Where Do Annuities Fit in Your Client's Retirement Strategy?

“You’re not necessarily selling stocks with a risk premium to purchase the annuities; you’re trading bonds for annuities,” he explained. “That sort of context really leads this idea that there are different viable strategies out there for how people can approach retirement, whether it’s with a total return investing strategy, a bucketing strategy or a strategy that might fill an income gap.”

For instance, the annuity could be used to build a protected income floor and create a framework for investing toward more discretionary goals.

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Selling Bonds to Purchase an Annuity

As noted by Pfau and reiterated by Look, it generally makes more sense for investors to trade bonds for an annuity rather than to liquidate stocks to purchase an annuity.

“If you’re getting an annuity for income purposes, it’s really going to be an effectively fixed income asset class exposure in your overall portfolio,” Look said. “It’s important to recognize that and use a portion of the bond portfolio to buy the annuity and to reflect that in future portfolio rebalancing.”

Pfau added that if an investor is selling stocks to purchase an annuity, they might be sacrificing the opportunity to build a legacy for their heirs. Selling bonds to fund the annuity purchase allows them to keep the overall stock allocation the same for their household balance sheet.

What Academic Studies Say

The panelists also addressed some of the many academic studies on annuities. Look mentioned that a number of these incorporate consumption smoothing, both pre- and post-retirement. Annuities can lead to a smoother income path because they provide more certainty of income.

Deferred annuities with living benefits are complicated financial products, Pfau said, adding that there is a concern that in the midst of that complexity it can be difficult for an investor to tell if the insurance company is taking too big of a cut from the annuity.

There are secondary factors as well, Pfau added. “One of these other factors you see with that total return approach is an accumulation mindset post-retirement. Some people still focus on maximizing returns over having a predictable income, whereas other people change to a distribution mindset, which is they’re more worried about having predictable income over maximizing returns.”

Social Security, Annuities & Inflation

When making decisions about annuities, investors mustn’t forget to factor in Social Security. Delaying Social Security claiming past full retirement age adds 8% per year to the benefit, Look noted, which may help retirees fight inflation better than any annuity.

Pfau added that he views Social Security as longevity insurance and inflation protection for a surviving spouse, with the benefits of the higher-earning spouse lasting for the joint lifetime of the couple.

Fixed Indexed Annuities

The panelists also made several important points about fixed indexed annuities.

Look mentioned a study he was doing that found these products can help mitigate the impact of any portfolio shortfalls over time. Unlike income annuities, which are basically commodity-like products, fixed indexed annuities are really deferred annuities that can offer a number of features to consider for retirees.

Pfau added that income annuities, single premium immediate annuities or deferred income annuities should all offer higher lifetime payouts than a fixed indexed annuity with a living benefit.