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Most financial advisors today are probably spending a lot of time helping baby boomers plan for retirement. Chances are at some point in your career you have run across annuities, but do you really understand them? You may not realize that annuities can be a solid foundation for a client who needs predictable, stable, lifetime income. With the need for reliable income streams in such high demand and the financial crisis of 2008 so fresh in investors’ minds, it is hard to imagine retirement planning without using annuities; However, it was not so long ago that annuities were simply marketed and used as a tax-deferred investment vehicle by insurance companies. For one reason or another, annuities seem to have had a negative connotation. Bring up the word annuity in your next client meeting and watch the facial reaction of your client. Maybe it is due to the higher fees than a traditional mutual fund or the negative press; after all who can forget the infamous Suze Orman clip?

From pensions to 401(k)s

In the 1990s you would have had a very difficult time finding an annuity with anything more than the standard death benefit and annuitization options to prevent outliving ones assets. It was a plain vanilla time in the annuity industry. At some point early in the 21st century, insurance companies foresaw the need for a product revival, or perhaps a product rebirth, for the annuity.

The baby boomer generation, with their vast amount of assets in 401(k)s, would need to find a new home and a new purpose for all of that money: lifetime income. Not only do baby boomers make up the largest part of the American workforce, they are the first generation in American history retiring without having the security of pensions. Most American corporations shifted away from defined benefit plans, or pensions, and into the 401(k) market back in the 1980s. With advancements in medicine, a low interest rate environment, and a shift to “self-accountability,” the market was almost primed for the rebirth of annuities. Never before have we seen such a large group of working Americans retiring being responsible for their own income and living so long. 

When annuities first began offering lifetime income benefits or living benefit riders, the industry primarily used “GLIB” benefits. Guaranteed Living Income Benefit (GLIB) riders offered policyholders a guaranteed step-up every year during their accumulation years on the premium. The typical range was between 5 percent and 7 percent during the early 2000s. The attractive selling point of this rider was the client’s ability to invest in the market and have a minimum guaranteed return on their premium for future income needs.

Unfortunately for most clients, the product was very complicated and as a result it took a lot of number crunching to see if it really made sense to invest in this type of annuity. You could not walk away with that guaranteed amount and it required the contract holder to annuitize the contract over their lifetime. Typically, the insurance company would set a minimum time the client needed to be in deferral as well, usually around 10 years. The insurance company would also calculate the amount of the future income using older tables at the time the contract was written. While this contract sounded great, it may have taken a lifetime to truly get the return most clients thought they were signing up for when opening the contract. Usually the client had to live 25 to 30 years to really get that 5 percent to 7 percent value. Once the client annuitized they also lost the control of the asset and the death benefit associated with it. 

A new day

Today, you would have a very difficult time finding a contract that offered this type of rider due to the annuitization requirements and the complexity of the investment vehicle rider. Most insurance companies replaced GLIB riders with a simple, easy to understand GWB rider. The GWB rider refers to the Guarantee Withdraw Benefit rider that you can still find on many annuity contracts today. Unlike the first rider most companies offered, the GWB does not require the contract owner to annuitize. This means that the policy owner does not lose control of the investment or the death benefit associated with it. It was also very easy to explain to clients that they would be able to withdraw 5 percent of their account value at age X rather than explaining what annuitization meant. 

With the Guaranteed Withdraw Benefit riders, most insurance companies included some sort of minimum step-up guarantee for each year the policyholder deferred taking income. Again, most contracts in the early part of this century offered 5 percent to 7 percent step-ups every year. The obvious attraction was that it was an innovative way to offer lifetime income and a hedge every year if the stock market went bust for that income to grow while in deferral. What stock, bond, mutual fund, or commodity trade could do this?

It seemed as if the insurance industry had found a solution that would fill a need for the baby boomers: lifetime income along with the ability to have control of the investment. Little did the insurance industry know that in 2008 everything was about to change!

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