Even though Americans say their primary financial fear is retiring without enough money, a poll by the National Foundation for Credit Counseling found that nearly 30 percent of households save nothing for retirement.

That is unfortunate, because tools are available for people to position themselves well financially before and during retirement. Our job as advisors is to bridge that knowledge gap so clients understand their options, make educated choices and realize their goals.

This is especially true with annuities, which aren’t the easiest investments for clients to understand. To help clients make an educated decision, here are five crucial topics to discuss before they sign on the dotted line. 

Know the Carrier

When clients buy an annuity, they’re really buying the carrier. The product is simply a vessel. So they need to understand the company selling the annuity.

Start with financials, because an insurance contract is only as good as the firm behind it. Go through the statements and show why it’s a solid carrier, why it can fulfill its obligations, and why it’s ultimately a sound company to entrust with your money. Understand the carrier’s assets, liabilities and solvency ratio to strengthen the quantitative side of the story.

The carrier’s ratings and industry longevity are the qualitative complement to the numbers. So go over the A.M. Best, Standard & Poor’s, Moody’s and Fitch reports, and discuss the firm’s history. Impressive ratings and demonstrated financial stability validate your proposed solution and provide invaluable third-party credibility that helps reinforce the decision to buy an annuity from a particular carrier.

Make sure clients understand the role the National Organization of Life & Health Insurance Guaranty Associations (NOLHGA) plays in protecting policyholders. It’s an additional piece of assurance for clients to know there’s an organization protecting them against carrier insolvency. 

Understand Liquidity Provisions

One of the main reasons clients purchase annuities is to harness the guaranteed income streams they can create, but clients need to understand that their money is not in a lockbox that can never be opened. In my experience, the biggest objection to buying an annuity is the lack of liquidity. That’s why clients must know the liquidity provisions before they agree to buy an annuity. 

At minimum, a list of discussion topics should include: 

» What amount they can get out of the annuity without a penalty. 

» When they can access that amount without a penalty. 

» Fees or penalties for excess withdrawals beyond the penalty-free amount. 

» The opportunity cost of withdrawing. 

» What happens in an emergency such as a terminal illness or when chronic care is needed. 

» How long they’re obligated to keep their funds in the annuity with penalties. 

Beyond that, clients also should understand the potential for market value adjustments. Something I see too often with advisors is that many of them gloss over market value adjustments too quickly. Changing marketing conditions can substantially affect annuities, and usually the popular fixed and indexed ones are first in line for adjustments.

If rates rise as expected, policyholders likely will feel the sting of these adjustments via higher penalties. Clients must realize this before buying, especially those who like to time the market or seek greener investment pastures.

I have helped advisors show clients how money gets put into an annuity, how the money works while it’s in the annuity, and how and when the funds can be withdrawn. Since liquidity is the biggest objection to an annuity sale, you won’t be surprised to hear there’s heavy emphasis on that last part! 

Making Money With Annuities

As with any vehicle, clients want to know how they make money with an annuity, and it’s your job to make sure they understand. Clients are most likely to be interested in the interest, so cover how and when they’ll earn it, along with how much and little they can possibly earn.

Advisors should act as if they’re explaining it to someone they love dearly, like a grandmother or spouse. Of course they’d want this person to know everything about how the annuity earns money. 

So here are some “must know” questions within that context for clients. 

» Can I lose principal due to market loses? 

» Does the annuity have a guaranteed interest rate? 

» How long is that interest rate guaranteed? 

» If the annuity is indexed, what index does it use? 

» What is the indexing strategy, and how does it work? 

» Are volatility control indexes being used? 

» How do the volatility control indexes work? 

» Can earned interest be lost, or does it lock in at any point? 

Also spend time with clients to explain modifiers and the fact that rates can change. Your clients need to know the caps, fees, participation rates and spreads, including how high or low carriers can adjust them. You also should explain the carrier’s adjustment history. 

Explain Living Benefit Riders

If your client is purchasing an indexed annuity with a living benefit rider, make sure they understand that rider. The most common misconception I see about such a rider is a misunderstanding of living benefit value versus cash accumulation value.

While the cash accumulation value is in an account and grows based on the indexing strategy, clients fail to understand that the living benefit value is a ledger value. It gives them the impression that their cash is earning the “roll-up” rate of 6 percent or 7 percent; they don’t realize the living benefit value isn’t their cash, but rather a value used to drive the future income stream.

It’s why you hear stories of soon-to-be-former clients screaming how they were told they’d get the better of the market or 7 percent, and they want their money back.

Because every product varies, it’s vital to fully explain the details before the sale. Be sure to cover income rider activation terms and how withdrawals outside of activating the lifetime income stream affect the living benefit value. You’ll help your clients make educated investment decisions, and you’ll lessen the likelihood of an angry encounter! 

What Are the Tax Implications?

Any annuity purchase should be discussed within the bigger picture of tax and estate planning. You have to help clients understand how an annuity will affect their taxes, and even work with their accountants if possible.

Because annuities can be confusing for clients, it helps to draw parallels with known entities, especially with taxes. Clients most commonly want to know the tax implications if they take income from the annuity, which comes down to the funding source.

Many clients understand tax-deferred retirement accounts. “Oh, yeah, my 401(k) at work,” they’ll say. So leverage that knowledge and connect the known concept of a 401(k) with a qualified annuity, explaining the tax similarities.

That said, nonqualified annuities differ taxwise from most investments, so drawing parallels may not always be an option. Still, explaining nonqualified withdrawal taxation is crucial and I’ve seen several methods work. Regardless of the technique, be sure to cover the last in, first out (LIFO) concept so clients aren’t surprised by a big tax liability after positive returns. 

Communication and Comfort

At the end of the day, your success comes down to clients feeling comfortable with the solutions you propose. That’s especially true with annuities, so make sure to communicate the points above clearly.

A recent poll identified lack of communication as the overwhelming reason advisors are fired. To be the advisor who’s continually hired, spend time with clients so they’re comfortable with and knowledgeable about the annuity purchase before the sale. 

Ray Kathawa  is vice president of practice development with M&O Marketing, Southfield, Mich. Ray may be contacted at ray.kathawa@innfeedback.com.