In opposition to long-standing conventional wisdom and research that extolls annuities ability to provide life-long income, most households should not annuitize any of their wealth, according to a study from the Congressional Budget Office.
In explaining their conclusion, the studys authors, Felix Reichling of the CBO and Kent Smetters, from the Wharton School, state that the present value of the annuity stream falls after a negative shock to health that reduces a households life expectancy. At the same time, the authors state that negative health shocks often produce correlated costs such as a loss of income, an increase in uninsured medical outlays, or both. Such factors, along with the liquidity constraints of annuities, combine to reduce their appeal.
The authors noted that these findings fly in direct opposition to economic modeling dating back to 1965 which shows that individuals who do not aim to leave bequests to future generations should put all of their investments into annuities rather than alternatives such as bonds.
The finding was no surprise, even to advisors who specialize in annuities. Many other research efforts find in favor of annuities, said Bob McCommon, senior vice president and director of annuity sales and operations at Wunderlich Securities in Memphis, and there is still a place for them. When clients need maximum income in order to cover essential needs, and concerns for legacy are minimal, then advisors see the benefits of immediate annuities. Clients often will raise the issue themselves, he says.
Nevertheless, McCommon said the older academic research in favor of annuitization usually does not persuade advisors or clients, especially in todays low-yield environment. Why would an advisor advise their clients to lock in record-low interest rates for the rest of their lives? he asks. The need or desire for the life-long guarantee of income, or longevity insurance, would have to far outweigh the reality of interest rates before an advisor would confidently recommend such a solution. Advisors often obtain quotes, but the resulting income is simply not attractive, relative to alternatives.
According to Jeff Spivack, senior vice president and head of the wealth planning department at Janney Montgomery Scott in Philadelphia, annuitization occurs very infrequently at his firm. Among other reasons, he said, Annuities have a bad reputation among some clients.
Joel Morris, vice president and senior financial planner with Janneys high net worth planning group, added that annuitizing assets can be an emotional as well as a financial decision for clients. If they are fearful of running out of money, annuitizing might help. However, we generally dont see that need with high net worth individuals. If there is such a need, holding an annuity in a diversified portfolio can provide peace of mind.
Spivack said that there are usually better solutions for such client concerns. Finding the right situation is case-by case, for individual clients, but one approach might be to include a variable annuity with a guaranteed minimum withdrawal benefit. Such a product could offer lifetime cash flow as well as flexibility.