Like a good quarterback in football or point guard in basketball, a financial advisor must be able to read and react – to assess prevailing market conditions and, based on that assessment, to determine the best course of action for a particular client. It’s a skill that financial professionals often must call upon when quarterbacking their clients’ retirement portfolios. Is it the right time to put money in a conservative fixed investment? If so, what’s the best fixed product to recommend given today’s interest rate environment and other market dynamics? A bank CD? A money market account? A traditional fixed annuity? And once the recommendation has been made, is the advisor ready to build a case for the recommended product if the client raises objections?
Advisors face these kinds of choices every day with all kinds of products. And these days, when evaluating the options for the fixed-income component of a senior client’s retirement portfolio, the ability to read and react is especially important, given the topsy-turvy interest rate environment.
“It’s been like this for the last six to nine months. Open the business section of the newspaper and you see all these CDs and money market accounts advertised paying 5 percent, 5 1/2 percent and that’s just for one year. And that’s pure liquidity,” observes Hap Patz, president of Financial Advisors Inc. in Englewood, Colo. “Fixed annuities can’t match that. As long as that’s the case, fixed annuities are a tough sell.”
Selling them hasn’t always been difficult, however. Historically, traditional fixed annuities have been “a pretty easy sell,” according to Mark J. Smith, principal at MJ Smith and Associates in Denver. “In the old days – I’m talking eight or 10 years ago – you could almost count on insurance company rates [on fixed annuities] to be a percent higher than bank rates on CDs. You could get your clients a 7 or 8 percent return and you would look like a hero. But with returns where they are, it’s not anything I’m excited about putting a client in right now.”
Instead, when the goal for a segment of a client’s portfolio is generating guaranteed income, Smith says he’s using other conservative strategies (what he calls “tweaking the portfolio”) as a means to that end, including blending growth- and income-oriented equities, dollar-cost averaging and even using variable annuities that come without surrender penalties.
Still the one
In situations where it’s clear a fixed investment is needed, the advisor still can read and react to produce heroic results. But with the interest rate picture as convoluted as it is, with an inverted yield curve that in many cases gives short-term fixed instruments such as CDs more favorable returns than those of fixed annuities, some advisors are shunning insurance company annuities in favor of bank CDs. Smith and Patz are among those who are steering senior clients away from traditional fixed annuities, recommending they put their cash into shorter-term fixed products like CDs and money market accounts, and in equity-indexed annuities, which in many respects behave like fixed annuities, but with more upside potential. They’re not interested in saddling clients with the interest rate risk that comes with tying up money for the long term in a relatively low-yield fixed annuity.
Because conventionally configured fixed annuities are a plain vanilla product, and because their returns aren’t anywhere close to the 7 percent or 8 percent that can turn an advisor’s simple recommendation into a heroic act in the eyes of a client, it’s not always easy to convince growth-minded clients to invest in one. But in the face of less-than-favorable fixed annuity yields, advisors like W. Neil “Doc” Gallagher, Ph.D., president of the Gallagher Group in Hearst, Texas, continue to recommend traditional fixed annuities because of the features they offer that CDs and money-market accounts typically do not – features that senior clients in particular find alluring.
Seven and 8 percent returns on fixed annuities may be a thing of the past, but Gallagher, a certified elder planning specialist and certified senior advisor, says he has no problem justifying his fixed-annuity recommendations to senior clients, even when the annuity he’s recommending can’t match a bank CD in terms of annual yield.
“As an advisor, you have to be able to show your clients the bells and whistles with a [fixed] annuity that make it different from a bank CD. There are important distinctions I think you’re obligated to share with clients. And usually, they will be happy you shared them.”
Though over the course of the last year fixed annuities have lost their historic rate-of-return edge over CDs and seen their sales drop concurrently (see sidebar), other features built into the product make it a worthwhile investment for the conservative segment of a senior client’s portfolio, Gallagher contends, even if the return it offers lags behind that of a CD.
“If the [fixed] annuity pays [a return of] 3.5 percent and the bank CD [a return of] 4 percent, the net return to the client from the annuity is still going to be greater over time [than the return from the CD] because of the tax advantages,” Gallagher says.
He’s referring to the tax-deferred status attached to income generated by a fixed annuity. Income from a CD does not enjoy that status. But that distinction isn’t the only reason to recommend fixed annuities to senior clients, he says. Gallagher also likes the probate and creditor protection fixed annuity contracts afford their owners. Assets in a fixed annuity can pass directly to a named beneficiary, free of probate, and in many cases (depending on state law) those assets are off limits to creditors in the event of lawsuit.
Gallagher also notes that unlike income from a bank CD, the government doesn’t count income from a fixed annuity toward Social Security income. Fixed annuities, unlike CDs, also give contract holders the option of annuitizing to access a regular, long-term stream of income.
Aside from those key distinctions, traditional fixed annuities are so similar to CDs that Gallagher dubs them “CD annuities.” That’s one way he helps senior clients understand the similarities between the two – and the differences. A CD is guaranteed by a bank, he points out, and a fixed annuity by an insurance company. When the primary goal is achieving absolute safety of principal, Gallagher says, once clients gain a grasp of all the similarities and differences, most ultimately opt for the benefits of a fixed annuity over the higher returns of a CD.
Where once they might have been on the same page regarding their fixed product recommendations, these days Patz and Smith are taking their clients on a different path than Gallagher is with his clients. Patz says he’s recommending senior clients opt for CDs because they offer greater penalty-free liquidity than a fixed annuity with unattractive surrender charges.
But according to Gallagher, liquidity is often a moot point for senior clients, at least as it relates to the fixed component of their portfolio. “This is what I call buy-and-die money, so it doesn’t matter if it’s in there for four years, five years, seven years or 10 years or more.”
Patz and Gallagher may differ about whether now is the right time to recommend fixed annuities to seniors. But that’s fine, because when it comes to looking out for clients’ best interests, not all advisors read and react the same way.