Annuities are a secure source of retirement income, offering peace of mind to risk-averse clients.
“Fixed annuity contracts provide the comfort that guaranteed income payments will continue for as long as clients live, protecting them against running out of money,” says John DiNovo, financial planner with Aligned Capital Partners Inc. in Toronto.
Yet, despite annuities’ attractiveness, they may not be the right fit for all your clients.
“If you have a ton of money, you don’t need an annuity,” says John Beaton, insurance and annuities broker with Beaton Insurance Services in White Rock, B.C. Clients with significant assets have no need to fear depleting those assets in retirement.
As well, annuities don’t make sense for clients who have employer-sponsored defined-benefit (DB) pension plans. In fact, annuities are similar to DB plans, DiNovo says, in that they could provide predictable, periodic payments for life.
Buying an annuity often comes down to a client’s unique psychological profile. Some clients simply want to avoid investment risk while benefiting from a product that provides them with the income they need during retirement.
For these clients, says Ron Sanderson, director of policyholder taxation and pensions at the Canadian Life and Health Insurance Association Inc. in Toronto, annuities are the “right product that fits their needs.”
When purchasing annuities, clients generally can choose one of three options: a life annuity, which provides guaranteed income payments for as long as the client lives; a term-certain annuity, which provides guaranteed income for a defined period; or a variable annuity, which provides a combination of fixed and variable income benefits that changes over the life of the annuity.
With a life annuity, your client can choose to add a joint life annuity option, which will continue to provide income payments to the client’s spouse or partner after the client dies.
In the case of a term-certain annuity, the client’s beneficiary receives the balance of the guaranteed income payments should the client die before the period of guaranteed payments runs out.
A client can choose to add an inflation-protection rider, which provides an increase in income each year by a fixed percentage to help offset inflation. (The fixed percentage is not necessarily indexed to a recognized indicator of inflation, such as the consumer price index.)
But annuities, despite their benefits, have declined in popularity during the past decade of low interest rates. The evolution of innovative, higher-yielding – albeit riskier – income-producing products such as ETFs has attracted more clients. As well, some insurance companies have shifted their focus from annuities to selling segregated funds with specified guarantees.
Typically, annuities become less attractive to investors when interest rates drop because income payments are linked directly to interest rates. With interest rates poised to rise, annuities could become more attractive. But interest rates will have to rise significantly to have a material impact on annuity income payments. For example, Beaton says, a 25-basis-point increase in interest rates would result in an 80¢-$1 increase in monthly income payments on a $100,000 life annuity. “That’s nothing to get excited about,” he says.
However, Sanderson says, while rising interest rates make annuities more attractive, interest rates should not be the determinant for whether a client buys an annuity. “If an annuity is the right product for a client,” he says, “interest rates shouldn’t be a factor in the decision to purchase an annuity.”
But even if interest rates rise to a level at which annuities become more attractive, your clients must contend with a shrinking market and fewer options, Beaton says. For example, Manulife Financial Corp., once Canada’s largest provider of fixed annuities, left the business earlier this year. However, some insurers, including Sun Life Financial Inc. and Canada Life Assurance Co., still offer annuities.
This reduction in the number of annuities providers had a direct impact on the cost of acquiring an annuity. Prices vary from company to company, Beaton says, and “there are fewer companies to go to for [good] rates.” Beyond specific variables such as the client’s age, gender and type of annuity, Beaton says, variables such as expenses and anticipated profit margins, which vary among providers, also are factored into the pricing of annuities.
Although annuities can be useful as a retirement-planning tool, many financial advisors don’t offer annuities as a core component of their product shelf. DiNovo says some advisors view annuity sales as a “one-off event” from which the advisor receives a single commission, so don’t recommend annuities often.
Buying annuities has certain disadvantages for your clients as well. Clients need to invest a sizable lump sum – usually, a minimum of $50,000 – which is locked into an annuity contract with the insurance company. Once the purchase is made, the client doesn’t have access to his or her money and usually can’t change or cancel the contract, although that may be possible for a fee in certain circumstances.