It’s Time to Buy Annuities. Really.

The often disparaged product seems ideal for these times.

(Illustration by RIA Intel)

(Illustration by RIA Intel)

When speaking with a friend that advises clients in Western Connecticut, I casually asked his view of annuities. His response was swift and to the point: “Most of my colleagues shun them due to their excessive expense ratios,” adding for emphasis, “I do, too.”

Rather than try to correct him, I let the issue go. Unfortunately, he—and many other advisors—are still stuck in a past era. John Faustino, head of Fi360, Broadridge’s fiduciary education and technology business, concedes that “annuities broadly got a bad reputation in the 1990s and early 2000s. This was driven by awareness of some advisors taking advantage of egregious commission schemes that were in place; they weren’t looking out for investors’ best interests,” he says.

As the old saying goes, “annuities are not bought, they’re sold.”

The industry’s bad rep is a shame because clients are struggling to find reliable and robust income streams. U.S. 30-year Treasury notes yield just 1.47%. The yield on 30-year investment-grade bonds hovers just above 3%.

That’s led some advisors such as Westerville, OH-based Brad Griffith to embrace annuities, which offer payouts exceeding 6%. Better still, “the ones we use have no hidden commissions, no surrender fees, better benefits and riders, and much lower expenses,” he says.

He’s referring to a new investment product known as “fee-only annuities.” To be sure, the bulk of the annuities business remains riddled with absurdly high sales loads, contracts with too much fine print, and “gotcha” clauses. And they remain a lucrative source of income for advisors that aren’t genuinely interested in their clients’ best interests.

In contrast, fee-only annuities can save clients up to 80% when compared with commission-based annuities. David Lau, CEO and founder of DPL Financial notes that “five years ago, there were just three or four such annuities. Now there are 20 carriers that offer them.”

While a commission-based variable annuity often carries a product cost of around 140 basis points per year, that figure drops to just 25-30 basis points for the fee-based version. “That kind of savings can really add up over time,” says Lau.

His firm works solely with fee-only RIAs and charges a minimum $1,000 annual membership to help shop around for the best deal for clients. And the ability to dig in and cross-shop various policies is crucial. The soon-to-be-deployed Regulation Best Interest (“Reg BI”) means that advisors must demonstrate that they have compared costs among investment choices before selecting the lowest cost-option (or at least clearly noting why another choice is the best one).

Firms like DPL and other fee-only annuity providers such as Lincoln Financial are able to produce reports that verify the due diligence process.

Faustino’s firm, Fi360, helps advisors adhere to fiduciary standards and is comfortable talking with advisors about this once-controversial investment product. “Our view is that with the right due diligence, annuities can play a strong role,” adding that there is a growing need for guaranteed income.

Make no mistake, there are clear limits for an annuity in portfolios. First, they make little sense for younger people still decades from retirement. Life offers too many uncertainties to be locked into a product that will be owned for life. Faustino says that there is a “life zone” where annuities make the most sense, usually when a client is looking to fill the gap created when employment income comes to an end.

Also, despite their more robust payouts, an annuity should never account for more than 20% (according to Griffith) or 30% (according to Lau) of a broader portfolio. Instead, they should complement bond and stock funds to boost retirement income streams and reduce dependence upon portfolio withdrawal strategies in retirement.

Advisors may also balk at the fact that the purchase of an annuity means that remaining assets under management (AUM) have shrunk by a commensurate amount. “If you’re billing on AUM, that’s lost revenue,” says Lau. Some advisors opt to count the annuity as part of their broader AUM calculation. For advisors that don’t include annuities in the AUM base, they’ll need to think through whether they are acting as true fiduciaries when their decision-making is impacted by such concerns.

Of course, many clients already ended up with annuities from past financial relationships, and they may be riddled with the myriad flaws that commission-based annuities came with. Advisors are often asked to compare annuities to see if a swap into a fee-only annuity makes sense. Many advisors outsource that analysis to a third-party while advisors like Griffith do the work in-house.

His team has developed spreadsheets that “can compare all the aspects of annuities on an apples-to-apples basis.” He adds that RIA/fee-based annuities have been a great vehicle to replace existing annuities” for his clients. Still, he’s careful to slowly walk clients through an analysis of whether to exchange an annuity or consider the first-time purchase of one. Griffiths cautions that “the advisor needs to be very knowledgeable and understand why an annuity may or may not make sense for a particular client.”

Annuities also address the sequence-of-returns risk, which refers to portfolio drawdowns during the early years of retirement. As Wade Pfau, an educator in the field of retirement planning noted in a white paper entitled Protected Lifetime Income, “a bear market occurring at or around the beginning of a person’s retirement may cause portfolio losses that are difficult to make up – even if the overall market eventually recovers.” That’s a real concern in today’s volatile markets. Diverting some of a client’s portfolio into an annuity can sharply reduce the sequence-of-returns risk, according to Pfau.

With each passing month, more clients will likely be venting about paltry payouts on their bonds and stock dividends. And that backdrop is unlikely to change soon as Fed chair Jerome Powell recently predicted that the benchmark rates will stay where they are through at least 2022. “Bonds just don’t do the job anymore. If you’re going to meet income needs, annuities can do that job safely,” says Lau.

David Sterman, CFP, is President of New Paltz, NY-based Huguenot Financial Planning

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