Displaying items by tag: FIAs
A combination of factors have thrust annuities into the spotlight recently. These include super low interest rates, market volatility, and a major demographic trend of retirees. With that in mind, instead of talking about annuities’ benefits, we thought it would be worth some time to focus on their downsides. Given the audience of this article (advisors), we will leave out some of the ways annuities have been mis-sold and focus on the underlying products. In terms of their core drawbacks, there are essentially three: limited upside, surrender fees, and fixed payments. Limited upside should be fairly obvious, but most annuities limit the potential upside buyers can earn in exchange for principal protection and/or fixed payments. Surrender fees are another issue, as buyers can be hit with 7-10% “surrender” fees if they try to get out of the contract and receive their principal back. And finally, fixed payments lose value quickly, especially over a long-time horizon, because of inflation.
FINSUM: Annuities are as useful as the client you are selling them to. They definitely have a role in a portfolio, but their risks and benefits need to be well understood—which has not always been the case! One key issue is that many times the same reason people need annuities—retirement cash flow security—means they are at risk of exercising one of annuities biggest downside: surrender fees.
Most investors don’t fully understand the differences and benefits between fixed annuities, variable annuities, and fixed index annuities, so it is only natural that most clients would not even begin to understand deferred annuities and their benefits. Deferred annuities work just like other types of annuities except they explicitly defer any payouts for a set number of years. It is essentially a lump sum that gets invested, with no planned withdrawals for, say, 20 years. In many ways that makes them like an IRA. These can be very useful for clients who have are conservative in their outlook, have a nest egg to buy an annuity, and don’t need income right away.
FINSUM: In our view this is a perfect product for Millennials and Gen X who are 15 years or more from retirement. It is like a self-funded IRA and completely fits with Millennials’ bearish view of markets and the economy. It may also be a good choice for clients who tend to overspend, as this can do a good job protecting them from themselves.
If there is a product that looks like it has a great ten-year horizon ahead of it, it might just be annuities. Just like eSports and electric vehicles seem to have a great demographic trend behind them, annuities will ride a wave of retirees into great success. However, that is not the only tailwind. The other is ultra-low interest rates, which have completely upended the role of bonds in a portfolio. They yield very little and have a great deal of risk. Understanding that, annuities have a very interesting role to play, as between the three major types: fixed, variable, and fixed index, they offer a range of options that can help replace bonds. Fixed annuities offer set guaranteed income, variable give banded income but offer some upside, and fixed index work as a hybrid between the two.
FINSUM: Annuities have gotten a bad reputation over the years because of some high fees and bad actors, but product suites have gotten better. They can really round out a client’s need for low volatility income.
Here is a non-sensical but fully logical sentence for you: bonds just aren’t “bonds” right now. What we mean is that bonds simply aren’t fulfilling their long-understood role any longer. They yield very little and have a great deal of risk—both the opposite of their traditional role. So where can advisors turn? One increasingly interesting area is annuities, and fixed index annuities in particular. They offer the downside protection investors need, and upside participation everyone wants. Principal is never put at risk to the market, but interest from the initial purchase is used to participate in upside. In other words, you have principal protection with some upside potential—just like bonds have traditionally been used.
FINSUM: Fixed index annuities seem to be a very good alternative to bonds in the current environment.
Fixed Index Annuities have suffered from some bad selling practices over the years, and resultantly, bad publicity. However, they can serve some very important roles in a portfolio. There are a few things to remember about them. Firstly, they were designed to compete with CD-like returns while giving complete principal protection. Don’t think of them as a market growth product, they are a life insurance product. Additionally, they are a very good vehicle for income rider guarantees, or contractually agreed guaranteed income. This latter point is especially relevant given that 10,000 Baby Boomers are reaching retirement age every day and we live in a near pension-less world.
FINSUM: When carefully considered and utilized, FIAs can be excellent products that provide steady income and peace of mind.