Clients–and advisors–need to understand how these benefits work

Death benefits are not the reason clients buy annuities, say industry leaders. Besides, many annuities terminate by surrender, rollover or annuitization–not by death of the policy owner.

Still, death benefits are important policy features in most annuity contracts, because people do die with annuities intact, sometimes never having touched them since the day of policy issue.

In fact, the client and advisor understanding the annuity death benefit and how it works definitely contributes to successful annuity outcome, says Gregory G. Theis, a financial consultant with Seniors Only Financial, Homer Glen, Ill.

If the client doesn’t understand and ends up with the wrong death benefit, he explains, “you can have a lot of problems.” Not the least of these are miscommunication, suitability and compliance issues.

A lot of people with whom Theis speaks tell him they didn’t even know their contract had a death benefit when they bought it, or they say they do not know how it works.

These buyers may have purchased a fixed annuity that does not waive the policy surrender charges at death, for example. “Most fixed annuities don’t do that,” Theis allows, “but some do.”

Even the simpler fixed annuities can pose complexities in the area of death benefits, he stresses, because not all death benefit provisions are alike and because structuring the product for the client situation can entail minute but critical details that impact other elements of a client’s financial and estate plan.

“You have to know what you are doing” when evaluating the various death benefit features, he concludes.

Gene Pastula, president of Westland Financial Services, San Diego, Calif., agrees. That’s true for advisors as well as clients, he says, noting that the majority of advisors either do not know how annuity death benefits work when they come to him for training, or they lack sufficient training to explain it clearly to clients.

That concerns him.

If understanding is not achieved, the resulting complaints will only fuel the flames of anti-annuity critics, Pastula says.

Consumers need to know there are good, user-friendly annuities available, Pastula adds. These are products that are good to the customer–including at time of death.

Most annuity products do have some form of death benefit, say experts.

These include deferred annuities of the fixed, indexed and variable variety; period certain immediate annuities; and even a few lifetime immediate annuities that offer to commute the policy value upon death of the annuitant, says Brent Salso, senior marketer at Ann Arbor Annuity Exchange, Ann Arbor, Mich.

Knowing that, Salso says he routinely checks out all the details on the policy under consideration, and then “I lay it all out for the client.”

It’s a full disclosure approach, Salso says. He goes over the death benefit with clients (along with the other features), keeps detailed notes about the discussion, dates the notes, and reviews it all again with the client when going through the company-supplied disclosure materials.

This disclosure “absolutely” has to happen for the client’s needs to be served, he maintains. For instance, if a variable annuity with an enhanced death benefit is involved, the client needs to know that there is a cost for this feature, says Salso.

Clients also need to know what their heirs should expect to happen if death occurs while the annuity is still intact. “It might be that a client does not want the heir to have a lump sum benefit option, due to the heir’s spendthrift tendencies,” he explains.

But how best to incorporate a death benefit discussion into the client session? That’s a nagging question for many advisors, given that people generally don’t buy annuities for the death benefit.

One approach is to screen products that the advisor will sell, to ensure that the death benefit and other features are client-friendly, says Pastula. Some insurance marketing organizations do this screening, he points out, and so do other marketers.

The message should be, “choose top-tier carriers and products you are proud to sell,” he says.

At the carrier level, the focus turns to providing education and materials that deal with the death benefit. One example is the approach used at Lincoln Benefit Life, Lincoln, Neb.

“We work it into the entire consultative process,” says Larry Dahl, the incoming president of the Allstate subsidiary.

“We want the agent and policyholder to know” about the death benefit features, he says, “because, with a variable annuity for instance, it’s a very important decision, about which death benefit to elect.” (As NU readers know, modern variable annuities typically offer a variety of death benefit options and enhancements, and these features do vary from contract to contract.)

At the base, “we want everyone to understand that they’ll get their money back,” Dahl stresses.

Lincoln also wants customers to know variable annuities have enhanced options, as well–and that these options are available for a cost and that the option selected can impact the overall plan.

Most important, says Dahl, is that “we want to keep it simple and to put the focus on understanding, so the client can make the right decision based on the right facts.”

To do that, Lincoln’s annuity product materials explain not only with words but also with charts and examples. A recent product brochure devotes four letter-sized pages to this presentation, for instance.

The discussion needs to be integrated into the overall planning, contends Dahl. To support that, Lincoln structures its presentation as a planning process that moves from building clients assets to enjoying them and then sharing them. The death benefit discussion is part of the “share it” stage, says Dahl.

Lincoln also expects its reps to do a suitability analysis, looking at the death benefit options in view of the client’s profile. They should have a template to go by, too, he adds, using the broker-dealer’s checklist, for example, to be sure all key points are covered.

The treatment should be twofold, covering legal and tax issues and also product features, Dahl continues. But it should also reach to things like how to set expectations about what happens at time of death, he says.

The key, he concludes, is that the client needs to feel comfortable with the rep. That includes being willing to ask some questions, Dahl says, stressing that the one-on-one exchange of the trusted client-advisor relationship is critical.

What about the nitty-gritty of annuity death benefit discussions? Which points should the advisor raise with clients?

For starters, it helps to point out that annuity death benefits pass outside of probate to named heirs (i.e., not the estate), say industry leaders. But there is much more to cover, as well. For instance:

==Ordinary income taxation. Point out to the client, during the sale, that gains in a deferred nonqualified annuity will be taxed as ordinary income to the heirs, says Pastula. “Let the client know that his or her heirs will receive a 1099 on that money.” Depending on the gain and the heir’s tax bracket, that could be a substantial amount, he cautions.

==No step-up in basis. Let the client know there will be no step-up in basis on the annuity death benefit, unlike that for stocks, bonds, mutual funds and real estate that is inherited.

==Surrender charge provisions. Some fixed deferred annuity carriers deduct the surrender charges from the death benefit paid to heirs, notes Carl Stern, chairman and chief executive officer of Imeriti, Del Mar, Calif. It’s best to let the heirs know this as well as the policy owner, he adds, because “some family members get all upset if they find out at the owner’s death.” Theis notes that these types of contracts require an either/or decision: either take annuitization or take a lump sum with the surrender charge.

==Relationship of the owner and heir. If the beneficiary is a spouse, most annuities allow that spouse the option of taking over the annuity without penalty (as well as the option to cash out or annuitize), says Stern. Children don’t have that takeover option, he says.

==Stretch annuity. Not all annuities include stretch provisions, says Theis, but when they do, this can be advantageous, especially for non-spousal beneficiaries. The stretch feature allows annuity beneficiaries to continue the annuity, taking distributions annually based on their own life expectancy (not the policy owner’s). This way, beneficiaries can defer taxes on the annuity value longer and also minimize taxes that must be paid on the required annual distributions, says Theis.

==Payment how-to’s. Explain to the customer how the death benefit will be paid, suggests Pastula. “For instance, say something like this: ‘Keep in mind that, at the time of your death, the income taxes you are deferring will transfer to your heirs, if the contract is still in place. Maybe we should work this into your planning and….’”

==Key questions. To identify the death benefit need, ask the client, ‘what will be done with this money; where will it go; and how do you want this to be done?’ suggests Pastula.

==Impact of bonus. Some fixed annuities that offer a large upfront bonus require the heir to annuitize the contract for five or more years in order to get the bonus, notes Theis. “So, point out to the client that ‘you lose the bonus if you don’t annuitize.’ If the person wants that, it could be OK. But the person needs to know upfront.”

==Downside-Upside. For variable annuities, lead clients to decide what they want to accomplish with the product’s death benefit protection, suggests Tim Vander Pas, assistant vice president-product management, Allstate, Northbrook, Ill. “Do they want downside protection? Upside opportunity? Help in covering the cash flow or tax bill at time of death?” Once that’s decided, then select the feature needed to accomplish that, he says.

==Immediate annuities. For period certain plans, point out that the death benefit lasts as long as the selected period, says Salso of Ann Arbor. As for lifetime plans, note that they typically have no death benefit. (However, as Salso previously noted, a few carriers will commute the remaining value of the immediate annuity at time of the owner/annuitant’s death.)

The bottom line, says Pastula, is that advisors need to demonstrate to the client that they understand and care about what they are selling, and its impact on the client’s plan.

They need to manage which products they sell and choose features and options that best meet the need, he continues. This includes the annuity death benefits. If done correctly and in the right situation, this “can create tremendous benefit and value” for the client, he says.