CHAPTER 1
Bailey McCann
Ask RIAs what they think about annuities and the answers will vary widely. Many initial responses would include a layer of skepticism about substituting investment products with insurance ones. Others will mention the complexity and the fees. Still others will say annuities can be a valuable tool for investors as long as everyone is clear-eyed about how these products work. But the overarching point is that more investors are asking about them. And, with a market mired in uncertainty, a new generation of investors is willing to strongly consider a predictable rate of return even if getting there means spending a bit more and sacrificing a degree of flexibility.
PIECE OF THE PUZZLE
In recent years, the annuities industry has taken steps to try to bring down costs and make annuity contracts easier to understand. Products like multi-year guaranteed annuities, or MYGAs, which are limited to a specific term – much like a certificate of deposit – have also emerged as a more flexible option. Taken together, these trends have turned annuities into another tool advisors can look to as part of a portfolio rather than a transition into an insurance product and away from investing.
‘We’re talking to advisors and wealth managers more at the portfolio construction stage than we have been in the past,’ says Nicholas Ross, chief distribution officer at Financial Independence Group (FIG), which represents and works with insurers on product development and distribution.
‘What we’re seeing is that advisors have a better understanding of annuities and they’re looking at options like fixed index annuities or multi-year guaranteed annuities as options for investors that aren’t yet in retirement and want options to help limit risk. As rates rise these can be helpful during the accumulation phase or they can work more immediately during the retirement phase.’
LOCKING IN RETURNS
Will Vaughn, wealth advisor at RegentAtlantic, adds that the current moment may be uniquely well-suited for annuities. Echoing Ross’ point on interest rates, he notes that annuities will pay out more when rates are rising – which can be compelling during periods of uncertainty.
‘When we are discussing annuities with clients, we take them through the pros and cons. These products have less flexibility than an investment portfolio. That said, there are investors who are very uncomfortable with risk and if you can say to them “here is a 5% guaranteed rate” they are going to look closely at that.
‘But there is also a bit of market timing embedded in the calculation. It’s like locking in a mortgage when rates are low: there are environments where these products are going to look better.’
ACCUMULATION AND QUALITY OF LIFE
Historically, annuities have focused specifically on the years when an investor is in retirement and providing an income for that. But growing flexibility in product structure has widened the lens to include pre-retirement and even retirement care.
FIG’s Ross notes that indexed annuities are showing up more as a tool for the accumulation phase. These products typically have a minimum and maximum return range, so while the total return is likely going to be lower than a traditional investment portfolio, there is a downside risk limit embedded into the product. ‘What we’re seeing is these annuities being used as a hedge, where a portion of the assets is being allocated during the accumulation phase
Riders are also being added to annuities to help cover care during retirement. ‘One of the newer areas that firms are working on right now is using riders to cover the cost of elder care,’ Ross says. ‘So that can look like an annuity paying out at a higher rate if that distribution is going directly to cover care costs.’
Other add-ons can create death benefits that go to heirs if they aren’t used over the life of the annuity. Previously, these used to go back to the insurers who provided the annuity. According to Ross, these are new areas that aren’t as common in the market yet, but insurers have started working on education and outreach efforts to explain these options. And these provisions have to be crafted with care as they come with additional fees which investors need to understand.
‘We’re at a time when there is a large aging population and this population is more open to using insurance planning if they see the value,’ Ross says. ‘It’s important for firms to invest in education out to the advisor community and the investor community about what the options are.’
ADVERTISING FEATURE
Multigenerational planning opportunities with tax-deferred annuities
Another tax season has passed. And, hopefully, after a much-needed reprieve, you are back at it, conducting mid-year reviews, rebalancing portfolios and helping clients pursue their financial goals. As you adjust client portfolios, and potentially create new taxable events, let’s discuss ways to potentially complement and enhance your existing strategies for multigenerational planning.
WHY TRUSTS?
Trusts can be an effective vehicle to reduce a taxable estate and shield assets from beneficiaries who may not have the capacity to manage them. To fulfill these objectives, trustees and financial professionals have a fiduciary duty to grow trust investments at a greater rate than inflation to protect from loss of purchasing power, a task that has become even more difficult in the current environment.
TAXATION OF RETAINED EARNINGS
The diversified portfolios needed to achieve the goals of the trust can generate a variety of taxable income, including bond interest, dividends and capital gains. If volatility triggers investment changes, a larger portion could be considered short-term capital gains. Similar to the individual tax brackets, irrevocable trust tax rates are progressive. However, because the IRS discourages assets growing outside a taxable estate, trust tax rates are greatly compressed. Achieving the necessary growth to pursue the trust goals and remain in line with the beneficiary’s expectation is a challenge.
COMMON PRACTICES
Given this challenge, the industry has adopted a few common practices. The most common is to distribute the taxable earnings to the beneficiaries – allowing the distribution to be taxed at the much more manageable individual rates. This strategy can be useful if there is an income beneficiary who needs all the income or doesn’t mind paying the tax on earnings that were distributed by the trust. However, this strategy can hamper the potential growth of the assets for a trust used for multigenerational planning, such as a generation-skipping trust, dynasty trust or other trust requiring capital appreciation for the remaindermen. Moreover, passing out the earnings merely due to taxes may increase the beneficiaries’ overall annual tax bill and push them into higher tax brackets, which may work against the goal of growing multigenerational wealth.
A COMPLEMENT TO YOUR EXISTING STRATEGY
A potential strategy to mitigate tax drag is to add a tax-efficient sleeve to the trust, such as a tax-deferred annuity*. A financial professional should compare the tax and growth consequences of moving assets into a tax-deferred annuity. By drilling down on assets that are currently creating ordinary income – bonds, dividend-paying securities, funds with high turnover and international exposures that create tax complications – one can measure with a simple calculator the overall tax benefit of not paying capital gains annually, even with the added tax liability from liquidating the assets used to purchase the annuity. The additional tax-efficient sleeve acts as a tax shield each year that the annuitant is alive and no distributions are taken from the annuity and can give more control to only take distributions when the beneficiary actually needs the income. This reduces the need to make tax-motivated distributions, and the overall effect on the portfolio is a potential new source of alpha.
Ultimately, the tax-deferred annuity can allow any earnings to accumulate more efficiently and quickly, allowing more assets to work for the beneficiary and the financial professional.
Product providers have made great strides in designing annuity products that appeal to fiduciaries and are compelling to clients. These modern annuities are fee-based, institutionally priced, without withdrawal fees or surrender schedules** and contain a robust line of investment options and risk management capabilities. When evaluating the product for clients, be sure to not only consider cost.¹
These annuities are long-term products; therefore – after addressing the client’s objectives – cost, product structure, technology integrations and service experiences are all prudent considerations.
For clients looking to grow assets for trust remaindermen, consider an investment-only variable annuity. Or, for clients that seek growth potential with some downside protection, consider using a registered index linked annuity to help reduce the downside risk of volatile asset categories.
When it comes to multigenerational planning, the good news is there are a growing number of options to choose from to help clients enhance their portfolios and pursue their financial goals.
JAMES PRYOR
¹https://content.naic.org/sites/default/files/inline-files/MDL-275.pdf
* Annuities are long-term, tax-deferred vehicles designed for retirement and are insurance contracts. Variable and registered index-linked annuities involve investment risks and may lose value. Earnings are taxable as ordinary income when distributed. Individuals may be subject to a 10% additional tax for withdrawals before age 59½ unless an exception to the tax is met. Tax deferral offers no additional value if an annuity is used to fund a qualified plan, such as a 401(k) or IRA. It also may not be available if the annuity is owned by a legal entity such as a corporation or certain types of trusts.
** With variable annuities, a contract charge and subaccount charges will apply. Market value adjustment may apply to withdrawals from registered index-linked annuities.
Jackson, its distributors, and their respective representatives do not provide tax, accounting, or legal advice. Any tax statements contained herein were not intended or written to be used and cannot be used for the purpose of avoiding U.S. federal, state, or local tax penalties. Tax laws are complicated and subject to change. Tax results may depend on each taxpayer’s individual set of facts and circumstances. You should rely on your own independent advisors as to any tax, accounting, or legal statements made herein.
Annuities are issued by Jackson National Life Insurance Company (Home Office: Lansing, Michigan) and in New York by Jackson National Life Insurance Company of New York (Home Office: Purchase, New York). Variable annuities are distributed by Jackson National Life Distributors LLC, member FINRA. May not be available in all states,and state variations may apply. These products have limitations and restrictions. Contact Jackson for more information.
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Jackson National Life Distributors LLC
CHAPTER 2
Bailey McCann
Rising interest rates and increased market volatility are making more investors consider annuities. Offering some type of guaranteed income over the life of the product in most cases, annuities typically pay out more when interest rates are high. They can also act as a bulwark against market volatility by offering a predictable income stream regardless of what’s happening in the market.
However, this type of predictable income can be tricky to acquire. Annuities are insurance products, so they fall under a different regulatory regime than other investment products. This means that to get an annuity, an investor needs to work with an advisor who is familiar with insurance products and is able to sell them. Like other insurance products, annuities come with complex contracts and often have significantly higher fees than mutual funds or ETFs.
Investors have quite a bit of choice in terms of types of annuities and their ultimate costs. Portfolio size is also a consideration. A recent survey of investment advisors from the Secure Retirement Institute suggests annuities might be a better fit for people with fewer retirement assets. According to the survey, nearly half (48%) of advisors servicing middle- and mass-affluent investors (under $500,000 in assets) feel that annuities are most appropriate for these clients.
Advisors would generally recommend a substantial proportion of retirees’ and pre-retirees’ assets — $1 in every $3, on average — be put into annuities, depending on the client’s wealth levels.
DEFERRED ANNUITIES
Deferred annuities come in a variety of formats. The defining feature is that they have a pay-in period and an income period. Investors can choose to pay in a lump sum or make a series of payments before taking the income in retirement.
Fixed annuities are one type of deferred annuity. These pay a specified interest rate on the funds invested. These are predictable vehicles, but there is also an element of market timing. If the interest rate that gets locked in at the point of purchase is low, it may not keep up with inflation or other investment products that have a dynamic rate.
Fixed annuities are catching the attention of investors now while rates are beginning to rise. According to insurance data provider Wink, sales of fixed annuities rose to $465m in the first quarter of this year – up 2.8% from the first quarter of last year.
Indexed annuities, where the annuity return is tied to a market index like the S&P500, are another type of deferred annuity. These products usually have a minimum and maximum rate of return based on where the index is at performance-wise. Wink data shows that sales of these products for the first quarter were $16.6bn – up 14.5% when compared with the same period last year.
‘Indexed annuity sales are blowing past where they were this time last year. If this quarter is an indicator of things to come, this could be a record year for indexed annuity sales,’ said Sheryl Moore, CEO of Wink and Moore Market Intelligence.
TIME-LIMITED ANNUITIES
Multi-year guaranteed annuities, or MYGAs, have also gained traction with investors in recent years, in part because they are limited to a specific time horizon.
This can provide a level of flexibility that is appealing to investors who are hesitant to sign on to an annuity that lasts over the retirement’s length. If an investor changes their mind or needs to change their retirement income plan, it can be very costly to try to switch out of an annuity that doesn’t have a time limit.
MYGAs work almost like a certificate of deposit, in the sense that they might last for a term of, say, 10 years and have a fixed interest rate. The rate is often higher than what investors will get with a certificate of deposit and the tax can be deferred. At the end of the term, investors get what they paid in plus interest. Sales of these annuities rose to $15bn – an increase of 9.9% – over the first quarter of last year, according to Wink.
The company’s report on first-quarter sales notes that if rates continue to rise, this category is likely to remain popular with investors.
VARIABLE ANNUITIES UNDER PRESSURE
Variable annuities are another type of deferred annuity that doesn’t guarantee a specific return. Instead, these include a basket of ETFs and mutual funds, and their return is based on the performance of those funds.
These types of annuities are also subject to a greater potential for losses because the return is not range-bound like fixed-indexed annuities.
In a market where stocks are doing well, these types of annuities might look more appealing. However, in a volatile environment, it can be hard to model out expected return and that reality is showing up in Wink’s data. Sales for the first quarter were $27.9bn – down more than 6.9% when compared to the same period last year.
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