Close-Up on Annuities
Don’t Let An Annuity Sale Leave Your Client Hanging Profiling Suitability–Targeting Safe Money Needs
by Kim O’Brien

There is a persistent misunderstanding on the suitability of fixed deferred annuities. Fixed deferred annuities offer life time guarantees and other benefits that set them apart from other financial products. The tax treatment of deferred annuities is different. If you understand these differences, you will see how these features are attractive to seniors, and more importantly, why fixed deferred annuities can be a suitable part of a senior’s financial plan.
They offer the ability to elect an income that cannot be outlived at guaranteed rates sometime in the distant future. This feature is unique to annuities for those who need certainty in the income portion of their portfolio. Insurance companies are stepping up to the plate to fill a need, given their unique capability for insuring longevity risk. In addition to specified guaranteed rates, at the customer’s discretion, the carriers generally offer to turn the deferred annuity into an income stream, which is guaranteed for a specific time frame, even for life. It is based on current factors that are generally even more favorable than the guaranteed rates.
The guarantees of fixed annuities are the primary appeal to an older population, a dynamic that has been universally recognized across the financial services industry. Given their ability to safeguard and insure principal and previously credited returns, insurance companies are in a unique position to meet the needs of seniors who are concerned about having their principal exposed to market risk. The convergence of this age group’s need and the unique ability of insurance carriers has created the substantial interest in fixed annuity products among seniors.
A secondary benefit of annuities is their tax-deferred nature. Accumulating and holding retirement funds in tax-deferred vehicles allows the asset to grow faster than they could in a similar, but taxable vehicle. Due to this significant advantage, Congress has imposed a 10% penalty for taxable amounts withdrawn before age 59 ½ in recognition of the public good of holding these products into retirement years. The tax treatment of deferred annuities lead to a significant proportion of owners over age 59 ½. Insurance companies have designed products in conformity with the tax laws and in response to the market demand for the product by those who have the most to gain from the benefits of these products.
Some casual observers say that tax-favored funds, such as IRA money and pension funds, should not be held in an annuity. The reasoning is that there is no benefit to using an annuity because they are already tax favored. They forget that guarantees and longevity insurance drive the use of the annuity in these situations.
Penalties for early withdrawal are common among financial products and annuities are no different. Still, most annuities include a variety of withdrawal provisions, some of which provide substantial withdrawal rights without penalty and without exposure to loss of principal through market risk. Circumstances that commonly allow for early withdrawal of the entire proceeds without penalty include death, terminal illness, nursing home confinement, required minimum distributions, and unemployment. Furthermore, most fixed annuities also allow for a specified annual withdrawal amount without penalty. The most common is a 10% of accumulated value penalty-free annual withdrawal. Other options may include interest (often cumulative) or a specified annual percentage amount that accumulates annually.
No other accumulation vehicle allows the owner to make withdrawals before the end of the penalty period without penalty fees or market risk to the asset. Surrender penalties are spelled out clearly in the contract.
The maturity date of the contract is also commonly misunderstood. A maturity date is a term of the contract required by state law. It is often the last date in which the funds must be dispersed. This legal requirement also ensures that the annuity complies with federal tax laws. Generally, surrender charges will be over before the maturity date is reached – in many cases long before the maturity date is reached. As indicated earlier, in most cases, there is liquidity each year and in many cases, the client can convert the proceeds to a stream of income before the maturity date without penalty.
In addition to tax-deferral, another significant tax benefit to recipients of Social Security benefits is particularly beneficial to older people. If a client’s income is above a certain provisional level, Social Security benefits can be taxed on up to 85% of the benefit amount at the client’s marginal tax rate. This is true even if the income is left to accumulate in a vehicle, such as a CD or is generally considered tax-free as with municipal bond interest. Returns left to accumulate in a deferred annuity escape current taxation and do not count in determining whether Security provisional benefits will be taxed and to what level they will be taxed. This is a significant benefit to customers, especially middle-class retirees who get a significant percentage of their income from Social Security and does not consume all of their assets for living expenses.
Finally, because an annuity is a contract, it generally passes to heirs through beneficiary provisions rather than through the probate process. For those without a will, this is one way to pass assets to a named beneficiary while not being subject to the intestacy provisions of the state and without the delays and costs associated with state probate. Since the cost of probating assets for a decedent can be significant, especially for middle-class retirees, this is another benefit to a senior who is wise enough to have some assets in a fixed deferred annuity.
In the end, these are the two most important principles of suitability:
1. 
Target safe money needs, not age or demographic.
2. 
Diversify products and risk by putting savings or investments into more than one financial product.
Suitability is always a matter for individual determination. Only a well-informed client can make an appropriate decision. Therefore, it is important to communicate all of the features and benefits of a fixed annuity to a prospective buyer fairly and accurately. q
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Kim O’Brien, CFP, MBA is executive director of NAFA Kim has been in the life and annuity insurance business for 28 years. Previously, Kim owned American Brokerage, LLC and received the 2002 Entrepreneur Award from Sun Life. Prior to American Brokerage, LLC, Kim served as executive director of Marketing and Product Management at Clarica. She previously headed the marketing department for life insurance, individual health, group health, and student health plans for Fortis Insurance Company now Assurant Health. In 1989, she was executive director of the CIGNA/WEA 403(b) Trust. She received her BA from Ripon College, her MFA from the University of Northern Colorado, and an MBA from Edgewood College, Madison, Wisconsin. Kim and her husband Kelly have been married for 30 years and live in Milwaukee, Wisconsin where there favorite activity is running along Lake Michigan with their two Irish Setters, Bailey and Darby.