The perennial Rodney Dangerfield of investments is on the cusp of getting a slew of respect: Annuities are poised to become the most important investment vehicle of the next decade. That's what the "father of financial planning," advisor Harold Evensky, told LifeHealthPro sister site ThinkAdvisor in an interview.
Chairman of Evensky & Katz/Foldes Financial, the biggest independent RIA in South Florida and managing more than $1.5 billion in assets from some 800 clients, Evensky, who formerly shunned annuities, calls the immediate annuity a powerful vehicle that's virtually the only strategy to ensure maintaining one's standard of living in retirement.
Why Evensky, 72, converted from annuity abstainer to annuity enthusiast, he reveals in the interview.
Last June the fee-only advisor, who has been expanding his practice for several years, merged with Foldes Financial Management, led by Steve Foldes, an attorney and CFP who worked with Evensky as an advisor in the 1990s, then spun off his own practice. He was originally an Evensky client.
A vocal proponent of the fiduciary standard for all advisors, the Memphis, Tennessee-born, New Orleans-bred Evensky, a Cornell University grad, started out at Bache & Co. in 1967, moved to Drexel Burnham Lambert and, in 1985, went independent.
His firm is based in Coral Gables, Florida, but the advisor mostly works out of an office in Lubbock, Texas, where he relocated a few years ago. On top of being actively involved in the practice, he is an adjunct professor teaching a graduate wealth management class at Texas Tech University, where wife Deena Katz — who merged her financial advisory business with Evensky's in 1990 — is a professor of personal financial planning.
The veteran advisor has a big celebration lined up this year to mark his three-decade anniversary as an independent; but in the phone interview, he was far more eager to celebrate the benefits of annuities than to talk party plans. Here are highlights:
ThinkAdvisor: Annuities often get a bad rap. Some people, including advisors, warn to not go near them. What are your thoughts?
Harold Evensky: For many years, I was one of those people. My change of thinking came with the advent of lower cost annuities from firms like Vanguard, TIAA-CREF and others. They're offering immediate annuities — also known as payout annuities, income annuities, longevity annuities and longevity insurance — in which the insurance company isn't taking all the mortality gravy off the table.
Why focus on immediate annuities?
They're about the only way that investors can manage their mortality risk — living longer — and maintain the income they need for the rest of their lives. The real risk that retirees don't think about is living longer and longer.
Does a deferred immediate annuity offer a big advantage?
If you're considering an immediate, it makes sense to buy a deferred annuity because in order to make the cost work, you need to have a long accumulation period and a long payout period. The tax benefits of deferral more than outweigh the cost of the product — if it's a low-cost product.
How significant will annuities become?
The immediate annuity will be the single most important investment vehicle of the next 10 years. The future is in deferred immediate annuities. They can be bought when someone is 65, but they don't start paying till the individual turns 80. People are taking the risk that they won't live until 80; but if they do, then the payout can be relatively significant.
The common wisdom has been that older people don't spend as much as younger cohorts; therefore they don't need as much in retirement.
That's an extremely dangerous assumption. And the best example of that is what I've seen on a number of [pricey] cruises that my wife Deena and I have been on: lots of people in wheelchairs and some with oxygen tanks. They may be old and getting sicker, but they're still out there enjoying life and spending money.
Some critics say that with annuities, you just get a return of capital and that if you die early, you've thrown money away.
Those critics probably have fire insurance on their house, and they don't complain when it doesn't burn down. If you die early, yes, you may have made a lousy investment; but you're dead and don't care. What people don't think of is the risk of not dying early. They focus too much on the probability of dying early and ignore the consequences of living longer. And people are living longer and longer.
What specific role does an annuity play in a portfolio?
It provides a baseline, in effect, of guaranteed income that's independent of both market volatility and interest rate volatility. And you know that it's not going to run out no matter what — it will last the rest of your life.
So an investor with an annuity would be smart to also make some riskier investments in, say, equities.
Absolutely. It's logical mathematically to invest the balance in more volatile assets; and emotionally, having an annuity makes it more palatable because you have a baseline coming in.
What's a good age to buy an annuity?
Probably 70 and older. Traditional investments, like stocks, bonds and real estate, only provide a couple of sources of income: interest, dividends or capital gains. An annuity provides a potential fourth form of income: a mortality return, which is unique to an annuity and makes it very attractive: If you live longer than the average of a particular age group making the investment, the people who die leave money on the table. Those that survive get the benefit of those funds that the [decedents] didn't collect.
What's the main difference between a variable annuity and an immediate?
A variable is simply a mutual fund with an insurance wrapper, a subaccount. It's purely an investment that has some tax benefit because you don't pay current taxes on it. An immediate is just a promise to receive an income stream. It's [like] Social Security, which is an immediate annuity that has inflation adjustment, and that's rare: You get paid the rest of your life; and when you die, they stop paying it.
When would be appropriate to invest in a variable annuity?
If someone is turning 70 and buys an immediate, then it may very well make sense for them to start saving for a low-cost variable. If someone is 55 or 60, it may make sense to start saving in a low-cost variable and at age 70 convert it to an immediate.
Do you bring up the subject of annuities with clients?
We talk about the concept, but it's not something we're recommending at this stage because the payout of immediate annuities is dependent on current interest rates, which are still historically low. I don't see much risk in delaying the decision. Even if someone delays buying one for a couple of years, they'll get the benefit of a much higher payout because they're a couple of years older.
If the Fed raises interest rates later this year, would that be a good time to buy an immediate?
I don't have a magic number. When interest rates get back to a more historical norm, then we would start looking at immediates very seriously.
From an advisor perspective, why would an FA want to recommend annuities?
There have been a lot of misleading presentations of annuities, but it's a relatively easy sale with good commissions. They're very attractive for brokers to sell [compared to mutual funds] because if someone puts $100,000 into mutual funds, there are breakpoints: The commission paid is lower with $100,000 than with $10,000. But when you put money into an annuity, there are no breakpoints. If someone puts in $500,000 the broker is getting paid the same commission as for $10,000. So it's a great deal.
Does the client have to pay the total cost of an annuity all at once?
For an immediate annuity, they pay the insurance company in a lump-sum transaction. People aren't necessarily comfortable taking a huge amount of money and doing that. Part of the concern is: Suppose I die tomorrow?
