When should I recommend an annuity?
By John L. Olsen, CLU, ChFC, AEP
Olsen & Marrion, LLC
When should an agent recommend an annuity? When should he or she not recommend an annuity? I get that question all the time. The following outline is one I use with agents in workshops. I hope that it will be helpful to ProducersWEB readers.
1. First, comply with the rules that are already in place. There are multiple rules, reflecting the fact that annuity sales are governed by multiple entities, at several jurisdictional levels.
a. NASD Suitability in Annuity Transactions Model Regulation #275 of 2010 (SATMR)
i. Consider all 12 factors listed
ii. Comply with the four-part test described in Section 6A of that Model Reg.
i. FINRA Rule 2390: “Know Your Customer”
ii. FINRA Rule 2111: Covers not only investment products, but investment strategies
iii. FINRA Rule 2330: Specific to annuity sales. Addresses surrender charges, exchanges from other annuities, full disclosure of all charges and restrictions.
d. What if the applicant is a senior citizen?
i. Your state may have additional requirements for such sales.
ii. Your broker/dealer or IMO may impose additional requirements, such as a “senior questionnaire.”
The following suggestions are submitted as just that — suggestions. They’re certainly not marching orders. Indeed, some of the suggestions may not be implementable, as they may violate the policies of your compliance department(s).
a. Confirm what the client is trying to accomplish, both initially and ultimately. For example:
i. Client may suggest that she needs a good investment, but what’s that investment supposed to do?
ii. Provide income? If so, starting when? How long must that income last?
iii. Does she want to benefit heirs?
iv. What kind of investment does she want?
v. What kind of risks is she comfortable in retaining and what risks does she need to transfer to an insurance company? If the client is not sure what that last question means, spend as much time as required to ensure that she does.
This phase should be completed before any recommendation is made (or, for that matter, before you even consider making a specific recommendation). Sample questions you may want to employ in that process:
1. “What is this particular 'pot' of money supposed to do for you?” (If client isn’t sure what you’re asking, try “If we were able to put these particular dollars into the best instrument possible, what would that instrument do?
2. “You mentioned that you want income. If whatever we put this money into will give you income, do you also need access to your invested dollars? Some instruments give you both. A savings account pays you interest and you can tap some or all of your money at any time. Some give you the maximum income possible, but you lose access to your invested dollars because you’ve exchanged that pile of dollars for a stream of income. Immediate annuities work that way. Some instruments give you some income (not as much as immediate annuities do) and also access to your invested dollars. For this pot of money, which type would work best for you?”
3. As you know already, you can’t have your cake and eat it, too. And you’re probably also aware that any savings or investment strategy involves trade-offs. So, to make sure that I understand what trade-offs you prefer to make, let me ask you this: Here is a list of things that many people want, and that can be accomplished by a well designed plan. I need to know how important each of those things is to you.
A. A guaranteed income for life
B. Keeping pace with inflation
C. Leaving a legacy for my heirs
D. Access to my own money when I need it
E. Pay as little income tax as possible
i. Have the prospect initial each descriptive section in the sales brochure on each of two brochures. You keep one and give one to
ii. After you’ve presented the product, ask the client to tell you, in her own words, how it works. Go through the major features and costs and listen to her explanation of each feature. If it’s not correct, explain that feature or cost all over again. If your client cannot tell you how the product works, she doesn’t understand it well enough yet. The time to correct that defect is right now!
iii. Send a letter to the client after the interview, summarizing what was said and what was agreed to and the client’s own explanation of the product [see ii, above]. Keep a copy in the client’s file. Better yet, send the client two copies and a return envelope and ask her to sign and date one of the letters and return it to you.
iv. Record the interview on video or audio tape. You’ll need to check that this is OK with your compliance departments. And, of course, you must obtain the client’s written permission. That will be easier to get if you explain that a record of the interview benefits you both; it’s a resource the client can check, later on, if she’s unsure of the features, benefits, costs, etc. that you explained.
a. If income must commence immediately:
i. A SPIA will, in most situations, produce the highest level of guaranteed income over all but the shortest periods (in very low interest rate environments, short-term, “period certain” SPIAs aren’t really efficient).
ii. If that income must be (a) guaranteed and (b) as high as possible and (c) must persist for life, a life SPIA (with or without a refund feature) is not only appropriate, but it’s the only appropriate solution.
iii. If growth in the amount of income is needed, a SPIA with COLA will work, provided the client is comfortable with the lower initial income amount.
iv. If some amount must remain for heirs, at the end of the income period, a SPIA is, by itself, never appropriate. It may work if coupled with life insurance.
v. An indexed or variable deferred annuity with some kind of guaranteed living benefit rider may offer both the income stream required and access to additional funds.
i. You match the client’s risk tolerance with the product
ii. Your client understands and accepts the impact of a possible penalty tax under Sect. 72(q).
iii. You’ve demonstrated that the benefit of tax deferral, offered by the deferred annuity, is worth the cost of same.
1. For a variable deferred annuity, that cost is (a) all ordinary income treatment of all distributions and (b) a possible 72(q) penalty. No annuity ever gets capital gains treatment.
2. For a fixed annuity, the 72(q) penalty is an issue, but the all ordinary income treatment probably isn’t, as alternatives properly comparable to a fixed annuity are generally subject to the same tax regime.
d. Never, ever compare an index annuity with investing “in the market." Be sure that your client understands that an indexed annuity is a fixed annuity that differs from conventional fixed annuities in two ways: (a) it offers the possibility of higher returns (on average, 2 percent to 3 percent better than conventional “declared rate” fixed annuities) and (b) the “cost” of that potentially better upside is lower minimum interest crediting guarantees and, often, but not always, longer/steeper surrender charges.
e. Never propose a SPIA with no COLA without also showing one with COLA. This makes sure that the client sees the potential erosive impact of inflation and has the opportunity to choose between a solution that ignores inflation and one takes the need for annual increases into account, but at the cost of a lower initial income level.
f. Never show the client a “bonus” annuity without showing one that is as nearly identical as possible except for the bonus and those cost features commensurate with the bonus (e.g., forfeiture of the bonus if the contract is not annuitized, longer/steeper surrender charges, etc.). Make sure that you can document which alternative the client chose and why.
g. Consider the complexity of the product you’re thinking of presenting in the light of how well your prospect will understand it a few months or years later. Do you plan on doing annual reviews?