This is the fourth in a series of articles that will be published on the annuity space.
According to the Gallup organization, a majority of non-retired Americans do not believe that they will have enough money to live comfortably in retirement. In 2002, 59 percent believed they would have enough money in retirement, while 32 percent did not. By 2011, the number believing they would have sufficient funds had declined to just 42 percent, while 53 percent believed otherwise.1 Faced with concerns about financial security in retirement, retirees must decide how much of their savings to spend at any time. Increasing longevity creates additional uncertainty. If resources are consumed too quickly, they may outlive their assets. Conversely, spending too little may impact their quality of life in retirement.
Purchasing an immediate annuity is a common recommendation for retirees looking to maximize retirement spending. One commentator notes that “[t]here appears to be universal agreement among financial economists and pension actuaries about the substantial social welfare benefits from payout (or immediate) annuity contracts. But the public and the media have yet to embrace this risk management instrument as being equally important as a well-diversified retirement portfolio of stock and bonds.”2 For a variety of reasons, the public has not embraced payout annuities as a financial solution to bridge the gap between accumulating wealth and guaranteeing retirement income payments. Industry studies point to “consumers’ reluctance to relinquish complete control over their assets by making such a purchase.”3 In recent years, academics have attempted to better understand the public’s reluctance to annuitize, and some have described products that they believe will encourage more use of longevity products. To address this issue, insurance companies are actively developing innovative products that can help meet clients’ needs for guaranteed income in retirement outside of traditional payout annuities. One focus of these products has been on providing benefits for late-life protection, rather than near-term income.
A contingent deferred annuity (CDA) is designed to offer protections similar to those provided by a guaranteed lifetime withdrawal benefit (GLWB), but does not require the purchase of an underlying variable annuity. The CDA isolates the “pure longevity” feature of the guaranteed withdrawal benefit, making it available to an array of individuals who do not want to buy a traditional deferred variable annuity simply to obtain the living benefit guarantee associated with it. The CDA benefit is an adjunct to an investment account owned and (subject to certain allocation constraints) controlled by the contractor holder. It is linked to the performance of an investment account that is not a life insurance company separate account.
Like any new product, a number of issues must be successfully addressed for the CDA to become a mainstream annuity product. First, the regulatory and tax treatment must be clarified. More importantly, however, the product must achieve market acceptance. On the regulatory front, after some discussions at the NAIC related to the nature of a CDA, earlier this year the NAIC CDA Subgroup concluded that because of the presence of life contingent pricing components, CDAs are best written through life companies. Noting that these products resemble GLWB riders with variable annuities, and that many of the regulatory issues apply, the Subgroup recommended to the A Committee that a new Working Group be formed to evaluate the solvency and consumer protections appropriate for CDAs. That process is currently under way.
With respect to tax, two issues needed clarification. The first was to confirm that a CDA was, in fact, an annuity contract under the Internal Revenue Code. Second, it was necessary to determine that the presence of the CDA would not affect the taxation of the underlying asset account, but would preserve the normal tax attributes of the underlying mutual funds. In a series of private letter rulings, the Internal Revenue Service determined that the products that were the subject of the ruling were annuities under Internal Revenue Code Section 72, and did not affect the treatment of the taxation of the underlying funds, providing clarification of the tax status of the products.4