Will RIAs Start Using Fixed Rate Annuities in Portfolios?

Among the five insurers who offer both commissionable and fee-friendly products for a five-year term, according to David Lau, CEO of DPL Financial Partners, the fee-friendly product had a yield that was 61 basis points higher on average, as of Feb. 2. This is roughly equivalent to the common 3% commission on a net present value basis.

Improving Portfolio Efficiency

There are two ways that allocating to a multi-year guaranteed annuity could potentially increase the risk-adjusted returns of a portfolio, through higher yields and higher after-tax wealth growth.

The average guaranteed annual yield of the five-year term advisory annuities that Lau described was 5.57%. This is relatively competitive considering that the return is guaranteed. Five-year government Treasury bonds were yielding 3.99% on Feb. 2. While the MYGA guarantee is different from the guarantee of Treasurys, since it is based on insurers' claims-paying ability, both are viewed as relatively safe investments. Therefore, not only do MYGAs have a higher yield than government bonds, but they also have no reinvestment risk or potential price risk as to when bonds are purchased in a mutual fund or exchange-traded fund.

MYGAs offer tax-deferred growth, which can be especially compelling when purchased in a taxable account given that more traditional bonds have gains realized annually taxed at ordinary income rates but gains on MYGAs or other annuities are not realized until the money is distributed.

For example, let's assume that an investor can earn a 5% return on an investment, has a 40% tax rate and plans to invest for 10 years. If taxes are paid annually, an initial investment would grow to $134,392 at the end of the period versus $137,734 in the MYGA, where the gains are assumed to be taxed at the end of the period. That difference of $3,342 is equivalent to an annual after-tax alpha of 25 basis points for the MYGA. On a pre-tax basis, the return of the bond portfolio would need to be about 40 basis points higher than the MYGA to generate the same final period wealth.

Allocating in a Fee-Based Account

While some advisors may have concerns about billing on accounts that hold multi-year guaranteed annuities, allocating to a MYGA in a fee-based account isn't that different from holding a relatively static portfolio, especially if the advisor leverages more passive exposures. While there can be additional administrative issues associated with allocating to annuities, there is clearly evidence regarding the potential value. 

Additionally, MYGAs could be viewed as a way to learn about the larger annuity landscape and products, in particular lifetime income annuities, since the fee-friendly space for these products continues to evolve.