Four Steps To Selecting The Right Annuity

By Bill Martina

If you’re fairly new to the world of helping people prepare for retirement, here is something that may not be readily apparent. Financial professionals who offer a suite of diverse, well-structured annuity products that can be paired with optional lifetime income riders may be a boon to certain clients. In particular, the ideal clients for these annuity products are those who can benefit by shifting part of their product holdings from more traditional types of savings vehicles to income-producing vehicles. The process of determining which types of annuity products may be best suited to specific clients involves four primary steps.

We all know this, but let’s emphasize it: The first step in retirement planning or the sale of an annuity is to conduct a thorough assessment of the client’s current financial situation and potential future income needs. This assessment must be based on existing income, assets and expenses, as well as individual goals and circumstances. This first step also includes having the client estimate their projected expenses in retirement.  

Then, you’ll want to calculate the client’s anticipated retirement income from all sources, including any part-time job; alimony; Social Security benefits; pension; 401(k) or other personal retirement plan; dividends from stocks, mutual funds, etc.; interest on savings accounts, bonds, certificates of deposit (CDs) and other financial instruments, and any other sources.

I’m not about to imply that all of those income sources should be removed from a client’s portfolio or that annuities should comprise more than an incremental part of any overall, balanced retirement program. However, today’s low-yielding vehicles may not be enough to help meet your clients’ needs. Now could be an opportune time to consider layering a single premium immediate income annuity (SPIA) or a single premium deferred income annuity (DIA) into a repositioned income strategy for the client.

I’ll focus more on SPIAs and DIAs in a moment, but meanwhile, let’s move to step three of the retirement planning process. At this stage, you’ll want to determine the potential income gap in the client’s retirement income: the difference between what he or she likely will have, compared to the anticipated need. Numerous income sources can be considered, but many financial service professionals recommend planning in such a way that the client will have access, during retirement, to 70 percent of their pre-retirement income.

This brings us to step four: determining potential ways to help meet the projected income gap. Millions of consumers have money socked away in mutual funds, bonds, CDs, etc. In today’s interest rate environment, these products pay relatively low interest and/or provide no growth or income guarantees, yet they are perceived as relatively “safe.” (It is important to note that CDs are insured by the Federal Deposit Insurance Corp. up to certain limits and certain bonds may be considered more or less secure, depending upon the issuer and credit rating). It’s possible that some of this money may be utilized better if shifted to an SPIA or a DIA. Both SPIAs and DIAs are designed to produce a guaranteed stream of income payments that can continue for life, depending on the option chosen: an SPIA, starting immediately, and a DIA, starting at some later, predetermined point in time. Other annuities, like indexed annuities, may have optional lifetime income riders that a client can elect to help secure more money for the future.

We should note here that, unlike the other vehicles above, both SPIAs and DIAs involve the permanent conversion of the client’s purchase amount into the guaranteed income stream but – as with all insurance products – the benefits/payments are backed by the claims-paying ability of their issuing insurers.

DIAs may be a particularly attractive choice for certain clients; the allure of these products has been on the rise recently. As LIMRA president Bob Kerzner noted in his second quarter 2013 industry briefing, DIAs “remain a hot topic and they’re continuing to gain interest. Sales of DIAs reached $390 million in the first quarter.” He added, “Now, this is clearly a tiny piece of the total annuity market, but it is 144 percent higher than in the first quarter of 2012.”

Further, potential new rules could make DIAs even more attractive. According to an Advance Notice of Proposed Rulemaking that the Department of Labor issued on May 8, new rules being considered would require defined contribution (DC) plans — commonly 401(k), profit sharing or 403(b) plans — to provide benefit statement estimates of the lifetime stream of payments that each participant’s accrued account balance could produce.

Implementation of the proposed rules could make it easier for clients to understand their own financial positions: current and for future retirement purposes. What’s more, as Kerzner said, “especially if interest rates were to rise some, this could create much more interest in the immediate deferred income annuity.”

Annuities with “living benefits” (guaranteed lifetime benefits) merit a closer look, too. Of particular interest is a newer type of annuity which offers a simple crediting strategy along with a guaranteed future income stream and doubling of the income base to 200 percent of eligible premiums, if no withdrawals occur in the first 10 years of the contract. It can be paired with a rider that provides for the annual roll-up of a specified percentage to the income base in years during an income-crediting period in which no withdrawals are taken.

While a variety of annuity products can provide potential solutions for accumulation or income stream generation, depending on individual circumstances, clients should be aware of the widely-held view that annuities, especially SPIAs, generally are not appropriate for people who lack a sufficient source of emergency cash or other liquid types of assets. Surrender charges and tax penalties may apply for early withdrawals from many annuity and insurance products. But, regardless of any living benefit rider that may or may not have been elected with the products, retirement savings and potential income are maximized if principal is not touched during the product’s accumulation phase.

Client needs and goals vary, and the world of annuity products and riders evolves continually along with the regulatory and tax climate. It’s critical for clients to have well-trained financial professionals who know how to position products to help fill retirement gaps, who have significant knowledge of how the products are structured, and who understand how tax laws may affect the products. When considering annuities for clients’ retirement savings, look toward carriers that offer robust online educational resources (including educational resources for clients), but keep in mind that clients still will need to consult a qualified tax advisor.

Bill Martina is divisional vice president, American General Life Companies. Contact him at [email protected].