3 Cases for Annuities in a Turbulent Market

Scenario: Since current income isn't a primary requirement, the couple is interested in exploring avenues to generate a return on their existing assets and defer taxes without the risk of losing what they already have saved. Their time horizon to retirement is 8–10 years. They are interested in investing roughly 10 percent of their JTWROS account assets in exchange for safety of principal and the potential to earn an annual return of 4-to-5 percent.

Suggestion: A fixed-indexed annuity without a guaranteed income rider could provide Kathy and Patrick growth potential, safety and an opportunity to take advantage of compounding returns. Compared to other investment vehicles, this type of annuity can offer competitive rates and strong guarantees.

(Related: Annuity 'Strategies' Don't Work)

By committing to a five-year lockup period — fixed-indexed annuities often carry contingent deferred sales charges (CDSC) — and a cap on maximum return — currently around 6 percent — Patrick and Kathy can avoid negative returns in the S&P 500 Index but still participate in a portion of any upside gains.

Since fixed-index annuities have lockup periods and cap rates, it's important that financial advisors fully explain the pros and cons of this type of investment when recommending them to a client. They should also clearly explain any compensation or fees the advisor stands to receive from the transaction.

Case #3 — Death Benefit Accumulation

Client Profile: Britt is a recent widow with three adult children. While two of her children are well-off financially, the third has struggled to build a portfolio. Britt is a conservative investor with $1.5 million in investable assets. She was the beneficiary of her husband's life insurance policy when he passed away a few years ago and used those proceeds to pay off her mortgage to become debt free.

Scenario: Britt has a strong desire to leave all three children an inheritance and wants to build some certainty around that. She expressed to her advisor that she would like to protect a portion of her assets while maintaining the opportunity for growth and would like to pass this to the next generation. As a recent cancer survivor, she is presently unable to obtain life insurance coverage.

Suggestion: Britt should consider a variable annuity with a guaranteed death benefit. Regardless of how the market performs, this type of solution can provide her peace of mind by guaranteeing the death benefit balance will grow for 15 years (7 percent annually) or until 200 percent of the initial premium is reached.

In addition, each of Britt's children will be able to select how they would like to receive their portion of the death benefit — lump sum, distributed over 5 years (annuitized), or stretched over their lifetime.

If they choose to stretch the payments over their lifetime they can continue the tax deferral on the remainder of the balance and add growth potential by keeping the balance invested.

In All Cases — Do What's Best for the Client

When selected and positioned correctly, annuities can serve a vital role in a client's financial plan. All annuities are not created equal however. There are many trade-offs and considerations when recommending an annuity to a client. These include the client's risk tolerance, time horizon, potential tax consequences (ordinary income vs. short- and long-term capital gains), and, last but not least, the client's goals and needs for the money.

When all of these elements line up an annuity can be a wonderful addition to a client's portfolio. If one of these elements doesn't align with the solution, utilization of an annuity could be less than ideal.

As financial advisors and planning professionals, it's important for us to explore the entire financial landscape to help clients address many of the risks we all face in retirement.

(Related: Making Retirement Income More Predictable)

Jason Allen, CFP, CLU, CLTC, CAS, is the senior advisor in the Wealth Management Consulting Department at 1st Global. He assists affiliated advisors with the growth and success of their financial practices by providing them with the guidance, education and support they need to help their clients achieve their financial goals. He specializes in identifying clients' insurance needs and works alongside advisors to offer insurance analysis and information on various carriers as well as the products available to 1st Global advisors. He began his career at 1st Global in 2007 and served as a wealth management consultant prior to receiving his promotion to senior advisor.