Annuities: The next step in retirement planning

When retirement planning with a client, the transition from the accumulation phase (where the focus is on building wealth) to the decumulation phase (where the focus shifts to using that wealth to generate income) is a critical juncture.

During this shift, the primary goal is to ensure a steady and reliable income stream that can support a retiree’s lifestyle. Annuities can play a significant role in this phase, offering a blend of security and flexibility that can complement other retirement income sources.

Client example: Recently retired woman

The first step in incorporating annuities into a retirement plan is to thoroughly understand the client’s financial situation, risk tolerance and retirement goals. One of our recent clients is the perfect example.

Susan is a 65-year-old recently retired actuary. She has accumulated significant savings over her career. She is risk-averse and prioritizes a stable income to cover her living expenses. One of her goals is to delay taking Social Security for five years, until she reaches the age of 70. She also wishes to put off tapping into her individual retirement account until after age 70.

By truly understanding Susan’s goals, her financial professional was able to design and recommend a custom-tailored plan to suit her needs, consisting of two complementary annuity products for a portion of her nonqualified assets:

1. A five-year period-certain immediate annuity. This provides her with a guaranteed stream of monthly income, beginning immediately and continuing for five years (60 months), until she reaches the age of 70. This income stream enables her to cover the income gap, allowing her to delay taking Social Security (ultimately resulting in a higher benefit) and allowing her IRA to continue growing. Since an immediate annuity distributes both principal and income, the distributions are also tax-efficient.
2. A five-year single premium deferred annuity with fixed rate (MYGA). This allows Susan to achieve the maximum yield for a fixed interest rate product during the five-year period in which she receives monthly income from the immediate annuity referenced above.

Plan result: Susan adopted the plan as recommended by her financial professional. She was more than satisfied that her needs and goals were addressed. Interestingly, this plan combined decumulation (the immediate annuity) with accumulation (the MYGA) to best address this client’s unique situation and goals.

Ensure clients fully understand the breadth and depth of annuities

Annuities can play an important role in providing a consistent and stable income stream throughout retirement. However, many clients are unaware of the benefits and options available to them. Below are the relationship components we have found to drive consistent success with clients.

• Clear communication: Effective communication is crucial when discussing annuities with clients. It’s essential to explain the different types of annuities — fixed, variable and indexed — along with their respective benefits and drawbacks. For example, a fixed annuity offers a guaranteed rate of return, making it an excellent choice for risk-averse clients like Susan. On the other hand, a variable annuity allows for potential growth through investment in subaccounts, which may be more suitable for clients with a higher risk tolerance. Also, it’s essential to discuss the potential downsides, such as higher fees and market risk.
• Stream of income: One of the most significant advantages of annuities is their ability to provide a steady stream of income. This is particularly important during the decumulation phase, when the primary concern is ensuring that the retiree has sufficient funds to cover their living expenses. By emphasizing this advantage, financial professionals can help clients like Susan understand how annuities can provide a reliable income, much like a pension. It’s also important to discuss other income sources, such as Social Security and IRA distributions, to create a well-rounded income strategy.
• Consider inflation protection: Inflation can erode the value of fixed income over time, so it’s crucial to offer the option of annuities with inflation protection. This feature ensures that income keeps pace with rising costs, thereby maintaining the client’s purchasing power as the cost of living increases. It’s also important to discuss options to diversify the portfolio with other inflation-protected investments, such as Treasury Inflation-Protected Securities or real estate.
• Transparency: Transparency is vital when discussing the fees associated with annuities. Clients should understand the total cost and the trade-offs associated with it. High fees can erode returns, so it’s essential to strike a balance between cost and benefit. By being upfront with these costs, financial professionals can build trust and ensure that clients make informed decisions. It’s also important to compare these fees with those of other investment options to provide a comprehensive view.
• Regular reviews and adjustments: Retirement planning is an ongoing process, and regular reviews are essential to adjust for changes in the client’s financial situation or market conditions. Even a great financial plan should not run on autopilot. Encourage clients to review their annuity strategies periodically to ensure that the plan remains aligned with their goals. It’s also important to review other components of the retirement plan, such as investment performance and tax implications.

Use tools and resources from reputable financial institutions to offer clients comprehensive and accurate information and options. This can boost your credibility and the quality of your advice. For example, using financial planning software can help you model different scenarios and show clients the potential outcomes of various annuity strategies and other investment options.

Advise clients to diversify their retirement income sources, combining annuities with other investments to balance risk and return. This can help mitigate the impact of market volatility. A well-diversified portfolio can provide a more stable and predictable income stream, ensuring that clients like Susan have a secure financial future.

• Tax implications: Discuss the tax implications of annuity income and how they fit into the client’s overall tax strategy. Annuity income is generally taxed as ordinary income; therefore, clients should be aware of how this affects their tax liability. By addressing these implications, financial professionals can help clients optimize their financial plans. It’s also important to discuss other tax-efficient strategies, such as Roth conversions or tax-loss harvesting, to minimize the tax burden.

Financial professionals can help their clients navigate the decumulation phase of retirement and achieve their financial objectives. Annuities can be a valuable tool in ensuring a secure and comfortable retirement; however, they should be considered in conjunction with other investment options to create a well-rounded and balanced retirement plan.

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Jay Scheiner is CEO of ASG – An AmeriLife Company. Contact him at [email protected].