Annuities

Benefiting from the Retirement Distribution Opportunity

by Jim McHugh, CLU

The defined contribution market is expected to grow to around $5 trillion in assets by the end of 2010, according to Cerulli Associates. Retiring employees will need to convert these assets into income. Today, I want to update you on a solution that has already met the retirement income needs of millions of pre-retirees and has met the needs of retirees for decades: income annuities.

"What's old is new again" is an appropriate adage for a new generation of income annuities. This new generation provides lifetime guarantees with a range of options, including personal pension products, longevity insurance, and income annuities with inflation protection. These new product features provide flexibility and help to overcome many common objections that brokers, plan sponsors, and consumers have about annuitization. They are also supported by a range of educational programs and tools.

An income annuity converts a sum of money into a stream of income, which is guaranteed to last the policyholder's lifetime. It is also known as a "payout" or "immediate" annuity. With an income annuity, a person can transfer the risk of outliving their assets in retirement to an insurance company. To put it another way, if life insurance offers protection from an early death, income annuities offer protection for a long life.

An income annuity is a personal pension plan that can guarantee income for life since it uses pooled risk. Joining a mortality pool is a better than trying to plan for your retirement assets to last the right amount of time while praying that you haven't underestimated your life expectancy. The pooling concept is at the heart of all insurance products (as well as the mortality element within defined benefit plans).

Longevity creates a much smaller risk for sponsors of large defined benefit pension plans. Like a large plan sponsor, an annuity uses the averaging effect created by pooling the mortality experience of a large number of annuitants. When a large group of retirees is pooled, the retiree who lives a long time is offset by the retiree who dies early.

Dispelling the Myths

Myth Annuities are expensive and not worth the cost.

Fact Fees from income annuities provide lifetime income guarantees, which are not available through other investments.

Myth I can do better on my own.

Fact Only income annuities can guarantee a specific level of income for life.

Myth The insurance company keeps my money if I die.

Fact If you die, the money remains in the annuity pool to pay the retirees that live a long time. Additionally, annuities now offer death benefits that include income payments that continue for a specific period (term-certain payouts) and refunds of premiums paid.

Myth I can't get my money if I need it.

Fact Many annuities offer liquidity options that allow purchasers access to their money in an emergency.

What's Old is New Again

Annuities have been issued to people for hundreds of years. TodayÕs generation of income annuities is more liquid, flexible, and customizable than ever. Of course, the guarantees of any annuity product are subject to the financial strength and claims paying ability of the insurance company from which the annuity is purchased.

Today's annuities offer the following:

¥ More access to money: Some insurers permit full and partial withdrawals. Others make money available for certain situations, such as long-term care, caregiver, nursing home, unemployment, terminal illness, and disability income needs. Others offer tie-ins that boost payments to help pay income taxes.

¥ More control over monthly income payments: To protect against market risk, some variable income annuity providers offer a floor on income payments and guarantee that future payments will never be less than a percentage of the original payout. To protect against inflation risk, other annuities offer annual cost-of-living adjustments to fixed annuity payments.

¥ Greater choice of investment options: With variable annuities, consumers can choose investments from a broader array of asset classes and investment styles including fixed income options from a variety of investment managers.

¥ Improved educational and decision making tools: Providers offer retirement income planning tools that help consumers model a retirement budget, investment strategy, and distribution strategy.

Why Plan Sponsors Offer Income Annuities

As the workforce ages, plan sponsors are acknowledging that planning for retirement must include a distribution strategy. Employers and employees are taking a renewed look at income annuities. Over the next several years, I predict that more companies will add an annuity distribution option to their 401(k) plans, particularly large companies.

Following are a few reasons why plan sponsors offer income annuities to their plan participants.

Fiduciary Risk: Annuities provide guaranteed lifelong income to employees, which may reduce the employer's fiduciary risk.

Diversification: By offering income annuities, a company is helps ensure that retirement portfolios are better diversified. This includes having guaranteed sources of retirement income that will last as long as they do.

Pension Plan Freezes/Terminations Ð Annuities are a viable solution as many companies are considering freezing or terminating their defined benefit pension plans. Annuities allow the employee to replicate the guaranteed lifelong income that was provided by their pension plan.

Annuitizing the 401(k) Nest Egg

By offering income annuities as a distribution option in retirement plans, plan sponsors give their employees the opportunity to make their savings last as long as they do.

Longevity Risk -- Perhaps the greatest risk people face once they retire is the risk of outliving their savings. In 2000, average life expectancy at 65 was projected to be 85 for males and 88 for females. Since this is an average, 50% of the population will live well beyond average life expectancy.

Legislation Will Help Pave the Way

The recently passed Pension Protection Act (PPA) addresses a wide range of issues affecting an employer's qualified plan including defined benefit funding reforms, automatic enrollment in defined contribution plans, and investment advice.

It also clarifies standards for employers when adding an annuity to a defined contribution plan as a distribution option. Previously, the guidelines for an employer were contained in Interpretive Bulletin 95-1 issued by the Dept. of Labor in 1995. They were intended to clarify fiduciary liability for defined benefit plan sponsors, but many defined contribution plan sponsors believed the rules applied to their plans as well. These guidelines were very onerous, making it easy for employers with a defined contribution plan to say no to adding an annuity as an option. The final regulations clarifying the defined contribution fiduciary standards should encourage the use of an annuity as a distribution option. The final regulations are expected later this year.

I ask the following questions to plan sponsors who are not now offering an annuity option from their defined contribution plan:

¥ Would you like to offer your employees the benefits of a defined benefit plan without incurring the liabilities of doing so?

¥ Do you agree that offering only lump sum or installment payouts is not always in the best interest of your retirees?

If you answered yes to these questions, consider this: It takes just seven steps to amend the plan document. Remember that you may be amending your plan to comply with Pension Protection Act. As long as you are making plan changes anyway, you can add this new distribution option at no additional cost or effort.

How Brokers Benefit

The workplace has been the outlet for employees to fund their retirement through payroll deduction. Offering solutions for the distribution phase of retirement gives you another way to add value and solidify your customer relationships.

You have the opportunity to educate your customers and deliver this new generation of solutions. In the not-too-distant future, more money will be coming out of retirement plans rather than going into them. Income annuities offer a huge opportunity for you to participate in this process and add value to it.

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Jim McHugh is director, Sales Strategy and Support, Institutional Income Annuities for MetLife. For more information, visit www.whymetlife.com/broker.