Simplifying Annuities Could Lead to Increased Take-Up

While annuities are not new to the retirement income marketplace, potential clients still hesitate to adopt them, even though they address a key worry: the fear of outliving retirement savings.

The most commonly cited reason for this hesitancy, according to experts, is the complexity of annuities.

“People try to compare [annuities] to other investments like a mutual fund or [collective investment trusts], and you can’t,” says Sri Reddy, a senior vice president of retirement income solutions at Principal Financial Group.

Most investment funds or CITs have a manager who is paid to invest in underlying assets, and returns depend entirely on market performance, but Reddy says annuities are not just investments. Depending on their type, annuities can offer protection against market loss; lifetime income to address longevity risk; or risk management through the insurer’s long-term fixed-income strategies. 

Streams of income for retirees have become essential as conventional forms of retirement evolve, according to Tamiko Toland, founder and CEO of 401(k) Annuity Hub. Toland, like other industry professionals, urges advisers to educate sponsors and retirees on exactly how annuities work, as well as to address negative perceptions that may be holding clients back from purchasing a guaranteed income product.

“People love what annuities do, but they often don’t really understand the products, and they may have heard negative things,” Toland says.

The Freedom to Spend

Retirement has changed, according to Toland. Plans are no longer meant to just provide a lump sum of savings to draw from, but rather provide options for retirees, meeting their dynamic and unique needs.

“We’re at this transition from a retirement plan being a savings plan to truly … offering retirement options—and I don’t just mean annuities,” Toland says. “Retirement options also mean being able to offer a drawdown strategy of some kind, [not] just lifetime income. … They’re going to need to keep some money that they can tap into at will.”

According to a recent report released by J.P. Morgan Asset Management, spending for retirees fluctuates dramatically from year to year, with 60% of new retirees experiencing annual changes of 20% or more—in both directions.

The same report found that retirees with a higher proportion of guaranteed income, including annuities, were less fearful of spending during retirement.

Similarly, a LIMRA study, “Guaranteed Income: License to Spend,” found that retirees with assets that annuitize income spend twice as much as retirees with an equal amount of non-annuitized savings.

Covering Essentials

Toland says when pre-retirees plan for retirement, they need to first figure out their essential needs. Once they answer this key question, they can figure that at least half of essential expenses should be covered by Social Security, while the other half should be by another form of guaranteed income.

That is where annuities fit in.

“Essential expenses [are] very personal. … It could be, obviously, food, housing, transportation, medical care. But it [could] be very important to you to get your hair done,” Toland says. “Guaranteed income gives retirees the freedom to spend that money. You can spend your whole [guaranteed income] check and know there’s another one coming, … and that is so critical for giving people the license to spend.”

Once these non-discretionary expenses are covered, more risk can be taken to cover discretionary assets, meaning investments in equities can stay longer, with more exposure to market conditions needed to keep up with inflation.

Make It Simple

Before helping participants grasp the concept of annuities, advisers need to first understand what they are, says David Blanchett, head of retirement research at Prudential Financial and a PGIM portfolio manager.

One challenge, Blanchett says, is that product suites are “constantly evolving what’s available. They’re all so different, and the nuances are really important.”

The vast annuity product market has two main types, according to Blanchett. One is a living benefit rider, which sits on top of a portfolio and can be accessed at any time, and the other is often an irrevocable transfer, meaning the transfer cannot be modified or terminated without permission from the beneficiary.

Blanchett says the majority of annuities sold are living benefit riders, and guaranteed lifetime withdrawal benefits are the most common kind.

Two prominent types of irrevocable transfer annuities are single premium immediate annuities and deferred income annuities. Blanchett says SPIAs, via which clients pay an insurance company a lump sum (single premium) for a guaranteed income stream, are the “original lifetime income annuity.”

Vanguard made headlines this month by announcing a new target-date fund that incorporates a TIAA annuity. This announcement was significant because, as a popular target-date provider, Vanguard’s adoption is “a great signal to the marketplace that this is not just a trend that’s going to disappear,” according to Toland.

Winning Over Advisers

Reddy says advisers associate annuities with paperwork and administrative complexity, since they are usually purchased from third-party companies.

“The suitability standards can be enormous,” said Reddy.

But new digital platforms and business practices are starting a shift to a more seamless approach to annuity offerings, he added, which could make advisers more interested in recommending them.  

Once advisers and clients have an in-depth understanding of annuities, Toland says it will be easier to “bridge the grab gap.”

“It’s one thing to say, ‘I like the sound of that,’ and it’s another thing to say, ‘I’m willing to commit my savings to that,” Toland says. “Show them how it’s going to fit into their plan and make it easy for them to then implement that.”

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