As many as several million older people have been forced out of work early amid the pandemic, and some are turning to annuities for a considerable chunk of their retirement income.
As insurance products, annuities are one of the leading recommendations for near retirees who are concerned about running out of money. But they’re also poorly understood by many consumers, which puts people at risk of being sold inappropriate products in amounts that represent an outsize portion of their savings.
Financial advisers play a critical role in guiding clients to the right products, ensuring that they don’t allocate too much of their portfolio to them and helping determine when to start taking income payments.
Adviser Rob DeHollander recently had such an experience with a new client.
That person, 61 years old and recently laid off from a manufacturing job, and their spouse had been sold three separate annuities that in total represented 100% of their net retirement assets, DeHollander said.
“There’s a liquidity issue there from a fiduciary standpoint that I have issues with. Liquidity is important, especially early in retirement,” said DeHollander, managing principal at DeHollander Financial Group. “Usually we want to keep enough liquidity [available] so clients can deal with unexpected needs and opportunities.”
Fortunately, he said, the $700,000 of annuities his new clients had been sold before coming to his office were still in their “look back” period, meaning the contracts could be canceled without penalties. He advised the clients to liquidate 70% of the assets in those recently purchased annuities, which meant having assets in only one of the products.
“It’s a tough spot for folks who have had retirement forced on them,” DeHollander said. Annuities “are good tools when they’re used well, but they’re way oversold.”
Since January 2020, nearly 3 million people age 55 and older in the U.S. have been forced out of the labor market, according to a report published in February by The New School’s Schwartz Center for Economic Policy Analysis. Over the past year, the proportion of people in that age group who are out of the workforce grew at about three times the rate in a normal year.
That trend isn’t reflected in unemployment figures, which leads to a misunderstanding about how heavily affected older workers have been by the Covid-era economy.
The unemployment rate for people 55 and over was 5.3% as of January, but that doesn’t include workers who were laid off and have little choice but to retire early, according to the report.
Retiring early can be a difficult proposition for people who had planned on having several additional years of income to help them save and plan.
(Source: Limra Secure Retirement Institute)
Prior to the pandemic, demand had been ramping up for products that offered return potential and some protection from losses. A subset of variable annuities, known as registered index-linked annuities, or RILAs, has grown to represent a bigger chunk of sales — and the Covid-19 world appears to have contributed to an even bigger market share.
Those products appeal to investors who want some potential for gains and limits on losses, both of which are capped.
Last year’s volatile stock market helped fuel demand, and RILAs were one of only two types of annuities to see sales increase on an annual basis. Sales hit $24 billion, up more than a third from the $17.4 billion RILAs raked in during 2019, data from Limra’s Secure Retirement Institute show.
Demand also increased for traditional fixed deferred annuities, hinting at how cautious people became regarding investment risk.
Those fixed annuities pulled in $51.7 billion in sales during 2020, up from $47.5 billion a year earlier, even as annuity sales industrywide fell to $219.1 billion from $241.7 billion, the figures show.
“Lower interest rates make annuities less interesting. In general clients typically want today what they should have had in place a year ago,” Jeff Farrar, co-founder and partner at Procyon Partners, wrote in an email. “I joke my job is to protect clients both from themselves and from Wall Street. Wall Street will always manufacture more of what people want — it’s just not always what people need.”
Similarly, Matt Bacon, an adviser at Carmichael Hill, said that requests from clients for annuities were higher before the pandemic, “when markets were healthier and clients were afraid it wouldn’t last.”
But since the pandemic, “our clients are more focused on yield and dividend-paying stocks than they were in the past,” Bacon wrote in an email. “Clients have been willing to move into riskier dividend-paying equities, a few to [master limited partnerships], in the search for yield. The shift to a focus on yield over safety is new for us.”
Even when sold annuities, people tend to misunderstand what the products do, DeHollander said. Often, new clients who were previously sold annuities don’t have the original marketing materials, he noted.
Importantly, DeHollander wants people to understand more clearly that annuities are insurance products. While assets can appreciate, they often do not do so at the same pace as the market, due to the products’ designs. And because it can take many years for someone to receive income beyond the principal they used to buy the contract, “you’re potentially leaving a fortune on the table,” he said.
What people take away from advertisements and radio shows is that the base amount of the contract doesn’t lose value, assets can appreciate and there are guarantees for lifetime income, DeHollander said. “For the unsophisticated investor … fear of running out of money is a powerful motivator,” he said. Annuities “are a greatly misunderstood, very complex product. So you really want to make sure you’re working with somebody reputable and make sure the product is a good fit.”
The 10-year Treasury rate was 1.55% as of March 9, reflecting the longstanding low-interest-rate environment. That has made it difficult for insurers to offer attractive rates on their products, including guaranteed living benefits. Last year, two major insurers disclosed plans to stop selling those guarantees on VAs — Prudential and Transamerica. The latter company is also stopping sales of fixed annuities.
“Most insurers are not clamoring to increase their income annuity sales. That is such a small portion of the annuity market,” said Tamiko Toland, director of retirement markets for Cannex.
“Income-generating products, for somebody who is facing an unexpectedly earlier retirement, may help them optimize so they have greater retirement security through that income guarantee,” Toland said. But she noted that much of that security boils down to how much they have saved, other income sources and their individual financial plan.
There is a good reason why fixed annuities have been selling well — they still provide an attractive alternative to certificates of deposit, on which yields are lower, said Dave Hanzlik, vice president of annuity and retirement solutions at CUNA Mutual Group.
“There’s a lot of cash out there. People sitting on the sidelines — they’re worried about the environment, they’re worried about the effects of the pandemic,” Hanzlik said. “A safe haven like a fixed annuity has been something that customers have been very open to … and advisers have found to be a very nice tool.”
On the other hand, RILAs can be useful for people who need higher returns but want a floor for losses, he said.
“People still want protection. They feel unsettled,” Hanzlik said. “But they need upside potential, because rates are low.”
(Source: Limra Secure Retirement Institute)
Putting a portion of a client’s assets in a RILA or a multiyear guaranteed annuity can help address behavioral risk and allow advisers to take a higher level of investment risk with the rest of the portfolio, he said.
The market dip last year scared people, and that has led to more interest in guaranteed income, said Benny Goodman, vice president of annuities at TIAA.
While individual needs vary, people should think about having roughly two-thirds of their retirement income provided by guaranteed sources, including Social Security, Goodman said. “Even if the walls start caving in on you, you still have a ceiling over your head.”
To illustrate, he noted that during the decades people typically spend in retirement, jarring events like market drops and pandemics are statistically likely. Further, if interest rates climb and the stock market goes into bear territory, “people might see both their stock and bond portfolios go down some,” Goodman said. “It’s worrisome.”
Consumers often like the things annuities can help them accomplish, but “they may not understand there are different products that do different things,” Toland said.
Further, how recommendations for different types of annuities fit into an overall financial plan is crucial, she said. Advisers can provide value by helping clients adjust spending according to their circumstances, as part of that wider plan. Clients tend to be most satisfied with annuities when they clearly understand how those products work as a part of their portfolio, Toland said.
“At some point, you have to decide when to start the income,” she said. “It’s not a one-time sale. It’s also a matter of monitoring and advising.”
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