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Life Health > Annuities

Immediate Annuities as Longevity Insurance

By Ed McCarthy, CFP, RICP

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Immediate annuities continue to draw attention as a financial planning tool but that’s not translating to higher growth for the products. LIMRA’s stats showed a decline of 10% in fixed immediate sales from 2008.

According to the Insured Retirement Institute’s figures, fixed income annuities accounted for 8.4% of the fourth quarter 2009′s fixed annuity market share, averaging about $1.9 billion per quarter for the year. The flat sales certainly can be attributed at least partly to low interest rates; nonetheless, advisors still find that it’s a viable solution in the right circumstances.

Cheryl Krueger, FSA and president of Growing Fortunes Financial Partners LLC in Schaumburg, Ill. recently met with a retired couple whose savings had been hit hard by the market crash. The clients received Social Security but no pension and the bulk of their savings had been rolled into an IRA. Based on the clients’ income goal, their (now former) advisor had recommended they move 100% of their portfolio into a variable annuity.

After meeting with the clients and analyzing alternatives, Krueger recommended they invest roughly one-third of the portfolio in an immediate fixed annuity, with the balance invested in a diversified mix of equity- and bond funds. They chose a joint-and-survivor annuity with a refund feature.

Krueger admits that current low interest rates were a concern but her analysis indicated the annuity was worthwhile.

“I calculate if you live 20 years, what’s your total rate of return that you would get from the annuity and if you live 30 years, what’s the total rate of return that you would get, because to me it’s really longevity insurance,” she says. “Also, many of my clients want to be able to pass on a large estate and for this particular client, that was not their main criteria — they really wanted to make sure they had enough income.”

Jerry Verseput, CFP, and president of Veripax Financial Management LLC in El Dorado Hills, Calif., recently worked with a newly widowed client who needed to create an “extremely low risk” income stream from the life insurance benefits she received.

After considering several investments, Verseput decided to use an annuity for the immediate-income “bucket” with the balance of the funds in slightly riskier investments including bonds and equities.

“I looked at a couple of options (for the annuity portion),” says Verseput. “There was an inflation-adjusted option, there was a 2 percent cost-of-living adjustment option, and there was the straight single life, no guarantee period.

“With the single life with no guarantee period, we could get starting from month one — which is when we needed to begin the income — about 33 percent more than the inflation-adjusted option and about 21 percent more than the cost-of-living adjustment,” explains Verseput. “We also looked at what if you have a guarantee period because in this case if she passed away a year from now, the rate of return wouldn’t look very good.

“But we weren’t trying to solve an inheritance problem — we were trying to solve a cash flow problem,” he concludes. “The best way to do that was to allocate a fourth of the portfolio to this annuity and then maximize the cash flow on that, which was single life, no guarantee period.”

Many advisors still believe that immediate annuities’ drawbacks outweigh there benefits, however. Stan Richelson, JD and representative with Scarsdale Investment Group Ltd. in Blue Bell, Pa., says there are multiple benefits to using individual bonds instead of annuities. “Probably the biggest one for many investors is that if you buy an annuity, you give away your principal and the insurance company becomes your heir,” says Richelson.

“While if you buy bonds, you get a stream of income, just like you get from the annuity, but you keep the principal,” Richelson shares. “Therefore it’s flexible if you need the principal at some point in the future.”

Richelson, who has written several books on bond investing, notes that adding features like refund options to annuities comes with a cost. “Every time you get a feature out of an insurance company, you pay a lot of money for it,” he says. “So every time you take away from the simple way of ‘I give you cash, you give me a stream of income,’ you’re going to reduce your rate of return. You could have that flexibility if you have your own bond portfolio.”

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