Annuities’ Bum Rap

Art by Miriam Martincic

Plan participants’ tendency to dislike annuities is well-documented. Yet, increasingly, workers who are nearing retirement appreciate the value of creating stable income to replace their paycheck. Some industry experts recognize the paradoxical desire for what annuities could do in a portfolio, while the same investors voice a disinterest in them.

Alison Salka, senior vice president and director of LIMRA Research, ascribes some of these attitudes to more than just the psychology associated with the term “annuity.” The surveys LIMRA has conducted show a pattern linking a good comprehension of annuities with a more favorable view, she says. In one example, 40% of people who are knowledgeable about the products said they would want to convert retirement assets into guaranteed lifetime income. This falls to 15% among those who are not knowledgeable, Salka says. 

Greg Adams, a consultant at Fiducient Advisors, blames some of the negative sentiment about annuities on those that had high costs or fees that were poorly explained. But annuities can serve a useful role for many investors, Adams says.

“The way I have looked at it, annuities are kind of like medication,” he observes. “The right medication for the right person will do wonders, whereas the wrong medication will be catastrophic.”

“… annuities are kind of like medication. The right medication for the right person will do wonders, whereas the wrong medication will be catastrophic.”

Finding a suitable annuity may require more than casual research, either from an adviser or someone else acting in a fiduciary capacity. Trusted experts can help match investors with an annuity that best meets their needs, Adams says.

Problems with annuities arise when there are surprises or misunderstandings in the purchase process. “You buy an annuity because of the protection, the safety and the guarantees,” Adams says. “You like the idea until you find out your all-in fees are over 2% a year, as opposed to an index fund where you could be paying a few basis points a year. When individuals are surprised by pricing or product features after the fact, it can seem like an annuity is a bad product, but there could actually be a ton of value that the individual was receiving.”

The Setting Every Community Up for Retirement Enhancement Act is also likely to usher new annuity options into the defined contribution space, Adams says. Already, he is helping plan sponsors establish a prudent process for selecting income products and making sure that process is in accordance with the governing bodies and regulations.

The biggest challenge is grasping what the regulatory bodies will look for to grant the safe harbor to plan sponsors, Adams says. Some of the questions he is helping to pose include: How should plan sponsors benchmark and compare products? How should they educate participants? What do they need to understand about the underlying organization providing the product? And will they now need to evaluate insurance companies?

Part of the solution may lie in developing more descriptive language. Adams already sees greater use of the word “income” or “income-oriented” or “managed payout” funds, where some providers offer balanced funds that include a 5% allocation that will generate income for the participant.

“Most people can say, ‘Hey, I need X amount of income per month to pay my bills,’” Adams says. “So, if they can start saving and investing, contributing their money, contributing the employer match[, say,] to something that’s guaranteeing them income in retirement, I think that’s a little bit more of an intuitive way for participants to save and invest.”

Salka’s research also shows a variety of investor goals. Some individuals are very interested in guaranteed income, and some would rather roll the dice on the markets, she says.

“We find that people are very interested in turning assets into guaranteed income, because it makes them feel more comfortable if they have that guarantee,” she says. “For those who say they don’t like [annuities] or don’t want them, those people tend to say it’s because they’re going to lose control of the assets.”