Are annuities finally getting some respect?

For years, financial advisers have had a love-hate relationship with annuities. The financial products, which offer a guaranteed stream of income, have long been maligned by some financial advisers and the broader public as being costly, confusing and opaque. "I would die and go to hell before I would sell an annuity," Ken Fisher, founder and executive chairman of Fisher Investments, said in a recent video discussing the products. He said most annuities have "nosebleed-level fees," are difficult to get out of, are "extremely confusing" and are made to benefit salespeople over consumers. The majority of annuity coverage by consumer media is either negative or neutral, according to a 2018 survey conducted by Cannex Financial Exchanges and Greenwald & Associates. But that sentiment may be changing, especially if lawmakers are succeed in making it easier to buy annuities in retirement plans. Indeed, the combination of Americans' generally low savings rate and longer life spans has many looking to annuities as a big part of the answer to the retirement savings crisis. Annuities come in a wide variety of product types: some expensive and complex, others more closely aligned to straight insurance for old-age income. Shoehorning them all into a single blanket item that an adviser either hates or loves discourages deeper evaluation based on a client's particular needs. "I can make the economic research case for annuitizing at least part of your income, but people don't want to buy them, and they're just not [buying them] in any large numbers," said Michael Kitces, partner and director of research at Pinnacle Advisory Group Inc. "I wrote my first book on annuities 15 years ago. I thought they were promising then." Sales have slumped more than 20% over the past decade, even as baby boomers are hurtling into retirement at breakneck speed, fewer Americans have access to guaranteed income from pension plans and people just keep living longer. But now, Washington policymakers on both sides of the aisle seem to be joining the chorus of academics who see value in annuitization for some consumers. Congress is aiming to make annuities more widely available in 401(k) plans, which hold more than $5 trillion and continue to raise their share of overall U.S. retirement assets. The Retirement Enhancement Savings Act of 2018 was introduced in March by Senate Finance Committee Chairman Orrin Hatch, R-Utah, and ranking member Ron Wyden, D-Ore. A sister bill was later introduced in the House. The legislation would relax rules around legal safeguards for employers offering annuities in-plan and help employees take their annuity with them if their firm changes its 401(k) plan provider or if they switch jobs.

Problems in plans

Current retirement plan due diligence, for example, involves evaluating whether an insurer will be able to make payments to participants years down the road. This requirement deters many employers from including annuities in 401(k)s, observers say. The Labor Department's current annuity-selection guidance is "kind of mushy, and people worry it doesn't give them a full protective cloak," said David Levine, principal at Groom Law Group. "This safe harbor you'd get from RESA language would be designed to get people more comfortable and move the ball forward." The bill could lend annuities more credibility in the eyes of consumers, too. And those bought in 401(k) plans often cost less than retail annuities because of commercial pricing, Mr. Levine said. (Watch: What the future holds for variable annuities) Nearly identical legislation unanimously passed the Senate Finance Committee in late 2016 but didn't come to the floor for a full vote before the end of the congressional session. Observers say the odds are good the bill will pass this year given the strong bipartisan support. "The federal government is looking out for the interest of the masses, saying more people should consider annuities, or they should be at least part of advisers' dialogue" with clients, said Mark Cortazzo, a financial adviser and senior partner at Macro Consulting Group.

Sales flounder

Deferred annuities, including variable, indexed and fixed-rate deferred contracts, held $3 trillion at the end of 2017, according to the LIMRA Secure Retirement Institute. But overall, yearly annuity sales have floundered since their peak in 2008, falling 23% to $203.5 billion for 2017. Several factors are at play. Persistently low interest rates after the financial crisis have hurt annuities' value proposition because they're sensitive to interest-rate movements, observers say. Variable annuity sales have fallen by roughly half since 2007, to $95.6 billion last year — their lowest level since 1998, according to LIMRA — partly because insurers are manufacturing less-attractive products to more effectively manage their risk.

The Labor Department's fiduciary rule, which raises investment-advice standards in retirement accounts, has led to fewer sales, too, primarily of higher-commission products like variable annuities. The future of that rule is now in question, though, thanks to a recent decision by the 5th Circuit Court of Appeals to vacate the rule. Annuity vendors are certainly keeping an eye on the DOL's next step — either to stand down or continue to defend the regulation — and what it might mean for future sales. "Actual annuity sales have been declining for years," Mr. Kitces said. "Not only that, but they're declining as baby boomers — the largest generational cohort, which in theory should have provided the largest uptick [to annuity sales] — retire en masse." Longevity risk is growing more acute as individuals live longer and assume more responsibility for managing their nest eggs long after retirement. Healthy individuals in their 60s are approaching the point at which 40 years, as opposed to 30 years, is a conservative time frame for retirement income planning, writes Wade Pfau, professor of retirement income at The American College of Financial Services. Research on the benefits of annuities for some consumers has been around for decades. Menahem Yaari wrote what is considered the seminal paper on the subject, "Uncertain Lifetime, Life Insurance and the Theory of the Consumer," in 1965. Mr. Pfau and Mr. Kitces are among others who've contributed research on the topic. They have found that partial annuitization of an investment portfolio can improve the sustainability of retirement income over a purely portfolio-based strategy, especially for those who live 35 years or more in retirement. But the retail market isn't the only place where interest in the products has been relatively low. Only 9.7% of 401(k) plans offer an in-plan annuity to participants, according to the Plan Sponsor Council of America.

Monthly income

The RESA bill aims to address this and seeks to help participants frame their retirement savings in terms of income instead of wealth accumulation by including on account statements the estimated monthly income stream a 401(k) balance would produce. The Obama administration sought to do something similar. His Labor Department pursued a rule to amend participant statements this way, but officials ran out of time when the administration's tenure ended. In 2014, the Treasury Department promoted the use of qualified longevity annuity contracts in IRAs and workplace retirement plans. QLACs are a type of deferred-income annuity that begins paying consumers in later life — perhaps around age 80.

QLACs, along with single-premium immediate annuities, are the "purest" retirement income vehicles, according to Mr. Kitces, meaning they pay the highest income per dollar put in. Treasury issued separate guidance in 2014 allowing deferred annuities, including QLACs, to be bundled into target-date funds' fixed-income allocations, and the DOL said these types of TDFs could be used as a 401(k)'s qualified default fund. At least one large employer, United Technologies Corp., has adopted a fund like this. Its TDFs, the default investment, allocate more money to annuities as participants approach retirement. "There appears to be a consensus that people need to be annuitizing more of their wealth in DC plans," said David Blanchett, head of retirement research for Morningstar Investment Management. "The funny thing is, five years ago I thought we'd be further along than we are today."

Skepticism remains

Of course, some retirement plan advisers are skeptical about offering annuities in 401(k) plans. "I actually agree that there is a segment of 401(k) participants who may not be equipped to properly manage their accounts through retirement, but I'm not convinced trying to mandate a solution for a small minority makes sense for all employees," said Chad Larsen, president and CEO of advisory firm MRP, referring to making annuities the default investment. Aaron Pottichen, president of retirement services at CLS Partners, thinks there should be a "separation of church and state," with annuities remaining outside 401(k)s. That is, he said, unless plans are able to secure a less-expensive annuity than a participant could find in the retail market. Mr. Pottichen fears that introducing more annuities into the 401(k) market would be like opening Pandora's box by allowing in products beyond plain-vanilla, deferred-income annuities. "If you let one in, who's to say they don't start creeping open the door a little bit more?" he said.