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Marrying fixed index annuities with actively managed accounts

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Editor’s note: The following article is excerpted from a white paper produced by Dressander|BHC.

While it is cliché to state that all clients are unique — and indeed all investors have unique needs and face different circumstances — those planning for retirement are choosing annuities more often than not as one of the many investment options provided to them by investment professionals.

In the past five years, we have seen more than $1 trillion placed in some type of an annuity, and the only segment of industry growth is in the category known as fixed index annuities (FIAs). These products are a natural evolution of the traditional fixed insurance product that offers one method of crediting interest.

FIAs offer owners the opportunity to receive interest based on positive changes in a financial market’s index coupled with insurance guarantees of purchase payments and minimum rates of interest. In other words, fixed index annuities offer guaranteed preservation of purchase payments with the potential for growth in value.

The case for fixed index annuities

Investment professionals today, especially those who list retirement planning as a core component of their practice, are challenged with volatile markets, low interest rates, rising health care costs and the fact that married couples today have a 25 to 50 percent change of living well into their 90s. These factors, when considered in the aggregate, can present an insurmountable series of roadblocks unless there is proper and efficient allocation of retiree’s assets.

Once upon a time, retirement planning was fairly easy. After a working career ended, many people were covered by a lifetime pension. Bonds and bank accounts paid 5 percent to 7 percent on average, creating comfortable flows of income.

Those days are long gone. Today, pensions are few and far between with only 25 percent of U.S.-based companies currently offering them down from more than 90 percent in 1998, according to Considering this trend along with increased longevity, money has to last longer than it ever has before.

Meanwhile, interest rates on shorter term bonds and bank accounts hover between zero and 2 percent. The stock market has risen to a point that is overvalued by most standards. Some sources, such as the “CAPE/Schiller Index,” are projecting average per-year returns over the next 10 years at less than 1 percent on the S&P 500. Translation: a crapshoot for the retired person.

Long-term care wasn’t as critical an issue 30 years ago with mortality rates in the mid-70s. Nursing home populations in America were a fraction of what they are today and the cost for such care was in the hundreds of dollars per month, compared to today’s costs which can approach $10,000 per month.

Many consumers are well aware of the benefits annuities provide but have become extremely risk averse and cost conscious, making the fixed index annuity an attractive alternative to variable annuities where the costs can exceed 4 percent when an income rider is part of the policy — which is the case in 70 to 80 percent of contracts written.

Coupled with the market risk inherent in a variable annuity, witnessed by many who held these contracts during the recent 2008-2009 market decline, sales have softened for these types of policies after peaking in 2007 at $184 billion to less than $140 billion in 2014, according to LIMRA Secure Retirement Institute.

Annuities and comprehensive retirement planning

With this list of current concerns, we have a Dickensian scenario reminiscent of A Tale of Two Cities where it appears to be both “the worst of times but also the best of times,” given the availability and breadth of today’s investment solutions.

Today’s retirement planning specialists generally agree you must have the ability to address the following in any sound plan:

    • Liquidity
    • Lifetime income, both near term and long term (preferably guaranteed)
    • Long-term growth capital and emergency capital

Beyond these, advisors differ greatly in their priorities. Some wish to address potential health concerns and emphasize a long-term care provision. Some retirees want to leave more for beneficiaries requiring a greater emphasis on life insurance.

No matter what your idea of a solid financial plan is, fiduciary protocol dictates the following be covered at a minimum:

    1. Preserve capital to the best possible degree and for the longest time possible.
    2. Create a reliable and sustainable income that cannot be outlived.
    3. Maintain ample liquidity as well as investments that have the potential to grow over the long term in order to offset inflation.
    4. Ensure important outcomes like long-term care, money for beneficiaries, and extra income to battle inflation down the road.

In addressing these particular objectives, a variety of investment options serve as worthy solutions, as each form of financial vehicle addresses a different goal. For example, when looking for potential diversified growth over long periods of time, mutual funds and ETFs may be the vehicles of choice. On the other hand, if you’re looking for a secure floor under your money with protection of principal, mutual funds and ETFs won’t do.

Bank CDs and treasury bonds can address guarantees of principal, but with current rates at generational lows, they may not be deemed as viable as they fail to yield the rates of return “retirees” have come to expect. When it comes to generating income that cannot be outlived, only an annuity can provide the level of returns on a guaranteed basis that are both reliable and sustainable.

Annuities come in a number of versions and as mentioned earlier, fixed index annuities are gathering favor and are being placed in portfolios as a result of clients becoming more risk averse and cost conscious. The current economic backdrop and consumer mindset are the drivers behind the growth of FIAs as these products yield the highest amount of potential income at the lowest cost while not subjecting clients to market risk.

Variable annuities can only do well in one kind of market: a bull market. In sideways and down markets, the fees combined with the losses accelerate the depletion of capital.

While many RIAs and other investment professionals feature actively managed accounts, they realize the risk of an over reliance on a singular approach in addressing their fiduciary responsibility. To mitigate this risk, many have adopted a method known as the ABC Planning Process. It involves placing various financial products in different segments (A, B or C) in order to address a specific set of objectives.

Here is an example of what this approach might look like:

The case for fixed indexed annuities

Column A: Yellow Money

Cash/money that is liquid. These are bank assets like CDs, saving and checking accounts, money market accounts and even IRAs. They can be taxable or tax-deferred, depending on how they are set up. The prin­cipal is protected and you are simply adding interest to the account.

Column B: Green Money

Moderate growth/tax-deferred/moderately liquid/safe money vehicles: Annuities (MYGAs, SPIAs or FIAs with income rider), cash-value life insurance products. Protected principal. Growth is linked to the performance of an index and credited as interest. Once interest is credited, it can never be lost regardless of what happens in the market.

Column C: Red Money

Assets that are in the market and subject to market swings (up and down). These are securities like stocks, mutual funds, intermedi­ate/long-term bonds, treasuries, etc. These can be actively man­aged accounts/professionally managed by brokers/brokerage companies, or personally man­aged, or they can be passively managed accounts. There is no limit to the upside earning potential of these assets. However, last year’s gains could be lost in the downturn of the market.

Today’s fixed index annuities offer a value proposition that makes them highly suitable for many pre- and post-retirement investors, specifically a benefit suite that combines income predictability and growth potential with downside protection of principal.

In 2010, six PhDs at the Wharton School of Business conducted a two-year study of FIAs, comparing them to four other asset classes over the prior 14 years. In an interview after the study concluded, the lead author, Dr. David Babbel, stated that the FIAs “performed quite well … indeed they dominated the alternatives,” and that “some have performed better … than (bonds), equity-funds, (and) money markets in any combination.”

Historically, FIAs have been sold by insurance agents and were shunned by brokerage firms and the security industry. In 2014, there were 44 companies offering 258 different index annuity products nationally. This year there are 49 such firms offering just under 300 different products, continuing the trend first begun in 1995. Among them are the very brokerage firms who were the loudest in maligning them just a few years ago.

We have seen an embracing of FIAs by the Wall Street community and with variable annuity carriers either limiting their availability or leaving the space altogether, it bodes well for the upward trend in FIA sales to continue for the foreseeable future.

The benefits of positioning fixed index annuities

For clients:

    • A floor on the premium placed in a fixed index annuity as this money isn’t subject to loss in the event of a downturn in the equity markets.
    • Ability to participate in the potential for higher returns relative to other principal protection vehicles.
    • Ability to participate in a percentage of the upside movement of the equity markets and locking in those gains as a result of the annual reset feature.
    • A fee structure which is transparent at a percentage of the cost of a comparable variable annuity.
    • Many FIAs provide for the income base to be passed on to beneficiaries upon owner’s death.
    • Deferring income in an FIA for just 3-5 years can result in a significant increase of withdrawal rates for a 60-year-old from 4 to 6 percent at age 65 and for a 70-year-old from 6 to 8 percent at age 75.
    • Ability to address concerns of longevity, outliving one’s money, disability, incapacitation, future health care costs and income multipliers for long-term care.

For FINRA registered advisors and RIAs:

    • An alternative to low yielding conservative allocations to hedge against longevity and rising health care costs.
    • Allows the investment professional to be as “active” as necessary in other areas of the wealth management process.
    • Provides a range of interest crediting methods with both capped and uncapped strategies managed by leading investment banks.
    • Provides an ongoing income stream due to the variety of compensation options available including trail-based compensation.
    • Trail-based compensation (recurring compensation) which isn’t exposed to a fee structure or potential market downturn, therefore prolonging the contract value upon which the trail compensation is determined.

See also:

Fixed index annuities: Sales growing, products evolving

FIA facts: 10 fixed index annuities truths

Helping clients understand fixed index annuities

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