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 workforce.com. 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:
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- 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:
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- Preserve capital to the best possible degree and for the longest time possible.
- Create a reliable and sustainable income that cannot be outlived.
- Maintain ample liquidity as well as investments that have the potential to grow over the long term in order to offset inflation.
- 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.