Inherited IRAs Seen As A Vast Untapped Market For Annuities

Tampa, Fla.

Given an abysmal savings rates, a slow-growth economy, an uninspiring stock market and continuing terrorism jitters, theres one thing advisors can do to fire up their practices and offer prospects financial peace of mind: sell more annuities.

That was a common theme of 3 educational sessions of the Society of Financial Service Professionals annual Financial Service Forum, held here last month. The presentations encompassed 2 sessions on annuities sales ideas by Tom Hegna, a corporate vice president for New York Life, New York, and a third talk by Jim Otar, a financial advisor with Partners in Planning, Richmond Hill, Ont., Canada, who focused on the vehicles performance relative to other investment tools over 103 years of stock market history.

“The annuity is the most underutilized [financial] tool in America,” said Hegna. “Yet, it is the only product on the market that will guarantee your senior citizens No. 1 concern, which is ensuring they dont run out of money.”

The biggest pool of prospects for annuities, said Hegna, are those with individual retirement accounts, including 401(k) and 403(b) plans. While these products enjoy tax-deferred growth, theyre taxed during the distribution phase.

If, however, a deceased individuals spousal beneficiary rolls over monies from an IRA to an annuity following the individuals death but prior to a death claim, then the funds can pass from one vehicle to the other tax-free. The recipient must, however, begin taking required minimum distributions (RMDs), and pay taxes on distributions, at life expectancy.

These “inherited IRAs” represent a vast untapped market. Yet, many advisors either dont know about the tax advantage or fail to pursue the opportunity by establishing relationships with the beneficiaries, according to Hegna.

“We as advisors have done a good job developing relationships with clients but a miserable job building relationships with the beneficiaries,” says Hegna. “Start putting beneficiaries on your birthday card lists and other mailings. When you develop a relationship and provide value by talking to them about inherited IRAs, you build credibility.”

Among the most popular and easy-to-understand products, notes Hegna, is a life annuity with a cash refund rider. Assuming an initial investment of $100,000, the product may be structured, for example, to provide the annuitant with $10,000 every year for life, depending on the persons age. Should the annuitant die after one year, the balance of the invested amount ($90,000) can be refunded to a designated beneficiary, such as a spouse or child.

The cash refund rider among other legacy options disprove a common misconception of prospects: That when they die, undistributed funds in life annuities automatically remain with the insurance company.

Such legacy options, said Hegna, also can prove powerfully attractive to prospects who want to keep their memory alive with designated beneficiaries, or who believe that certain estate inheritors lacking in financial maturity would be better served if they received monies as regular monthly payouts, rather than as a lump sum distribution.

Hegna pointed at other product uses and feature add-ons that might help advisors clinch the sale: the ability to use annuity disbursements to pay for long term care premiums; guarantees on the invested principal in a variable annuity; and an inflation rider.

The case for the last, observed Hegna, is not always clear-cut. While inflation can significantly erode retirement assets over the long term, Hegna noted that “it may take 7 to 8 years” before the riders benefit outweighs its added cost. In general, he said, the younger the client is, the more that inflation protection makes sense.

Riders notwithstanding, the longer a client lives, the more appealing the annuity is to the client. The reason: The clients age determines the annuitys net effective interest rate. The older they are, the higher the rate.

“There are only 2 things that matter with annuities: the payout [crediting] rate and how long [annuitants] live. I can give clients a 3% crediting rate, but if they live to 100, they can take the insurance company to the cleaners.

“The crediting rate is not based on the interest rate,” he added. “The only way to determine the real interest rate is to know how long the person lives.”

That knowledge, of course, is beyond the grasp of all but the terminally ill. Clients can take comfort in knowing, however, that a life annuity can effectively insulate them against market gyrations and provide them with steady, lifelong income security.

So noted Jim Otar during a presentation on the mathematics of lifelong income planning. Otar illustrated, using 103 years of stock market history, a hypothetical clients inability to fund adequately for retirement when employing various assumptions.

Given, for example, a standard financial plan, wherein the hypothetical individual starts with a stock market investment in 1929 valued at $1 million, a withdrawal rate of 6%, an average rate of growth of 8% per annum and an inflation rate of 3.5%, the investor depletes his portfolio in less than 20 years. Similar results ensued when Otar revised his illustration using actual inflation and average growth rates; a start date of 1966; a balanced portfolio of stocks and bonds; and all fixed income assets.

“It doesnt matter whether you assume [a portfolio rate of return of] 4%, 8% or 12%,” said Otar. “The probability of running out of money after 20 years is 52%. That number grows to 69% after 30 years.

“Given insufficient savings, no smart strategy exists [to fund for retirement], other than a life annuity or extreme luck,” he added.

Commonly used techniques for insulating the investor against market fluctuations can backfire, Otar added. He noted, for instance, that frequent rebalancing of a portfolio can deplete the value of investments sooner than would otherwise be the case. In a bull market, the rebalancing would stunt portfolio growth; in a bear market, the technique is akin to throwing good money after bad.

“You cannot reduce random risk by rebalancing more often,” said Otar. “You can reduce the trend risk by rebalancing after an observable trend.”


Reproduced from National Underwriter Edition, November 11, 2004. Copyright 2004 by The National Underwriter Company in the serial publication. All rights reserved.Copyright in this article as an independent work may be held by the author.