Annuities Are Potentially More Useful Today Than Ever

Anxiety about turning DC plan assets into a “lifetime retirement paycheck” in such a low-rate environment is keeping aging Americans in the workforce—including many who very likely have enough money saved to retire comfortably and don’t want to keep working.

David Lau, founder and CEO of DPL Financial Partners, a firm that bills itself as a commission-free insurance network for retirement plan and wealth management fiduciaries, uses a personal story to explain the source of his deep interest in the topics of income insurance and annuities.

“Watching my father’s experience during his late career really drove me to become interested in annuities,” Lau says. “My dad was a successful professional who by the end of his career clearly had enough assets saved for retirement, but he kept working for five or six years after the traditional retirement age.”

Lau and his other family members assumed their father simply liked to work and would never hang it up willingly. In reality, Lau’s father choose to keep working because he thought he had to.

According to Lau, his father’s long-term financial adviser had very little knowledge about—and thus very little help to give with—the decumulation phase of retirement and wealth planning. As a result, Lau says, his father was not presented with the clear and compelling evidence that he had amassed enough wealth to retire comfortably. There were no retirement income projections being given, no estimations of future living expenses, and no distinctions being made between discretionary and required income.

“As soon as I had the chance to sit down with my dad and his adviser and ask about the retirement paycheck, I could see immediately that the adviser had a totally lackadaisical approach when it came to planning for spending in retirement,” Lau recalls. “The best he could say was, ‘We’ll figure it out as we go along.’ Hearing this, we went out and found my dad a new adviser that was focused on real retirement planning. My father is now happily retired, and his only regret is that he hadn’t found this support sooner.”

With this anecdote in mind, Lau’s firm recently fielded a survey of some 200 advisers, the vast majority of them being fully independent registered investment advisers (RIAs). The goal was to learn more about what RIAs are doing in terms of serving and educating their clients on the retirement income topic. Do they discuss longevity? Annuitization? Expenses in retirement?

The results are compiled in a report that shows quite a divergence in the RIA industry in this matter. Very roughly speaking, about half of firms appear to be plugged into the “decumulation challenge” and are actively supporting clients when it comes to spending down their assets.

“When you look at the fact that bond returns are still so low relative to earlier periods when it was easy to just clip coupons as your retirement income strategy, this really puts the pressure on advisers to gain skills and knowledge in this area,” Lau says. “There are still so many advisers out there that cannot or simply do not discuss sequence of returns risk in a sophisticated way, for example. They don’t help their clients map out things like discretionary spending in retirement versus mandatory spending. The approach taken by many advisers is just too casual.”

Sampling some of the survey data points, Lau points out that 79% of RIAs say “predicable income” is more important to their retirement-focused clients than “asset growth.” Similarly, 70% of RIAs say these clients “value the certainty of not running out of money” over “achieving a certain retirement lifestyle.”

It is perhaps surprising to see, then, that only 14% of RIAs say their clients strongly like or somewhat like annuities, while more than quarter (27%) of RIAs “aren’t sure” what their clients think.

“These are disappointing figures to see, but they make sense given the fact that so many advisers aren’t talking about annuities with their clients,” Lau says. “Retirement savers are left with inaccurate biases about annuities.”

According to the survey, only 52% of advisers say they look to fund essential projected expenses differently than discretionary expenses. Further, the majority of advisers report generating retirement income for their client’s through a bucketing strategy or through advising them on safe withdrawal rates.

“In our opinion, bucketing is highly inefficient, given the returns on cash right now are almost nothing,” Lau says. “On the other hand, safe withdrawal rates are either going to leave wealth on the table or they are going to cause the retiree to run out of money. On the other hand, in the last decade, there has been a large amount of academic research focused on annuities and how to best use them in individual retirement planning. Thanks to this research, our survey shows, today 84% of advisers are aware that annuities can generate income more efficiently than traditional fixed-income investing. This shows RIAs are familiar with the current academic thinking about how to fund retirement, but the client understanding is just not there yet.”

If advisers could take one action based on these results, Lau says, it could be to ensure that clients understand just how diverse the annuity product set actually is. In particular, he encourages advisers to educate their clients about the fact that single premium immediate annuities (SPIAs)—the classic annuity structure people commonly think of, in which the full cash value of the annuitized portfolio is given to the insurer up front—represents only about 4% of the annuity marketplace.

“In reality, where the bulk of income generated out of annuities is coming from is out of variable annuities, or increasingly, fixed annuities,” Lau says. “With this approach, the income is in fact paid out through a rider, which means that the annuitized assets retain a cash value for the retiree, which depletes slowly over time in direct relation to the amount of income that has been paid to the individual. I think that better understanding about this fact will really drive greater use of annuities, because it is the immediate loss of control using SPIAs that makes people hesitant to annuitize.”

Notably, first quarter 2019 fixed annuity sales were $38 billion, a 38% increase compared with first quarter 2018, according to LIMRA Secure Retirement Institute (LIMRA SRI). As the First Quarter 2019 U.S. Retail Annuity Sales Survey shows, fixed annuity sales have outperformed variable annuity sales in 11 of the last 13 quarters. Overall, according to the survey report, U.S. annuity sales were $60.8 billion. This is an increase of 17% from the first quarter 2018 results.

Todd Giesing, annuity research director, points out that this is the highest first quarter for total annuity sales going back a decade.

“This is the strongest start for fixed annuities ever,” he says. “The uptick in fixed annuity sales continued the momentum fixed annuities experienced in 2018, and was bolstered by recent volatile equity markets, which had investors seeking solutions with guarantees.”

Giesing suggests the significant turbulence in the equity markets experienced in the fourth quarter of 2018 “really sparked a flight to safety.”