6 Tips to Kickstart Succession Planning with Your Business Owner Clients
Here are 6 tips you can share with your business owner clients to help kickstart their succession planning.
You may be hearing more about annuities – both from your clients and in the news – lately. And that could include some warnings – that annuities are expensive and complicated. But there are many types of annuities, and they can be an essential part of a comprehensive retirement plan. If your clients have been thinking about an annuity, here are five common questions they might ask—and important answers that you need to give—to determine if it might be the right solution to help them reach their financial goals.
Many investors say that running out of income in retirement is their number one fear. Tax-deferred qualified retirement accounts such as a 401(k) or IRA allow investors to accumulate assets that they will then draw down in retirement. But those assets—and that income stream—can be subject to market risk. An annuity, on the other hand, is like an insurance policy for your client’s retirement, that can convert their investment into a guaranteed stream of protected income for specific period of time, or even income for life.
For starters, clients can control when they will receive income from their annuity by choosing between deferred or immediate annuities. Deferred annuities allow investors to grow assets tax-deferred, over years or decades, before choosing how to generate an income stream. Immediate annuities, such as a single premium immediate annuity (SPIA), will begin income payments soon after making an initial lump sum investment, and typically are a better fit for individuals when they are ready to begin their retirement.
You can also choose from annuities based on the growth potential of the assets that your client will be investing. There are variable annuities, where returns are tied to market performance for greater growth potential—but with more risk as the contract value fluctuates based on the market’s ups and downs. In recent years, many financial professionals have been recommending fixed index annuities (FIA) as a better bond alternative. These annuities can provide some upside potential when markets rise, but also offer protection from market downturns. There are also fixed annuities, which provide a guaranteed interest rate, regardless of what may happen in the market.
Just like other retirement accounts, such as a 401(k) or IRA, there are also expenses associated with annuities. Fees for variable annuities can easily total 3% per year or more. The industry average for five typical fees include: 1) mortality and expense fees (M&E) (1.35%), 2) administrative fees (0.10% – 0.30%), 3) investment management fees charged for the underlying funds inside the annuity (1.00%), 4) fees for optional riders or insurance guarantees (1.00%), and 5) surrender fees which may be charged for withdrawing funds from an annuity too soon (as much as 8.00%). Surrender fees exist to help the insurance company recoup the cost of any commission paid to the firm that sells the annuity, typically ranging from 5.00% – 9.00% of the amount invested. As a financial professional, be ready to explain all of the fees associated with an annuity, and help you evaluate them.
If fees are a concern for your clients, consider low cost and no-load annuities when determining which annuity will fit best into their overall financial plan. These low cost, no-load annuities often charge an M&E that is one-half to one-fourth of the industry average, or even a flat subscription fee, eliminating commissions and other insurance fees. The tradeoff may be limited access to insurance guarantees and limited downside protection.
Annuities can offer many choices for guaranteed income, from the simplicity of an immediate annuity, to a range of different optional living benefit riders that are designed to protect portfolio assets or income payments when markets decline. Some of these living benefits provide guaranteed income even if the underlying investments lose value.
Because the annuity is a contract with an insurance company, the guarantee of future payments is based on the financial strength of the insurer. Insurance companies are highly regulated, with strict requirements related to their investments and capital reserves. Their financial strength is regularly reviewed and rated by five independent agencies, A.M. Best, Fitch, Kroll Bond Rating Agency (KBRA), Moody’s and Standard & Poor’s, each with their own rating scale and rating standards.
In addition, each state has a Guaranty Association to protect policyholders in the unlikely event that the insurance company is unable to meet their financial obligations. A study by the U.S. Government Accountability Office determined that even following the profound effects of the 2008 financial crisis, the impact on the majority of insurance companies and their policyholders was limited, with a few exceptions.
Financial professionals can recommend many ways that annuities can be an effective financial planning tool to meet a range of investing needs at all different stages of the financial lifecycle. For example, investment-only VAs (IOVAs) are built specifically to maximize the power of tax deferred accumulation—with lower costs, more fund choices and sophisticated portfolio management platforms.
IOVAs can be beneficial for high earners and the high net worth, who can easily max out qualified plans, such as 401(k)s and IRAs, and are looking for another tax-advantaged investment vehicle. With virtually unlimited contributions, IOVAs can also be used to shelter a large cash infusion, such as the proceeds from selling a business. And tax-inefficient asset classes, such as fixed income, commodities, dividend-yielding stock and liquid alternatives, can be “located” in IOVAs to increase returns—without increasing risk.
Annuities can also be used for tax-efficient legacy planning. Many offer a range of optional death benefits, from a lump sum payment to a guaranteed income stream for heirs. These proceeds typically receive favorable tax treatment, and can be transferred to heirs without the hassle of probate and legal fees. Some annuities offer a restricted stretch provision, to minimize the tax burden of a large inheritance by spreading taxes over a beneficiary’s lifetime, while controlling distributions to heirs with less complexity and expense. As a financial professional, you can also help clients with a tax-efficient strategy to fund trusts in a low-cost IOVA, allowing the assets to accumulate and grow tax-free.
Remind your clients that annuities are long-term investments and should be considered carefully. They might not make sense for an investor who wants immediate and unrestricted access to their capital, because the tax-deferred structure means certain kinds of withdrawals may incur tax consequences. But for other investors who don’t have immediate liquidity needs, especially high earners and the high net worth, or for those who value guaranteed lifetime income, annuities might fit perfectly within their financial plan.
Before they invest in an annuity, work with your clients to determine their retirement income needs, evaluate liquidity needs and create a holistic picture of their existing retirement income sources, including qualified retirement plans. Then be prepared for your clients to ask these questions and be ready to give them the answers they need to determine if an annuity might fit within their holistic financial plan.