Suitability standards may well mandate that the use of annuities be at least discussed with clients when providing retirement counseling.
For the more than 40 years that we have been in the legal support of the financial-services industry, we have always been astounded by the fact that few people really understood the longevity value of annuities. This has been particularly disappointing when we've been in discussions with government officials, both elected representatives and regulators. Moreover, for most of our career in this arena, the vast majority of financial advisors has looked at annuities more as some form of tax-deferral mechanism than the true insurance products they are--insurance against outliving your money.
Today, after all these years of arguing that the true purpose of annuities is to provide longevity protection, the concept seems to be catching on. Recent pronouncements by high-ranking government officials have stressed that people need to be concerned about outliving their retirement funds and that annuities are the best (if not the only) method to alleviate such concerns.
We often joke that our will reads, "being of sound mind, we spent it all." Yet, the only way most of us can ensure that our money and our time on earth end at the same time is through the purchase of a life contingency annuity. Certainly, Silicon Valley dotcom billionaires and even multimillionaires do not have to worry about outliving their assets, but everyone else must be constantly aware that the problem is real.
A few years ago, during the halcyon days of the dotcom bubble, many rank and file workers found that their retirement plans (particularly those which invested in their employer's stock) had made them unforeseen amounts of money. Many of them opted for early retirement and, using long-term projections of investment income, took advantage of Section 72(t) of the Internal Revenue Code to speed up the distribution of their retirement assets free from early distribution penalties. When the crash took place in 2000, many of these people found that their retirement funds had pretty much disappeared. As a result, a large number of financial advisors found themselves in trouble because they had not effectively kept their clients from engaging in such folly.
We observed this phenomenon, and one of our partners spent a substantial amount of time acting as an expert witness in the litigation that ensued. The most common theme of this litigation was that the retirees had unrealistic expectations about their assets and how long they would last. If a worker at a blue collar job suddenly finds himself with a seven-figure retirement fund, it is difficult for him not to feel that he is "rich" and financially independent. He can buy the boat he always wanted, get the retirement home on the beach, and live on an annual income that is greater than what he made during all the years he worked. Unfortunately, time is inexorable. So is unpredictable longevity.
When the federal government enacted ERISA in 1974, it first codified the concept of requiring pension schemes to consider "life expectancy." The life expectancy figures used by the federal government for retirement plans (and for deferred annuities) takes the entire population and determines average life expectancy as when half of the people in a particular age group will be dead and half will still be alive. Defined contribution pension arrangements must provide for distributions for life expectancy. Unfortunately, most people understood "life expectancy" to be the same as "for life"--which it is not! Half of the people who have planned their pension distributions for "life expectancy" will run out of money. Even the federal government has finally discovered this fact.
We are now seeing releases from various segments of the government extolling the virtues of annuities as a solution to this longevity problem. Some government officials have even gone so far as to suggest that annuities be made mandatory for tax-qualified retirement plans. What a change over past years when the government viewed annuities as merely some form of tax dodge for the wealthy!
The point of all this is that financial advisors should be aware that the standard for retirement advice is changing. Suitability standards may well mandate that the use of annuities be at least discussed with clients when providing retirement counseling. Access to longevity planning programs and analysis of the various options available could well spell the difference between suitable recommendations and those that are not suitable.
In the past, most retirees under defined contribution programs such as 401(k) plans rolled their retirement funds into IRAs--usually at a bank or similar institution--and, after taking out funds for the new boat or the beachfront home, began taking distributions for life expectancy. We often ponder what will happen in future years when half of these people begin to complain that they have run out of retirement funds, just when they are of an age where they have no employment options. We often also ponder what kind of litigation will ensue when these retirees begin to look to their financial advisors and hold them liable for bad advice.
The various types of annuities available in the marketplace today are more flexible and more complex than at any time in history. They provide numerous guarantees--not just protection against outliving retirement funds, but with inflation safeguards, premature death protection, and even the ability to fund for long-term care needs. Annuities are often believed to be the oldest form of life insurance. It now appears that this ancient product is also the most modern and that everyone in the financial services business needs to have a detailed knowledge about them and understand how to counsel clients on their effective use.