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Life Health > Annuities

Qualified Annuity Sales Go Mainstream

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A key factor observed to be fueling record sales of annuities among the now retiring baby boomers are the guaranteed living benefits provided as optional riders to these products. Less well remarked upon, say market-watchers, is that these guarantees are having the most profound impact on qualified annuities: those offered as part of a qualified retirement plan, such as a simplified employee pension (SEP) or Keogh plan.

“The baby boomers who are transitioning into the distribution phase of retirement planning have to figure out how to make their assets last a lifetime,” says Brandon Buckingham, a vice president and director of qualified plans in the special markets department at John Hancock Financial Services, Boston, Mass. “Qualified annuities with living benefits riders provide the guarantees needed to make that financial objective a reality. That’s why we’re seeing more and more of these contracts sold in SEP-IRAs and other small business retirement plans.”

Buckingham adds that, whereas 5 years ago approximately 40% of all annuities sold were qualified and 60% were non-qualified, today the percentages are roughly reversed. That shift has resulted in a progressively higher share of assets under management on the qualified side of the balance sheet.

According to the 2007 Annuity Fact Book, a publication of The Association for Insured Retirement Solutions, Reston, Va., qualified annuities (variable and fixed) accounted for $1.07 trillion in net assets in 2006, or 56% of the market. In 2001, the figures were $612.2 billion and 49%, respectively.

Sources say the development of the riders–the big 3 provide guaranteed minimum accumulation, withdrawal and income benefits–have allowed advisors to overcome the chief objection raised about placing an annuity inside an IRA or qualified retirement plan: That such bundling makes redundant the tax-deferred treatment of retirement assets.

Sources note, however, that the growth of qualified annuities has so far not resulted in their widespread adoption within 401(k) plans. The reasons are twofold: (1) group annuities–contracts that provide a monthly income benefit to members of a group of employees and are underwritten on a group basis–generally offer a lower payout rate than individual annuities that can be purchased outside a plan; and (2) group annuities carry a higher cost relative to mutual funds, the vehicles traditionally used fund such plans.

Neil McCarthy, a certified financial planner and president of McCarthy & Associates, Roswell, Ga., observes that because the “unisex” life expectancy attached to group annuities is longer than that for the average male, men can secure a higher annuity payout rate on annuities in the open market. (The lower the individual’s life expectancy, the higher the payout rate, and vice versa.)

Clark Randall, a certified financial planner at Lincoln Financial Advisors, Dallas, Tex., adds that group annuities tend to be more expensive than mutual funds, which are still the principal vehicles for funding qualified plans. To illustrate, Randall recounts how he saved one small business client more than $14,000 annually in administration costs by changing the firm’s defined contribution plan from a group annuity to a mutual fund-based contract. The annuity’s added cost, representing about 1% of assets under management, was borne by employees as a fee charged against their return on investment.

To be sure, says Randall, the group annuity does have a place in the market. “I can envision a group annuity for companies that don’t have much excess cash with which to set up a qualified plan,” he says. “The product is typically a bundled contract wherein the insurer does all the administration. And because the fee structure is built into the plan, companies don’t have to pay out cash flow to fund it.

“But the moment the company grows to, say, $500,000 in assets, then it’s probably time to think about moving into a lower-cost plan wherein it makes sense to pay a third-party administrator to do the calculations separately,” he adds. “The company is now absorbing the cost to administer the plan; and employees are paying management fees for the mutual funds in which they’re invested.”

To make annuities more attractive inside 401(k) plans, some companies are offering both immediate and deferred annuities as an investment option, as opposed to a group-wide product. Boomer-age plan participants could thus choose from varied mutual fund options in the plan and also allocate a certain portion of their money to the insurance contract.

Hancock’s Buckingham suggests, however, that marketers of qualified annuities may have to wait for new federal legislation before the products (either individual or group) achieve widespread adoption in 401(k) plans. When that day arrives, employees will stand to gain–and not just because of products’ much-touted guarantees.

“For most clients, substituting an immediate annuity for bonds in a portfolio is the best way to get the most out of your retirement dollars,” says McCarthy. “That’s because an immediate annuity yields a higher cash flow. And when combined with dividend-paying stock, you get both tax advantages and growth.”


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