If you could only see a portion of an artist’s painting, would you be able to guess the story he or she was trying to tell? It’s highly unlikely, right? The same is true if you are only looking at a portion of an annuity and trying to determine if it fits within your client’s story.
Before any recommendation or plan can be developed, we must consider the entire annuity picture, starting with the demographics of nonqualified annuity purchasers. A quick Google search reveals numerous conclusions about the predominant buyers of nonqualified annuities.
Over the years, it does not appear that the results have varied much: Middle-income Americans earning less than $100,000 each year are the most common purchasers of this product. That’s good news because, of course, this is a very large market. There are a lot more middle-class investors than affluent investors — though some of them buy annuities, too.
Now, what’s the average age of an annuity purchaser? Some estimates show that 30 percent are age 72 and older. As one would expect, age does differ somewhat depending on the type of annuity purchased. Younger purchasers will have a different objective for annuities than retired purchasers looking for immediate income replacement.
Why an annuity?
Why do these groups buy annuities? There are many articles, studies and surveys that attempt to answer this question. Many of them give the following reasons:
- For supplemental retirement income
- To have funds to purchase care following the onset of a serious illness
- For income for a spouse in the event of his or her death
How do the characteristics of an annuity help us see the whole picture? We must first consider demographics and age as discussed above.
- Single premium annuities work well for clients who receive funds from their employers’ qualified plan or, perhaps, as part of a severance package. As baby boomers continue to age, funds can also be from a recent inheritance.
- Single premium immediate annuities work well for clients who are newly retired and are looking to supplement their income.
- Single premium deferred annuities can provide funds for both the second and third bullet points above.
- Flexible premium annuities also work well for these points because they allow the contract owner to pay more into the annuity when their cash flow allows, providing the opportunity to save even more for retirement.
Reviewing the details
Surrender charges should always play a role in reviewing the whole annuity picture. It is important that clients not only understand surrender charges and how they impact withdrawals, but also that the client’s age, financial situation and future plans are considered when determining if a product makes sense for the individual.
Other things that must be considered: the payout timeline and start date, the lives covered by the annuity, death benefit options, annuitization methods and what type of riders, if any, should be added to the product.
Adding fixed annuities
Is our picture now complete? Not quite yet. We still need to determine which type of fixed annuity should be represented. Each type serves a purpose and has the potential to change the landscape of our picture.
- Traditional declared-rate annuities will establish both a first year and renewal interest rate to be credited. Depending on several circumstances — volatility of interest rates, the economy, etc. –the frequency of a new interest rate can and does vary.
- A bonus annuity is a deferred annuity, which typically offers a first-year interest crediting rate that is greater than the rate anticipated for future years.
- A multi-year guarantee annuity is a fixed annuity, as well; however, the current interest rate is guaranteed for a period longer than one year.
- An indexed annuity provides the client with the opportunity to participate in market gains, but not in market losses.
It is impossible to determine which product is the best choice for your client without determining the client’s demographics, age, income and financial objectives.
A closing note
Finally, annuity taxation and the impact of pros and cons should always be considered when determining if an annuity fits your client’s story. Without this consideration, we have not really looked at the whole picture. Tax deferral; required minimum distributions; and qualified, nonqualified and early withdrawal penalties are all factors in determining the best solution for an individual’s situation.