Kerry Pechter knows a lot about annuities. As the founder of Retirement Income Journal, author of Annuities for Dummies (John Wiley & Sons, 2008), and former annuity marketer at Vanguard, he’s been writing about them for almost 20 years. Pechter has no vested interest in selling annuities and has a broader perspective about these products than most.
Here is an edited Q&A with Pechter:
Q: What prompted you to write “Annuities for Dummies?”
A: There is a lot of confusion about annuities, and I wanted to clear the air.
There are five or six types of annuities, and they have less in common with each other than they have in common. Each of them is purchased by different types of people in different situations, and for different reasons. As soon as you talk about “annuities” in general, it gets very confusing.
What they have in common is tax-deferral and the option to convert the assets to lifetime income. Beyond that, they differ markedly. A fixed annuity is an alternative to a certificate of deposit. A variable annuity is a way to invest in mutual funds on a tax-deferred basis. An immediate annuity maximizes your income from savings but is illiquid. Different people buy different kinds of annuities at different times for different reasons.
Q: What has changed since “Annuities for Dummies” was published in January 2008. That was nearly nine years ago.
A: The sharp reduction in interest rates has been the biggest change. Interest rates are the lifeblood of all insurance products. When rates are dramatically low, as they are now, it essentially cuts the annuity industry’s air hose. When the government first lowered rates, most insurance companies could still rely on the their older bond investments that were paying higher yields. But as time went on and bonds matured, they had to be reinvested into new, lower-yielding bonds. Many insurers thought that interest rates would rebound within a couple of years after the financial crisis, but they haven’t.
Q: As insurance companies saw interest rates decline, they trimmed annuity payouts, right? Has that hurt sales?
A: Yes, but it’s complicated. Lower rates translated into lower monthly payouts for income annuities, lower guaranteed rates on fixed annuities, and lower payouts on the living benefits of variable annuities. At the same time, lower rates have helped the stock market, which helps increase the value of fixed indexed annuities and variable annuities. The bull market of the last eight years may also have made people forget the pain of the financial crisis.
The retirement of Baby Boomers – thousands retire every day – does creates a growing demand for lifetime income products. But that tailwind has been at least partly offset by the headwind of lower interest rates.
Q: Short-term interest rates may bump up a bit, as they already have since hitting a record-low in July. Will this change things?
A: If I were marketing annuities, I might suggest to older clients that the low rates that inflated the stock market appear to be coming to an end, and that they may want to lock some of their gains into a lifetime income product.
Q: So are we about to see a resurgence in annuity sales?
A: I’d like to think so. But most people aren’t used to the concept of buying their own personal pensions at retirement. More importantly, advisors who are accustomed to putting clients in mutual funds don’t suddenly start recommending annuities when their clients retire. They keep recommending mutual funds. Then you have the Department of Labor’s fiduciary rule, which will create confusion in the variable and indexed annuity markets for some time to come.
Q: So you expect lackluster annuity sales?
A: LIMRA, a life insurance industry group, has predicted lower variable and indexed annuity sales over the next year or so.
Q: Annuities in general seem to get a bad rap. Why is that?
A: The word-of-mouth on annuities isn’t good. Annuities receive a lot of negative media coverage. A lot of what’s written about annuities is flat-out wrong, however, even in the most respected publications. We live in a stock market-driven world. It’s no coincidence that the Dow Jones Industrial Average and the S&P 500 Index are reported throughout the day, every business day. The biggest problem is that certain annuities are marketed as investments, and inevitably come off looking inferior to investments, precisely because they are not investments. They are insurance.
Q: There seems to be a big problem in the way that annuities are sold – often at broker-sponsored presentations offering a free dinner, and at which only a couple of annuities are presented. It’s as if an annuity was a one-size-fits-all product. What do you think of this?
A: Agents and brokers have traditionally sold annuities on commission. The desire to earn a commission can make some agents and brokers very aggressive. That’s one reason why the DOL now requires intermediaries to sign a Best Interest Contract before selling variable or indexed annuities to IRA owners for a commission.
Q: If interest rates do eventually rise significantly, will we see more attractive annuities—something more akin to what we used to see on the market?
A: The payouts from income annuities should move up along with interest rates.
Q: Some people today are thinking about buying an annuity but are holding off until interest rates rise more and insurance companies respond by offering higher annuity payout rates. Is this a good idea?
A: As a rule, it’s a mistake to try to time the market. And, as I mentioned before, higher rates could hurt the stock market and take away some of the opportunity to convert equity gains to guaranteed lifetime income.
Q: Is there an annuity in the market that you especially like?
A: I like Great American Life’s new fixed indexed annuity, called the Index Protector 7. It charges no commission and offers a living benefit rider for only 50 basis points a year. It was introduced in July, partly because the DOL rule is expected make it harder for agents and brokers to sell commissioned indexed annuities.
Q: Do you yourself own an annuity?
A: Not currently. If I do buy an annuity, it will probably be a QLAC, or Qualified Longevity Annuity Contract. A QLAC is a recently approved type of deferred income annuity that allows you to postpone withdrawing part of your tax-deferred savings—and to postpone paying the income tax on those withdrawals—until as late as age 85. You can apply up to 25% of your tax-deferred savings, but no more than $125,000, to the purchase of a QLAC. It would, in effect, insure me against the risk of running out of money before I die.
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