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Income Annuities: A Coming Trend

There are several possible causes for the increase in sales of income annuities.

Judith A. Hasenauer, 12/06/2012

The Insured Retirement Institute (IRI) has reported an interesting increase in the sales of income annuities--i.e. annuities where income payments begin within a year of the date of issue. The total sales, $2.3 billion for the third quarter of 2012, is still very small when compared with total annuity sales for the quarter of $52.9 billion. Nevertheless, such an increase in income annuity sales (3.8%) indicates a trend that flies in the face of conventional wisdom regarding annuitization.

It has long been accepted that purchasers of deferred annuities never, in fact, annuitize their annuity contracts. The common belief has been that deferred annuities remain deferred until such time as the contract owners surrender their contracts for their cash values or die and leave the contracts to their beneficiaries. The reasoning behind this behavior has been twofold: 1) that the annuitization process was discouraged by financial advisors who did not want to lose the ability to use contract values to sell new or different forms of investment; and, 2) that annuity owners were reluctant to "tie up" the assets by annuitization that would make it impossible to access the funds for emergencies or other uses.

Many observers have also expressed the belief that the value of a life contingency annuity has not really been understood by either financial advisors or by their clients. It seems that for years annuities have been perceived merely as a tax-deferral mechanism and not the insurance against outliving retirement funds that is the real purpose of an annuity.

There are several possible causes for the increase in sales of income annuities. First, there has been a dramatic shrinkage in available capacity among annuity issuers. With interest income as low as it has been for the past few years and the probability that it will remain low for the foreseeable future, insurers have pared back the amount of sales volume they are willing to take--particularly in view of the costs they incur with the guarantees that are included in most annuities sold today. Insurers are often more willing to accept sales of income annuities than they are  sales of deferred annuities. Income annuities are more stable and enable insurers to assume a longer time horizon for the investments that will underlie the product. Cash flow management remains a concern but is much more predictable than is the case with deferred annuities that can be surrendered without notice. Therefore, financial advisors are perhaps more likely to recommend income annuities because they are more readily available than are deferred annuities.

Another possible reason for the increase in sales of income annuities is the huge volume of publicity given to the Social Security system and the highly politicized maneuverings currently taking place in our country. All the publicity has alerted people to the increased longevity that can dramatically decrease retirement security. Our favorite legacy in a last will and testament is the phrase: "Being of sound mind, I spent it all!" Everyone fears running out of money before their lives end. Yet, for the average person, the only way to ensure that this will not happen is to own a life contingency annuity. As this realization has dawned on more and more people, it is logical that sales of income annuities should increase.

It may also be that the increase in sale of income annuities is the result of the beginning of retirement for the "baby boomer" generation that is now in its second year of possible retirement. The huge number of "baby boomers" should have a profound impact on the need for retirement planning and a resultant increase in demand for income annuities. The advent of 401(k) plans as a replacement for defined benefit retirement plans alerts potential retirees of the need to consider their own longevity in retirement planning, rather than relying on employers alone for long-term retirement security.

There are few reliable statistics available about how many deferred annuities actually annuitize. Indeed, it is possible that the increase in sales of income annuities is, in reality, a form of annuitization. One of the beauties of any annuity is the ability to make a tax-free exchange for another annuity. It seems that few deferred annuity owners actually annuitize their contracts in accordance with the annuity provisions of the contracts. It is prudent for the owner of a deferred annuity to "shop" for more favorable contract rates and provisions than are contained in the deferred annuity already owned. An interesting phenomenon of the past few years has been the development of a form of "clearing house" market for income annuities with the resulting ability of financial advisors and retirees to find the best contracts available.

Accurate financial planning must take into consideration the longevity expectations of retirees and insure that adequate funds will be available regardless of the length of life. A life contingency income annuity is the only sure way to insure that a retiree and his funds will expire at the same time.

Judith A. Hasenauer, JD, CLU, is an attorney with the law firm of Blazzard & Hasenauer, P.C. She devotes her practice exclusively to the financial services industry, providing consulting on the development and regulatory clearance of products, compliance issues, distribution issues and related matters, such as advisory activities and industry initiatives.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.
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