Annuities

The New Look of Variable Annuities
by Del Campbell

Your clients face greater financial uncertainty as reliable retirement income sources are leaving the landscape. New versions of annuities are starting to fill the vacuum left by the many defined benefit plans. Retirement assets in United States are in the trillions of dollars. About $3.6 trillion is sitting in deposits; $3.8 more is sitting in mutual funds with about $1 trillion in annuities. Roughly, $3.5 trillion (net) is going to move.
In the past, annuities were unpopular among those who wanted to retain control of assets and have the flexibility to make larger than planned withdrawals to meet unexpected expenses. People bought annuities and then never used them for lifetime income. Clients and brokers were forced to give up control of that asset when annuitization occurred. After a drop in the early 1990s, the market was doing very well until the first few years of the new century (2000-2003). Brokers had enough assets in their clients’ books to provide income the way they always had -- through systematic withdrawals, bonds, etc. Before March 2000, some advisors and many clients believed asset allocation alone was sufficient for longevity risk management. Today, brokers are better at understanding the true longevity risk that retiring Baby Boomers face and are adjusting their planning process.
Annuities are no longer the inflexible prototypes of the past. Variable annuities, in particular, have emerged as a solution to enable people to grow their assets and protect their futures simultaneously. It allows them to secure a lifetime income stream and meet shifting priorities, such as having additional income needs down the road. No other investment offers guarantees that can protect clients while they are in the accumulation phase and allow them to draw an income.
Still, many people have been self-insuring by placing the bulk of their retirement assets in guaranteed products, such as CDs or money market accounts, which don’t provide significant growth potential. Some are putting the assets in investments that offer upside potential, but no protection against market fluctuations.
All of that is changing as advisors think beyond the accumulation phase. A complete financial plan must include strategies to cover healthcare costs and provide for an income phase when having retirement income security is paramount, which means continued growth with protection.
Insurance benefits set variable annuities apart. An annuity is the only vehicle on the market that can give clients a level of insurance for their investment. An annuity’s insurance component allows it to protect clients’ assets while they are accumulating, while they are being spent, or in the event of an early death. There is an associated cost, but the value is there for those who need this type of protection.
Insurance companies are in the only segment of the financial services industry that can mitigate longevity risk with a life contingency. With strength and experience in the risk management business, insurance companies are uniquely positioned to move retirement security risk away from these self-insured scenarios and into an insured one.

Tax Advantages

One of the greatest advantages of a variable annuity is the ability to defer taxes on earnings. Earnings can grow faster without the drag of taxes. Like a 401(k), a variable annuity was designed to provide retirement income, not to transfer wealth. So clients don’t pay taxes on their money until they withdraw it. Variable annuities can also allow for a portion of each income payment to be the return of cost basis.

Product Evolution

Different annuity product designs have brought new elements to the table. In the beginning, there were guaranteed minimum income benefits (GMIBs) and guaranteed minimum accumulation benefits (GMABs). For an additional cost, they offered opportunities for clients with a strictly defined goal. But they offered little flexibility or investor control. These evolved into the popular guaranteed minimum withdrawal benefits (GMWBs), which have seen steady growth and interest from clients and advisors.
This type of rider evolved in response to some of the GMIB’s limitations, especially during bull markets. In a bear market, financial focus swings to the downside protection benefits of guarantees. But, when markets are bullish, clients also need to keep taxes in check to maximize after-tax returns, particularly in nonqualified accounts. Protecting spendable income is critical.
A lifetime GMWB offers a good safety net during a down-market cycle while still offering up-market potential. It protects clients’ principal investment and guarantees that it can be withdrawn over a set period without annuitization. Clients can remain invested in the market and take advantage of equity upswings.

Features to Consider

Most of these features appear equal in terms of capturing upside potential and downside protection during the accumulation years. But the latest features offer clients more flexibility, greater access and more control over their income path than ever before. Advisors realize that the most efficient way to take income in the future is not necessarily known at the time of sale. They value features that don’t lock their clients’ into an income path that may not meet future circumstances. The method of taking income can depend on the effect on the taxes and how important it is to maximize income and increase the amount after it begins.
All GMWBs allow lifetime withdrawals at a given percent. But some new generations allow withdrawals while giving clients the option to set a floor guarantee and then take income that can exceed this floor. Think of it as a floor versus income ceiling (withdrawals). Advisors who are planning for these unknown circumstances should weigh the benefits carefully and look beyond the marketing highlights. Healthcare enhancements can offer significant increases in withdrawal amounts to cover unexpected expenses. Money-back guarantees provide additional peace of mind for investors who understand that there is no guarantee that their future will turn out as scripted.
Companies continue to review and effect changes in legislation to offer increased tax advantages or risk-management features or riders. The industry continues to pursue combination products, such as annuity-long term care products and other combinations to maximize coverage and minimize risk for clients.

The Variable Annuity Advantage

The market has been so cluttered with information about features and benefits that it can be overwhelming and confusing. Take time to understand the basics. Learn about the core value that variable annuities can bring. They can provide the following:
• An all-encompassing solution -- They addresses multiple needs and are packaged with protection for the risks that clients are concerned about as they retire including inflation; longevity, market downturns, and unexpected healthcare costs.
• Tax efficiency -- They provide a combination of tax-deferral and the ability to receive a portion of your cost basis back in each income payment for non-qualified dollars.
• Flexibility, Control and Access -- Brokers and clients retain full control of the asset and full access to it. Also, income amounts can be adjusted to offset unexpected costs. Consider features that don’t require you or your clients to decide the most efficient income path today, when it may not be known for years.
• Floor guarantee -- They provide upside potential with downside protection to offset longevity and market risks.
Putting clients in the most appropriate retirement investment is always the key. There’s no more effective vehicle to help certain clients accumulate, protect, and provide security for lifetime retirement income.
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Delson (Del) Campbell is assistant vice president, variable annuity product manager with The Lincoln National Life Insurance Company. Del has been with Lincoln for 14 years, and has been dedicated to variable annuities for the last 7 years. Before that, he worked for Lincoln Financial Advisors developing and marketing investment advisor programs to planners focusing on the high-net worth market. Prior to his career at Lincoln, Del was a financial consultant with Merrill Lynch.The Lincoln National Life Insurance Company is an affiliate of Lincoln Financial Group (LFG). Lincoln Financial Group is the marketing name for Lincoln National Corporation and its affiliates. For more information, visit www.lfg.com.