Tax-deferral: Taxes can have a big impact on long-term investment returns — making the benefit of a tax-deferred variable annuity especially attractive for high net worth and affluent investors
• Legacy options: Many variable annuity contracts offer special riders (for a fee) to provide death benefit protection for loved ones.

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 sufficient income from those assets. While interest rates have risen recently on the back of Fed tightening, they could decline if, as expected, the Federal Reserve begins to ease monetary policy in the months ahead. Dividend yields on stocks are also low by historical standards and after adjusting for inflation, remain in negative territory. Combined with elevated market volatility, retirement income planning has become more challenging than ever. It is precisely because of volatility in interest rates and equity markets that your clients likely will need more protection for their income than historically. This requires diversifying your income generation beyond what investors can reasonably generate from dividends and interest, by accessing 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.

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.