Liquidity–meaning cash, or rather the ability to turn an asset into cash–is a consideration for all financial transactions.
Some assets are considered more liquid than others. For example, bank accounts are liquid because cash or checks (a cash equivalent) are easily moved in and out of the accounts with no penalty. In contrast, real estate is an asset which has to be sold and the sales proceeds are generally cash. Hence, real estate is not considered a liquid asset.
What about fixed index annuities? FIAs are issued in the amount of premium paid. A FIA may be liquidated, with the premium and interest earned turned into cash; however, surrender charges may also apply.
At the heart of criticism against the FIA is the product’s liquidity features. Whether a FIA’s liquidity provisions are matched to client’s needs is determined by needs-based selling and a suitability analysis. Consumers have to understand what liquidity features they need. Producers need to understand how the liquidity features in an FIA work.
When matching liquidity features of an FIA to a client’s needs, 3 important considerations include: How is the client going to use the money in the FIA? When is the client going to need access to the money? What amount of money from the FIA is the client going to need?
If the client will need funds from the FIA during the contract term, these 5 key FIA liquidity features often provide answers to the questions of when and how much money the client needs from the FIA.
1) Contract term. This is the number of years that surrender charges apply to a FIA.
The contract term dictates the length or duration of surrender charges. If the contract has a 10-year term, it has 10 years of surrender charges. Likewise, a 5-year term has 5 years of surrender charges. Determine how the client intends to use the FIA funds to assist in deciding on an appropriate contract term (aka, surrender charge period).
2) Maturity date. This is the date when the client will be forced to withdraw funds.
It is perhaps the most misunderstood feature of an FIA. Each FIA carrier has a default maturity date, such as when the client reaches a certain age. This does not mean that the client is denied access to funds before the maturity date. To the contrary, the surrender charge period dictates when full access to funds is available, not the maturity date. Likewise, the maturity date in an FIA can be moved up when the client elects a payout or settlement option.
3) Penalty-free withdrawals. Available on most FIAs, the penalty-free withdrawal means a certain amount of money can be withdrawn from the FIA without surrender charges being applied. Typically, the feature enables policy owners to withdraw at least 10% of the FIA value a year without surrender charges.
But be aware of these points:
–Timing: Withdrawals may be available one day, 30 days, or one year after the FIA is issued. Check the disclosure form to identify specifically when the penalty-free withdrawal is available.
–Amount: While 10% is typical, some FIAs limit the withdrawal to interest only. Other FIAs will allow the withdrawal percentage to accumulate to 20% if the 10% was not taken the previous year.
4) Nursing home waivers. These waivers answer the liquidity issues that arise when the client enters a nursing home during the FIA contract term.
Terminal illness waivers provide additional liquidly in the event a client is diagnosed with terminal illness. FIAs offer a variety of waivers which eliminate or reduce surrender charges under certain circumstances. The key is to find the waivers best fitted to the client’s needs.
But be aware of these two points:
–Timing: The nursing home or confinement waiver may not be available to all clients based upon their age. Also, read the waiver requirements, including the timing of confinement or diagnosis of the terminal illness.
–Amount: Understand that some waivers may allow 100% access to funds–in other words, a complete waiver of all surrender charges. Or the waivers may apply to 75% of the funds, for example. It is important to read the waiver language to understand how much will be available from the FIA should a specified event client trigger the waiver.
5) Income riders or settlement options. These are liquidity features which provide the client a stream of income payments.
An “income rider” is an option that the client must purchase and add on to a FIA. The “settlement provisions” in a FIA are part of every annuity. These features differ in form and function, but each offers additional means to receive cash from the FIA.
Liquidity will remain at the heart of suitability considerations for FIAs. Determining the client’s needs and how an FIA’s liquidity features fit those needs will continue to be a key concept for the industry.
Danette Kennedy is president of Gorilla Insurance Marketing, Inc. Waukee, Iowa. Her e-mail address is [email protected]