In recent years a major development has occurred with respect to annuities … more and more insurance companies are offering annuity products with no commissions. These products can deliver more of the returns of the capital markets to the consumer. If offered to plan participants, such products could greatly enhance a retiree’s financial security and enhance their quality of life.
There are many different types of annuities. In my view, variable annuities possess very little attractiveness (this deserves its own very long post), as they often fail the cost-benefit analysis.
In contrast, fixed index annuities (FIAs) and registered index-linked annuities (RILAs) are based upon an investment theory that I believe possesses sound academic support, but marketing techniques for many of such annuities are troublesome, and better structures for FIAs and RILAs are needed. Concerns also exist over the pricing of call options on indexes, given limits in the supply of such options as demand increases. And financial strength of the insurer is a prime consideration.
In the remainder of this post, I focus on immediate lifetime fixed annuities. In other words, this is when a plan participant or other investor chooses to “annuitize” – transform part of their retirement nest egg into a lifetime stream of income.
FOUR BROAD PRINCIPLES (APPROACHES) THE DOL CAN EXPLORE IN FUTURE RULEMAKING
When the process of considering annuitization is underway, how can we ensure the best possible (non-conflicted) advice to the individual investor? I suggest four broad principles be explored by the U.S. Department of Labor (EBSA), as it further considers how to minimize conflicts of interest for ERISA-covered accounts (and IRA rollovers).
(1) ANNUITIZATION IS A FINANCIAL PLANNING DECISION.
First, in its various rule proposals and future pronouncements, the U.S. Department of Labor should encourage plan sponsors to realize that the decision to annuitize a portion of a retiree’s nest egg is not merely the choice of an annuity product but is rather a key lifetime financial planning decision. Considerations in the annuitization decision involve:
- health and genetics – essentially the need to estimate longevity of the retiree (and spouse);
- the presence of debt;
- both present and future anticipated cash flow needs;
- the interplay with the participant’s (and spouse’s) strategy to maximize the utility of Social Security retirement benefits and/or pension benefits;
- the desire or need of the retiree (or couple) to provide support to other family members (including by means of inheritance);
- the presence of other assets or resources;
- the risk tolerance and capacity of the client, and the need to take on risk;
- the current interest rate environment;
- whether inflation adjustments occur over time with annuitization and the nature (size, or method of computation) of any such inflation adjustments;
- the current expected returns of various asset classes given valuation levels in the capital markets;
- what portion of the nest egg to annuitize;
- whether to annuitize in stages (some one year, some during a later year);
- whether to consider, for any portion of the sums to be annuitized, a deferred income annuity (DIA) (or whether, in contrast, to choose a term-certain annuity for a period of years (such as 20), followed by increased withdrawals from an investment portfolio, which in a fashion minimizes some forms of risks; and
- Other considerations, not listed above, some of which may be unique to a client’s situation.
In other words, deciding whether to annuitize is a complex FINANCIAL PLANNING decision. It deserves the attention of a trusted, expert investment adviser – i.e., a fiduciary.
(2) COMPETITIVE SHOPPING OF NON-COMMISSION ANNUITIES SHOULD BE UNDERTAKEN.
Second, even following this complex financial planning process, if annuitization of a portion of a retiree’s nest egg is to be recommended, then annuities should be competitively shopped. This is not just a “one and done” decision by a plan sponsor, each and every year, as payout rates change frequently among insurers. Strong consideration must be given to the financial strength of the insurer, as well as the presence (and limitations of) state guaranty programs. I encourage the DOL to encourage plan sponsors to ensure competitive shopping of no-commission annuities.
(3) A FIXED OR FLAT FEE FOR THE ANNUITIZATION ADVICE, FROM A NON-CONFLICTED RIA, SHOULD BE THE STANDARD FEE STRUCTURE.
Third, how should financial advisors get paid for doing the analysis as to whether an annuity is proper, and for undertaking due diligence on the annuity product(s) selection (assuming annuitization is recommended for that particular plan participant)? The problem exists that many fee-only investment advisers, who generally seek to minimize conflicts of interest with their clients, often possess – in this instance – a significant conflict. If the investment adviser would charge a fee (such as an assets-under-management fee) for managing an IRA rollover (or the 401(k) plan account), then that fee-only investment adviser would possess a disincentive to recommend annuitization.
(While some annuities exist from which AUM / AUA fees can be paid, I’m personally not comfortable with this. Once an immediate annuity is purchased, is there anything to manage? Or, if a FIA or RILA is utilized, is the investment adviser truly able to add value in determining (periodically) which options should be chosen with the annuity contract)?
Perhaps the solution is this. Given the emergence of immediate annuities with no commissions, the DOL should encourage plan sponsors to entertain proposals from fiduciary (trusted, expert) and completely independent financial advisors – even going so far as to exclude those who manage investment portfolios for a fee.
In other words, should an independent investment adviser – who neither sells annuities, nor manages investment portfolios for a fee – be hired to undertake a flat or fixed fee engagement for the annuitization analysis?
Do such investment advisers exist? Yes. There certainly are RIAs who only provide financial planning, and who choose not to manage investment portfolios.
(By way of disclosure, my own firm does AUM/AUA fees, in which financial planning is integrated with investment portfolio management and advice. Hence, my own firm would not qualify under this test. But I know other RIA firms – which eschew asset management – who would so qualify.)
(4) THE FIXED OR FLAT FEE SHOULD BE PAYABLE FROM THE RETIREMENT PLAN / IRA ASSETS.
Fourth, lI would further urge the IRS and DOL, as a means to minimize conflicts of interest, provide authorization for the payment for such flat fee(s) for the annuitization analysis (and for the due diligence for the subsequent choice of the annuity), to be paid from the defined contribution account (and/or an IRA account), without treating such as a taxable distribution to the account owner.
Often plan participants have virtually all of their liquid investment assets in qualified retirement plans and IRAs. Rather than forcing a (usually taxable) distribution to occur, to pay for the financial planning advice (relating to annuitization), the payment for such advice should be made easier, with no tax burden imposed.
This page represents the personal views of Ron A. Rhoades, JD, CFP®, and does not necessarily reflect the views of any institution, firm, organization, motley crew of pirates, cult, or gang, to which Ron has ever belonged to or ever been kicked out of.
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