Fixed annuities complement investment planningArticle added by Kim O'Brien on September 17, 2010
Joined: October 13, 2006
Ranked: #97 (742 pts)
The investment community uses fixed annuities as a stable value component of an integrated investment strategy. Now, two recent innovations within the fixed annuity insurance industry are expanding the role of these products. These innovations provide new opportunities for financial advisors to diversify risk and complement the investment side of an individual’s retirement plan with guarantees and insurance.
These new types of annuities are deferred lifetime annuities and fixed annuities with long term care benefits.
The challenge of retirement planning
To understand how these annuities are used, it is helpful to examine the core challenge facing retirees and individuals planning for retirement. To retire with confidence, most retirees need:
An investment portfolio can create a desired income and provide the potential for value and income growth over time. However, without an insurance portfolio, the investment-only portfolio creates uncertainty and troubling variability for clients. Plus, when retirees don’t prepare in advance, the cost of adding solutions at a later date to provide for these contingencies increases significantly year after year.
- Sufficient income to cover their expenses
- Income that increases over time to bridge the gap between Social Security and any other income
- Certainty that they cannot outlive their income
- Emergency income for long term care or assisted living assistance
- Discretionary income for travel, vacations, weddings and so forth
Dealing with longevity risk
Consider the need to guarantee income for life. Ignoring longevity risk, a typical investment-only approach is to build a portfolio that creates a desired income and asset value through the client’s life expectancy, and perhaps a few years beyond that. However, there remains the possibility that a client could be the outlier — the person who lives 15 years or more beyond the typical life expectancy. How do you deal with that?
A common answer is to use immediate annuities and guaranteed lifetime withdrawal and income benefits on variable annuities. Unfortunately, creating a sufficient income with these products often requires committing a large chunk of the client’s assets. Thus, the longevity risk “tail” ends up wagging the investment strategy “dog.”
Annuity innovation: Longevity insurance
The new solution is a form of longevity insurance called a deferred payout annuity. The basic idea is that your client, who is perhaps age 65, purchases a guaranteed stream of life-contingent income starting at an age well in the future, such as age 85. The payout can be based on a single life or the lives of a married couple. Because the income is delayed until far into the future, and because it is only paid if your client is then alive, it is cost efficient.
This annuity solution can be a win-win. Since less money is needed to fund the guaranteed lifetime income stream that can increase over time, more money can be available to create an optimal investment portfolio to take your clients to age 85. Your clients are free to live their early retirement years with confidence — perhaps traveling more — because they know the later years are covered.
Dealing with long term care risk
Next, consider the issue of long term care. Medicare typically does not cover such care beyond a short period following a hospital stay, and Medicaid will typically not pay for long term care until after your client’s assets are depleted. The federal government estimates that half of nursing home residents are paying out of their own pockets. Thus, this is a risk that is clearly the family’s to bear, and it can be costly.
In their 2010 Cost of Care Survey,Genworth Life Insurance Company indicated that nearly two-thirds of Americans over age 65 will need long term care at home or through adult day care, an assisted living facility or nursing home. Median national costs range from $38,220 to $75,190 annually, depending on the type of care needed, and these costs are in addition to — not a replacement for — your client’s current living expenses.
Historically, this risk solution has been long term care insurance (LTCI), but clients tend to be cool to the idea since they often believe such care will be unnecessary, or prefer a home-care solution and either wait until it is too late or too expensive. This mindset is demonstrated by the fact that LTCI sales have fallen six out of the last seven years.
Annuity innovation: Long term care benefits
The new solution is an annuity that automatically increases the benefits it pays if long term care is needed. Congress included some helpful provisions in the Pension Protection Act of 2006 that went into effect on January 1, 2010, which provide for such benefit payments to be income-tax free.
Under these annuity designs, clients do not pay out-of-pocket for the long term care coverage. Rather, the carrier deducts charges from the interest that is credited to the annuity. These charges are less than the amount of interest being credited to the annuity, so the annuity balance continues to grow. Moreover, these monthly charges are not included in the owner’s income, but instead simply reduce the income-tax cost basis of the annuity.
The benefits for your clients are easy to see. They can do a 1035 exchange of their existing annuities and get something more — sometimes up to triple their money if long term care is needed. They get long term care coverage and don’t need to invade their savings, and they can receive benefits for care received at home. But notice, it is not use it or lose it — if they never use the long term care benefits, their annuity balance grows.
Finally, almost all deferred fixed annuities provide many surrender-free liquidity options for unexpected expenses such as trips or to purchase a special gift. So, retirees can still enjoy the spontaneity and joy of visiting loved ones or the smile of giving a treasured gift.
These new annuities are not for everyone, and it is the financial professional’s job to look for all suitable solutions that meet their client’s unique needs. However, many clients may want to consider these affordable and powerful benefits. The insurance industry is innovating all the time and these new products are a great balance to an investment portfolio. To ensure suitability, the National Association for Fixed Annuities (NAFA) encourages investment advisors to consider these insurance options to complement investment planning solutions.
The views expressed here are those of the author and not necessarily those of ProducersWEB.
Reprinting or reposting this article without prior consent of Producersweb.com is strictly prohibited.
If you have questions, please visit our terms and conditions