Fixed Annuities
Helping Consumers Understand the
Value of Fixed Income Annuities

 

by Holt McGee

Traditionally, consumers have shied away from annuities in favor of alternative investment vehicles or products they are more familiar with, such as mutual funds and certificates-of-deposit. Just over a year ago, these popular investments were performing well and account balances looked good on paper. Since then, the financial markets have suffered some trauma and many people have -noticed significant drops in their retirement portfolios, forcing them to make decisions about their retirement investing approach.

Financial professionals have also been slow to warm to annuities; they are finding that their clients need to protect at least a portion of their retirement savings with guarantees that only an insurance product can provide. Guarantees are particularly important during market downturns and such guarantees cannot be found in today’s traditional investment vehicles.

In a recent MetLife poll, consumers responded overwhelmingly that they are interested in products that provide protections against market risk. There are deep fissures in the retirement landscape due to the recession and losses in defined contribution plans, such as 401(k) plans, and in other savings and investment vehicles; not to mention the fact that the number of working people covered by traditional defined benefit pension plans has shrunk to approximately 31% compared to 57% 20 years ago, according to a recent study by the Employee Benefit Research Institute. Today, Americans typically have no guaranteed source of retirement income, aside from their future Social Security benefits, meaning that the financial burden is on the client to generate enough income to last throughout retirement.

Unfortunately, many discover, too late, that their bag of cash is not big enough to cover needs and wants throughout retirement. This is especially true after the recent market meltdown. However, there are ways for financial professionals to help consumers create their own version of a -personal pension plan with income annuities.

A Flock to Guarantees

Today’s economic turmoil has shined a spotlight on the need to create a guaranteed steady stream of income in retirement. Annuities are beginning to gain some popularity among consumers and formerly skeptical financial professionals.

Total fixed annuity sales have increased significantly; sales grew to $28.6 billion, which is an 11% increase from the second quarter of 2008. Year-to-date, sales totaled $64.2 billion, which is a 39% increase year-to-date, according to LIMRA. Additionally, 70% of retirees describe themselves as fiscally conservative in 2009 compared to 53% in 2008.

Like traditional defined benefit pension plans, fixed income annuities are designed to provide guaranteed consistent payments that won’t change, even during market fluctuations. A primary goal of any solid retirement plan is to be able to pay for fixed monthly expenses with the most efficient, reliable income.

Consumers must look at their annual fixed costs, such as food, housing, medical and insurance expenses, and assess how much money they may need. Then, they’ll need to take into account any regular income, such as Social Security. Any gap, which would have been filled by a defined benefit pension plan, can now be filled by an income annuity, so the consumer can take comfort knowing that their monthly expenses are covered. But consumers should consider keeping some of their savings liquid for emergencies and they may also want to keep other assets invested for growth to combat inflation.

Income Now or Later

Most people can’t sustain a comfortable living in retirement with only one or two investments in traditional product classes, such as mutual funds and money market accounts. The longevity risk of depleting investments without lifetime guarantees is too high.

It is generally understood that annuities can provide guaranteed income for the rest of a person’s life. That’s a critical component to any retirement plan since all retirees face a longevity risk. (Guarantees are subject to the financial strength and claims paying ability of the issuing insurance company.)

A financial professional may recommend a fixed income annuity to a client who needs income now. It could provide higher payouts than what the client would have been able to generate with traditional withdrawal strategies, thereby allowing them to stretch their money as far as possible.
For example, a 65-year-old man with $500,000 in savings and investments would get $20,000 annually before taxes, using what many experts believe to be a safe withdrawal rate of 4%. Suppose he allocates a portion to an income annuity ($165,000 or one-third in this example). Using current tables and assumptions, the annuity would produce guaranteed income of $11,900.

If the remaining (two-thirds) $335,000 assets, which had been left in savings and investments, were withdrawn at the 4% rate, they would provide an initial annual income of $13,400. The client would have a total income of around $25,000 ($11,900 + $13,400) annually before taxes, which is 25% more.

(Income annuity payment rates in this example assume the Annuity 2000 Mortality table and a 4% interest rate and are not guaranteed. Actual income payments are based on an insurance company’s annuity purchase rates in effect when a purchase payment is received. Ordinary income taxes apply to income payments.)

By dedicating a portion of savings to a fixed income annuity, the retiree can benefit from a three integral facets of immediate annuities and gain a LEG up, so to speak:
• Leverage (higher income-to-asset ratio derived from mortality pooling).
• Efficiency (relatively high level of income generated from an accumulated investment).
• Guaranteed income for life.

Think Product Allocation

In addition to income annuities, other retirement income vehicles should always be considered. A personalized combination of three different income solutions could be considered to maximize the sustainability of income in retirement:
1) Systematic withdraws from traditional investments.
2) Variable annuities with guaranteed living benefits.
3) Fixed income annuities.
This combination can result in a higher level of retirement income than just relying on a traditional withdrawal approach. It also benefits from a higher level of guarantees. In essence it becomes a repair strategy for depleted portfolios, and therein increases the retiree’s peace of mind.

Building a Personal Safety Net

Advisors can overcome many of the barriers to selling annuities by following the do-it-yourself personal pension approach. Consumers have shied away from annuities in favor of alternative investment vehicles or products they are more familiar with, such as mutual funds and CDs. But now is the time to take advantage of a growing need for protection and guarantees for retirement investment vehicles.
By using the pension comparisons to help consumers view annuities as a familiar vehicle, advisors have an opportunity to rebut many common consumer objections and help bring clarity to a valuable but often misunderstood product. Most importantly, advisors can help consumers create invaluable guaranteed lifetime income in retirement at higher sustainable levels, salvaging the retirement dreams of many Americans.
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Holt McGee is national sales director, Annuities, for MetLife.