While there’s nothing unusual about volatility in stock markets, the big swings up and down we’ve experienced recently can amplify anxiety for those clients who are nearing retirement. Whether you are planning for the next correction or the next bear market, advisor-client conversations can focus around answering the following series of questions:

  • What are the available investment options to protect against a market correction?
  • Does it make sense to take some of the gains achieved over the past decade off the table?
  • How important is establishing a guaranteed source of income in achieving long-term goals?
  • What level of certainty is needed to achieve generational wealth transfer goals?

Making the Case for Annuities

With many clients experiencing double-digit growth in their portfolios over recent years, now may be the right time to explore annuities as they can provide certainty and guarantees for a portion of a client’s investable assets.

Originally designed to provide a guaranteed source of income, annuities have evolved over the years to fulfill particular areas of financial planning. Similar to other areas of the investment product universe, annuities have gone through many transformations, new product developments and enhancements over the last 20 years to keep pace with consumers demanding more from their portfolios.

Today, annuities are available in many different forms but one size does not fit all and they’re not for everyone. It’s critical for financial advisors and planners to thoroughly vet a client’s financial situation and needs to ensure the annuity product selected doesn’t do more harm than good.

However, selecting the right annuity product for the right client situation can be a powerful addition to a client’s overall investment strategy.

When is an annuity the right choice? Below are three different cases for consideration.

Case #1 – Must Have Income

Client Profile: Jason and Laura are a married couple. Jason is 67 years old, his wife Laura is 66 and both are retired. The couple has $2 million in investable assets spread out across IRAs, Roth IRAs, 401(k)’s and a joint-tenant with rights of survivorship (JTWROS) account. Their risk profile is ultra-conservative.

Planning Scenario: Jason and Laura have worked with their advisor to create a retirement budget and together they determined that the couple’s monthly income requirement is $11,000 ($132,000 annually). Neither Jason nor Laura have any guaranteed source of income outside of Social Security.

(Related: Making Retirement Income More Predictable)

The estimated annual Social Security payment for Jason is $26,000 and $31,000 for Laura; which means Social Security will meet roughly 43 percent of their $132,000 annual need. This means that the couple will need to draw down, or cash in, roughly 3.75 percent of their investable assets to close the remaining $75,000 income gap and satisfy their “must have” income needs.

Jason and Laura have mentioned to their advisor a desire to increase their guaranteed income sources to help reduce the chance of outliving their assets.

Suggestion: A variable annuity with a guaranteed lifetime withdrawal benefit. These are designed to provide a non-annuitized income stream for as long as either client is alive and may be a good option.

The suggested solution carves out 25 percent of investable assets ($500,000) and produces a guaranteed joint lifetime withdrawal rate of 5.75 percent, or a guaranteed annual income source of $29,000. When added to Jason and Laura’s Social Security payments, the clients now have nearly 65 percent of their income need being met with guarantees. The remaining income requirement of $46,000 can be drawn directly from their investable assets of $1.5 million, about 3.07 percent of the portfolio.

In this scenario, the annuity with a guaranteed lifetime withdrawal benefit solution increases the couple’s guaranteed income by 51 percent (from $57,000 to $86,000) and reduces the required drawdown on the remaining assets by approximately 18 percent (from 3.75 percent to 3.07 percent).

Case #2 — Safety of Principal

Client Profile: Patrick, 55, and Kathy, 51, are approaching retirement and want to reduce their investment risk. Patrick is young enough and comfortable with some risk, but knows preservation of principal is a top priority in their retirement years. Kathy is very conservative when it comes to investing and is always worried about balance fluctuations and losing value in their investable accounts.

Together, the couple has managed to save $1.5 million over the years; spread across qualified accounts and a JTWROS account they share. In addition, Kathy worked for the state and will receive a modest pension once she retires.

Scenario: Since current income isn’t a primary requirement, the couple is interested in exploring avenues to generate a return on their existing assets and defer taxes without the risk of losing what they already have saved. Their time horizon to retirement is 8–10 years. They are interested in investing roughly 10 percent of their JTWROS account assets in exchange for safety of principal and the potential to earn an annual return of 4-to-5 percent.

Suggestion: A fixed-indexed annuity without a guaranteed income rider could provide Kathy and Patrick growth potential, safety and an opportunity to take advantage of compounding returns. Compared to other investment vehicles, this type of annuity can offer competitive rates and strong guarantees.

(Related: Annuity ‘Strategies’ Don’t Work)

By committing to a five-year lockup period — fixed-indexed annuities often carry contingent deferred sales charges (CDSC) — and a cap on maximum return — currently around 6 percent — Patrick and Kathy can avoid negative returns in the S&P 500 Index but still participate in a portion of any upside gains.

Since fixed-index annuities have lockup periods and cap rates, it’s important that financial advisors fully explain the pros and cons of this type of investment when recommending them to a client. They should also clearly explain any compensation or fees the advisor stands to receive from the transaction.

Case #3 — Death Benefit Accumulation

Client Profile: Britt is a recent widow with three adult children. While two of her children are well-off financially, the third has struggled to build a portfolio. Britt is a conservative investor with $1.5 million in investable assets. She was the beneficiary of her husband’s life insurance policy when he passed away a few years ago and used those proceeds to pay off her mortgage to become debt free.

Scenario: Britt has a strong desire to leave all three children an inheritance and wants to build some certainty around that. She expressed to her advisor that she would like to protect a portion of her assets while maintaining the opportunity for growth and would like to pass this to the next generation. As a recent cancer survivor, she is presently unable to obtain life insurance coverage.

Suggestion: Britt should consider a variable annuity with a guaranteed death benefit. Regardless of how the market performs, this type of solution can provide her peace of mind by guaranteeing the death benefit balance will grow for 15 years (7 percent annually) or until 200 percent of the initial premium is reached.

In addition, each of Britt’s children will be able to select how they would like to receive their portion of the death benefit — lump sum, distributed over 5 years (annuitized), or stretched over their lifetime.

If they choose to stretch the payments over their lifetime they can continue the tax deferral on the remainder of the balance and add growth potential by keeping the balance invested.

In All Cases — Do What’s Best for the Client

When selected and positioned correctly, annuities can serve a vital role in a client’s financial plan. All annuities are not created equal however. There are many trade-offs and considerations when recommending an annuity to a client. These include the client’s risk tolerance, time horizon, potential tax consequences (ordinary income vs. short- and long-term capital gains), and, last but not least, the client’s goals and needs for the money.

When all of these elements line up an annuity can be a wonderful addition to a client’s portfolio. If one of these elements doesn’t align with the solution, utilization of an annuity could be less than ideal.

As financial advisors and planning professionals, it’s important for us to explore the entire financial landscape to help clients address many of the risks we all face in retirement.

(Related: Making Retirement Income More Predictable)


Jason Allen is senior advisor in the Wealth Management Consulting Department at 1st Global.

Jason Allen, CFP, CLU, CLTC, CAS, is the senior advisor in the Wealth Management Consulting Department at 1st Global. He assists affiliated advisors with the growth and success of their financial practices by providing them with the guidance, education and support they need to help their clients achieve their financial goals. He specializes in identifying clients’ insurance needs and works alongside advisors to offer insurance analysis and information on various carriers as well as the products available to 1st Global advisors. He began his career at 1st Global in 2007 and served as a wealth management consultant prior to receiving his promotion to senior advisor.