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  • 01 hr 00 mins 06 secs
One of the growing risks to retirees is outliving their assets. Annuities can help protect against that longevity risk, offer tax and diversification benefits, and provide guaranteed income during periods of market volatility. Three panelists explore ways that advisors can use annuities within client portfolios.
  • Jared Nepa, CFS®, Vice President and National Sales Manager, Bank/Wire and Independent Planner Channels and Annuities, Lincoln Financial Group
  • Steven Sweeney CFP®, CLU®, ChFC®, RICP® Director, Advanced Planning Retirement and Life Distribution, Prudential Financial, Inc.
  • Mike Sosnowski, CFP®, ChFC®, CLU®, RICP®, CFS®| Director, Advanced Markets, Transamerica

Jenna Dagenhart: One of the growing risks to retirees is outliving their assets. Annuities can help protect against that longevity risk, offer tax savings and provide guaranteed income during periods of market volatility.

Jenna Dagenhart:  Joining us now to explore way that advisors can use annuities within portfolios, we have three panelists. Steven Sweeney, Director, Advanced Planning Retirement and Life Distribution at Prudential Financial. Jared Nepa, Vice President and National Sales Manager of Annuities at Lincoln Financial Group. And Mike Sosnowski, Director, Advanced Markets at Transamerica. Everyone, it's great to have you with us. Steven, kicking us off, what are some of the key components of a strong retirement plan?

Steven Sweeney:  Thanks, Jenna. Yeah. A cornerstone in the foundation of any retirement plan is creating predictable and sustainable streams of income to cover essential expenses, and annuities serve this purpose specifically and have done so for a long time. The reality is, they're a critical component to the financial plans of millions of Americans, and they add a level of security, while helping alleviate some of the financial uncertainty the future can sometimes bring.

Steven Sweeney: In fact, those receiving income from annuity solutions have reported that they find them to be highly valuable as an addition to their retirement income strategies, particularly when they're considered in combination with strategies related to things like Social Security. And while a strong retirement plan often requires a combination of strategies, investment, and products, really the best approach first and foremost considers the client's unique objectives and the goals that they have and time horizon available and so forth.

Steven Sweeney: And to determine if an annuity can make sense as a part of that overall plan, especially right now, annuities have evolved, really then providing greater flexibility and lower in costs and options that allow for owners to participate in the market, having upside investment potential, and a level of downside protection, both in the accumulation and distribution phases of retirement. And this is particularly evident in, and has led to a rise in the popularity of indexed variable annuity solutions that can come with or without income riders. And the goal here is to help clients mitigate and manage those common risks to retirement that are relevant in today's environment.

Jenna Dagenhart: And there are certainly a lot of risks out there as we'll discuss during the program. But Mike, building off of Steven's comments about where annuities fit within a portfolio, what's a common practice when determining the percentage of an individual's portfolio that might get allocated to an annuity?

Mike Sosnowski: Well, thank you, Jenna. And Steven mentioned, everybody's situation's different, everyone's circumstance is unique, and this is actually a common question that we come across quite often, and really instead of a blanket answer, we really need to look at the individual's retirement strategy that they have.

Mike Sosnowski:  So instead of allocating maybe a generic percentage of someone's overall portfolio to the annuity, we need to look at, as Steven mentioned, their essential expenses, those expenses that they're going to have in retirement, like housing, like food, utilities, maybe transportation. And what we want to do is really compare those expenses to any sources of guaranteed income that they may already have in their portfolio.

Mike Sosnowski:  Do they have a pension? How much are they going to receive from Social Security? Here, what we can see is if essential expenses exceed those sources of income, then we're going to have what could be considered to be an income gap. This is where the annuity can come into play and maybe fill that gap, so that way, all essential expenses are covered. So really, instead of looking at the annuity as an investment within a percentage of somebody's portfolio, what we can do is instead figure out what lump sum amount will generate the amount of income to cover those essential expenses going forward.

Jenna Dagenhart: That's a great way of looking at it. Now turning to one of my personal favorite topics. Jared, financial professionals and industry experts often talk about behavioral finance and how it plays into clients' portfolio decisions and the products that best suit them. Could you talk a little it more about how this is particularly relevant to today's annuities market?

Jared Nepa: Absolutely Jenna, and on behalf of Lincoln Financial, thank you for giving us the opportunity to participate on your panel today. So when you think about behavioral finance, it's interesting because what we know is that over time, what we've found is if you looked at just even a core 50-50 portfolio based on kind of the S&P and the Barclay AG over the last 30 years and an individual's performance benchmarked against that, there's, as Mike said before, there's a gap, a performance gap. And if you think about what that performance gap looks like, if you look at their most recent study, I have it here, going back to 1990 to 2019, the typical 50-50 allocation to US stocks and fixed income generated about 7.8% return, but if you look at the DYI investor, those kind of doing it themselves, you'll see a gap of over 500 basis points to their return.

Jared Nepa: And what's interesting is you look at, it's not always the investment strategy that's important. It's around coaching your clients to kind of stay invested and stay the course. And what's interesting is we've looked at kind of what drives behavioral finance, and two things stick out. Number one, recency bias is something that a lot of people use or lean on to drive their investment decision-making process, because the pain of a loss oftentimes supersedes the euphoria of a gain, so when things start to happen that they question their portfolio, they go back to their most recent experience of loss. The second thing is just the amount of information that clients have to consume in today's market. This is why your show and what we're doing here is so needed because we're trying to offer facts to keep people to stay the course, but as we know, most news that's consumed is really heavily weighted towards negative nature.

Jared Nepa: So you put those into context, and what we find is that what a financial professional does today is more important than it's ever been before. And I'll quote one more study that we've used recently through Russell Investments, and I want to make sure I get these percentages right because what Russell Investments has found going back to 2021 is that there's five major components that can help fill that gap and improve the investor's opportunity to kind of, like I said, improve the gap between their return and what the market's doing. And what's interesting is these five factors have nothing to do with the investment philosophy in itself. If these are done correctly, you can make up over 480 basis points of that 500 basis point gap that the individual investor sees versus the market.

Jared Nepa: First on the list, Jenna, is behavioral coaching, being there as a consultant, listening, having an opportunity to provide clients with facts and historical data. That makes up over 200 basis points in return. We think about the next largest is 120 basis points come from tax smart planning and investing, so making sure that you have your investments in a tax-efficient type vehicle, which certainly is where an annuity can play in. And I think Steven and Mike would both attest that the investment-only variable annuity space is also kind of tax-deferred wrapper around optionality of different investment options is growing exponentially because of that. Then you look at customized portfolio selection, product alignment, not having a cookie-cutter strategy, but using every tool in your bag to meet the specific need of the client's strategy, and then actively rebalancing.

Jared Nepa: If you add all five of those things up, none of which have to do with an investment selection, more around behavioral coaching, you're going to be able to add an additional 480 basis points of return to a client's portfolio. So again, we're an annuity fits is not only in the tax-deferred investment wrapper, but the other part is when clients know they have a level of protection, whether that's protecting their account value or whether that's protecting their income behaviorally, they may be more inclined to stay the course than to make rash decisions.

Jenna Dagenhart: Yeah. Whether they think they're acting rationally or not, many investors are influenced by their emotions, hence the importance of financial professionals and that behavioral coaching. Now, Steven, how does investor behavior ultimately impact performance?

Steven Sweeney: Yeah. Really doubling down on some of Jared's comments there, we have to acknowledge that investor behavior has a profound impact on portfolio performance, and investors are often influenced by their emotions. These emotions can range from fear, excitement, greed, to even panic, and all of these can be disruptive to a long-term investment strategy.

Steven Sweeney: And investors tend to get into the market after it's gone up and get out after it's gone down, effectively breaking that cardinal rule of investing by buying high and selling low. There's really a lot of data to support this effect, and in fact, most of these studies often conclude that the average investor barely beats inflation. And as we pointed out, this really is rooted in the discipline of behavioral finance, which suggests that we tend to treat losses differently than we treat gains. So in other words, investors tend to be affected by losses much more than they are by gains, and research has show that this could be as much as twice as much more.

Steven Sweeney: So our aversion to loss then often distorts perspective and makes it difficult to stay in the market and stay the course, and the result is that investors will often succumb to these natural tendencies and get out of the market at the wrong time. So to benefit from a potential long-term market appreciation, the investor really does need to stay the course, particularly during difficult times. We also have to bear in mind that missing even a small number of days can have an enormous impact on long-term performance. What I mean by that is that someone full invested in the S&P, from early 2000s to the end of 2020, would've experienced that average annual turn of just over 7%. So in other words, $10,000 invested, would've grown over that period to a little over $48,000. However, if you tried to time the market and are dealing with these emotional tendencies, then you missed just the top 10 days out of 5,000 trading days, you would've had an average annual rate of return of just over 3%, and your $10,000 investment would've only grown to just over $19,000.

Jenna Dagenhart: That's a pretty painful to think about, hence the importance of staying invested there. Now Jared, annuity sales jumped 16% in 2021, so investors' interest in annuities is certainly growing. Why do you think this is and what trends are you seeing in terms of clients?

Jared Nepa: Yeah, that's a great question, Jen. And really to a point on the previous question, because Steven had some great comments around performance, and if you look at the most recent DALBAR study, what they found was the performance inside of a tax-deferred investment, or an annuity for lack of better terms, because... There's several reasons. One for taxes, but two, I think it's just the fact that it's held in its own account and it's not as easily tradable for a consumer as maybe clicking on an app or their personal investment platform. What that's found is the combination of the tax deferral and because it's not as easy to maybe make a trade, certainly you can make a trade, but it's not as quick, it prohibits people from maybe taking action as quickly as they were before, and it leads to some big results.

Jared Nepa: If you look over the period of time of the study, the equities that have outperformed by over 198 basis points a year, when you look at what's held in a tax-deferred wrapper, and as you can imagine for fixed income, what's held in a tax-deferred wrapper, you've seen an additional 291 basis points about performance. So really, and that kind of dovetails into the second part of your question, because what we're seeing today from a trend perspective is a few things.

Jared Nepa: Number one, we're seeing some new buyers to the market place. As Steven mentioned before, the registered index link variable annuity or structured annuity space, because of the value proposition of that and what it provides, we're finding a lot more younger people taking action to put money into an annuity, and I think it's the lack of defined benefit plans out there. People are looking for ways to not only have an opportunity to grow their assets, but to do it with a level of certainty or protection, whether it's account value or income. So, number one is younger buyers.

Jared Nepa: Number two, we're seeing more competition in this space, and that's a great thing. I'm a firm believer that a rising tide lifts all boats, and we're seeing companies come in and entering the income market or the fixed index annuity or the RYLA space that we haven't really seen before. We're finding private equity is looking at opportunities to get into this space, and it's because they see the need for it. Americans want protection in their portfolio, and the more options we have and can bring to them to meet that need, the better.

Jared Nepa:  Third is product innovation, and I know we'll probably go a little bit it deeper on this later, but this isn't your grandparents' annuity market anymore. It's not just a single premium, immediate annuity. There's investment strategies. There's more control. There's more flexibility. There's advisory type annuities where there's no surrender and you could walk free. So the innovation in this space has also led to a growing trend, and specifically the two that we're seeing right now in the marketplace, and I'd love to get feedback from Steven and Mike on this as well, is really around this idea of risk-share opportunity. We're finding that, whether it's the registered index linked annuity, it's a risk sharing component to where the insurance company is contractually obligated to offer a certain level of protection, and for that, you are capped on the upside, and the more risk you're willing to take, the larger the cap essentially is. So that's one thing for the account value protection side.

Jared Nepa:  When it comes to income, we're seeing more of this risk sharing opportunity where clients, frankly, fortunately or unfortunately are not as prepared as maybe they thought they should have been as far as their total assets heading into retirement, so what we're finding is more people are looking for the most income they can in their early years of retirement and willing to spend more income when you're 62, 65, 67. And if you do run out of money over time, that there is a safety net, for lack of better terms, of a guaranteed rate of 3%, 3.5%, 4%. If you benchmark that against the traditional options of a dividend-producing portfolio, if you run out of money, there is no backup. So this idea of risk share for clients willing to trade off higher opportunities for either growth or for income, with the ability to take on a little bit of risk on the backend if all of a sudden they run into a poor sequence of return scenario and they run out of money, we're really seeing that marketplace explode today.

Jenna Dagenhart:  Looking at wealth transfer, Mike, do annuities still play a role in wealth transfer planning since deferred annuities do not receive a step up in cost basis at death and annuity gains or taxed as ordinary income to beneficiaries?

Mike Sosnowski: So the short answer is yes. So Jenna, this is a very common question. In fact, it's a very common annuity objection that we come across. No stepping up on cost basis at death, so any growth in the deferred annuity, it's going to result in tax liability to the beneficiaries. So that's true, but the annuity is still a valuable piece to really any well thought out wealth planning type strategy.

Mike Sosnowski:  First, as far as a taxation component, well there's, with a non-qualified annuity and the inheritance that it provides beneficiaries, there's an ability to actually control the taxable income because only the amount that's distributed each year is going to be subject to income tax, and an option that most insurance carriers have, an option that they'll provide most beneficiaries during that claims process is really the ability to set up a non-qualified stretch. So beneficiaries can stretch that death benefit, that death distribution, and really spread out any taxable gains over their remaining life expectancy, through RMDs or required minimum distributions.

Mike Sosnowski:  And many individuals I talk to either don't realize that this option exists or those that are familiar with this type of payout thought it was taken away with the SECURE Act. Now that the SECURE act from a few years back, it did impact IRA and retirement plan beneficiaries because it took away the stretch feature option for those type of accounts. Non-qualified annuities and the beneficiaries attached to those annuities were not impacted by the SECURE Act, so they can still set up a stretch, they can still control taxation through those minimum distributions, so that's still an option.

Mike Sosnowski:  And then really, secondly, annuities, they continue to be an important part of really any will transfer because of the death benefits that they offer, but then also that downside protection they provide. As Jared mentioned previously, most out there will probably look towards life insurance. That's the tool of the trade to transfer wealth, but really depending on the individual, as well as the preapproval underwriting process, well, that whole process can become burdensome, and then future premiums on the contract could actually get really expensive.

Mike Sosnowski: So the annuity, what's nice about the annuity is that it does not have an underwriting requirement to issue the contract, specifically with any type of guaranteed death benefit. So we have the lack of the underwriting requirement, plus there are products out there that provide that hedge or that buffer to protect on the downside, to protect against those market downturns. And it's really that downside protection that's, it's really vital to any well drafted wealth transfer strategy. So long story short, annuities still have a very important role in the whole wealth transfer planning strategy, wealth transfer planning process.

Jenna Dagenhart: Now, Mike, is there a way a deferred annuity owner can control the distribution of annuity assets to intended beneficiaries?

Mike Sosnowski:           19:40                Oh, sure. Great piggyback question. So as we know, annuities provide contract holders with that ability to designate beneficiaries. However, something that's overlooked is that some annuities will actually allow restrictions to be put in place as to how those beneficiaries can actually receive that death benefit, how they can receive the inheritance.

Mike Sosnowski:           20:06                And this is referred to as a restricted beneficiary payout. And what this is really a no-cost option that actually can be an alternative to using a trust. And we know that trusts, they can be somewhat costly to set up, costly to administer and really the cost associated with some of these trust could be quite significant, so this restricted beneficiary tool or restricted payout tool really provides that annuity owner with options as far as how a death benefit is going to be distributed after they pass away. And that's why there's a terminology out there, or I guess a nickname as far as this tool and it's referred to as control from the grave. So that's really the reason why account owners can control how that distribution's going to be passed.

Mike Sosnowski:           20:58                And with that being said, there are a number of options that the annuity owner can use, including the non-qualified stretch. So the account owner, basically they can force their beneficiary to stretch the inheritance, and this is a common election where we'll see those individuals that maybe there's a concern about spend thrift beneficiaries squandering inheritances. There's a couple stats out there. The first one is that 70% of wealthy families lose their wealth by the next generation, 90% after two generations. So this can be a powerful and well, inexpensive wealth preservation tool that again, most annuity owners are going to are going to have access to.

Mike Sosnowski: And really with that being said, speaking of beneficiaries, now is the perfect time for individuals to review those beneficiary designations, see if they have the tools like that at their disposal. And we want to make sure that all designations are up to date, because anything outdated can create a huge mess for a family to deal with after somebody passes away. A colleague of mine once said, he once told me that beneficiary designations are a topic that is unimportant until it becomes important, which is usually when it's too late. I think that colleague was Steve.

Jenna Dagenhart: Well Steven, over to you, I want to get your take on some of the risks out there. How can annuities help people in retirement protect against market risks?

Steven Sweeney: Right. So market conditions and fluctuations and asset prices are among the most important factors to portfolio longevity, perhaps second only to withdrawal rate. And investors typically spend decades saving for retirement. Systematic investing coupled with secular increases in those asset prices have helped many Americans, at this point, build sizable retirement accounts. However, when Americans retire and stop contributing to those accounts and start withdrawing from them, they become much more susceptible and vulnerable to market volatility, and chances are most retirees will have to manage multiple bear markets. More specifically, research has shown the average retiree will phase three to even five bear markets in retirement.

Steven Sweeney: So since 1945, there have been 26 market corrections of around 10%, and 11 bear markets, which represents losses in excess of 20%. Now the average bear market only lasts 16 months, but has an average loss by as much as 35%. So if a client experience is a 20% loss, assuming no withdrawals are taken from the account, it'll typically take, under average conditions, around 25 months to recoup those losses. But here's where the today's annuity solutions can really play an important role and meet the marketplace where it is, in terms of addressing this risk and this concern that investors have and have to deal with, by developing and working with annuity solutions that have the potential to participate in that market appreciation, but also mitigate the downside risk.

Jenna Dagenhart:   And Jared, for those newly retired or nearing retirement, what are some strategies or invest and approaches that offer greater control over investment risks?

Jared Nepa:  Yeah, that's a great question, and I think that Steven did a great job kind of opening up for that. But before I get to that Jenna, Mike said something in his response, particularly around and related to your question on taxes from a distribution, from an annuity. Lincoln's been around for some time, and when he talks about this idea of a non-qualified stretch, there are opportunities out there, and again, I would call this a trend, where there are tax-efficient ways to stretch that as well.

Jared Nepa: So if you've had an annuity for multitude of years, you've grown that annuity and it has a plenty of tax-deferred growth within it, and now the beneficiary doesn't want to pay last in, first out, and I'll explain what that is. It's that typically when you take a stretch distribution from a death benefit annuity, all gains are taxed first until you get down to your original basis. There are strategies out there, particularly that identifying, give a client opportunity to take a distribution that's made up of part of that basis and part of that gain, and there are opportunities for beneficiaries to take one contract that maybe doesn't offer that, to now have an opportunity to move that contract, to take advantage of a tax-deficient distribution for the remainder of their life. So great points made by Mike and I just wanted to address the tax piece, that there are opportunities to be extremely tax efficient in your distribution of income from a stretch contract.

Jared Nepa:  So to that end, in regards to your question, I think that Steven was talking about it earlier. We're seeing a tremendous trend in the annuity business right now around, like as I said earlier, risk share, but particularly in the registered index linked annuity space. And I'll start there first. The value proposition of what these are offering to consumers today is really incredible. When we think about what consumers are looking for, so [inaudible 00:26:27] tells us first and foremost, in 2021, the number one thing on people's mind is investment protection, and that aligns so nicely to what's most important as you head into retirement. Sequence of return is an extremely important concept that I don't think we do a good enough job of educating consumers on. It's not your average rate of return. It's how those returns come in your portfolio, and the more volatility, the earlier you see losses in your retirement, that could have a detrimental effect toward your overall outcome.

Jared Nepa: So registered indexed linked annuities, if I were to sum them up in three value propositions is number one, they offer a stated level of downside risk. So a client has clear understanding of what the insurance company is on the hook for, for lack of better terms. So if they see an investment loss, they know what the insurance company is responsible for returning back to them. On top of that, you still are able to kind of participate in the market appreciation aspect.

Jared Nepa:  And then lastly, for many of these contracts out there, they're structured in a way where there's no explicit fee charged to the client. So when I think about a consumer, they all want protection, especially those nearing retirement. They all want to capitalize on market appreciation. It's the old have your cake and eat it too, and what they don't want to pay is they don't want to pay a lot of fees for it. So this investment strategy fits so nicely into the consumer value proposition today. It's no wonder why not only pre-retirees are offering this, but as I mentioned earlier, we're seeing clients as young as 30, 35, 40 years old purchase these investments as well.

Jenna Dagenhart:  And circling back to deferred annuities. Mike, in what ways can a deferred annuity mitigate some of the common retirement risk factors?

Mike Sosnowski:  That's another great question. That's a, and really the answer, really I guess piggybacks again what Jared was saying as well as Steve. We'll just start. So to start, really there's probably three common risk factors that are shared by most retirees out there, and those are longevity risk, market risk and inflation risk.

Mike Sosnowski:  And when we look at longevity risk, that's just the risk of outliving your assets. And as a society, we go through the whole planning process really by almost overlooking the longevity issue, because as a society, we have a tendency to underestimate our longevity. We live longer than we plan to, and unfortunately, what this can create is a significant retirement income shortfall when it's too late.

Mike Sosnowski: Now, Social Security has a couple stats out there as far as longevity. Their actuaries have found that those that reach age 65 today, half of all men will live past age 84, and half of all women are going to live past age 86. In fact, they found that one out of every three 65 year olds today are going to live past age 90, and about one in seven past the age of 95, so that means there's a good chance that today's retirees are going to spend more time in retirement than previous generations, so today's retirees have to make sure that their income plan has taken into account this longevity. It could be a 20, maybe a 30 year retirement that they have to plan for.

Mike Sosnowski:  And really, one way to plan for longevity is really by adding that insurance to the portfolio. That annuity can provide that insurance wrapper on the portion of that portfolio that is going to be responsible for generating that lifetime of income that will never run out and will last as long as they do.

Mike Sosnowski: So there's longevity, and then what Steve had mentioned, market risk. It's that exposure to loss. It can be referred to a sequence of returns risk, and this is a risk of really starting that distribution phase of your life in that down market. Taking distributions while a portfolio is down, what that's going to do is increase the likelihood or the probability of a portfolio failure, and that can mean that the retiree is going to have maybe reevaluate their income strategy going forward. Do we continue to take that same dollar amount, that fixed dollar amount out of our portfolio each year going forward, and if we do, if that's the decision we make, how much greater of a percentage of the portfolio value is that going to be?

Mike Sosnowski:  And I'll just give you a quick example. We'll just use easy math. Let's say we're taking a 5% withdrawal on a million dollar account. $50,000 distribution. If we lose 20% of that account value, that portfolio value, where we're down now to $800,000, our withdrawal bumps up to over 6%, it's 6.25%. Do we continue with what could be an unsustainable withdrawal or are we forced with maybe the decision as to whether or not to take that retirement pay cut, live on less, live on like $40,000 a year and potentially lower our standard of living in our golden years? Both options are not good ones. Both are bad. So having that annuity with the guaranteed income stream can really, really help take that risk off the table.

Mike Sosnowski:  So there's market risk and then inflation risk. If you look at today's retiree, you can really see the impact of prices and how prices impact purchasing power and standard of living. These retirees are living on fixed income. They have the same expenses as yesterday, but now they're just getting less in return. So it's really that inflation risk where it could be mitigated by the downside protection that the annuity provides, because that's going to allow the retiree to invest maybe just a little bit more aggressively to help keep up with inflation and those inflationary pressures. They'll have the equity exposure with just that additional layer of risk control. So really the annuity, when we think of the three common risks out there, it can help mitigate that longevity risk, that market risk, as well as that inflation risk.

Jenna Dagenhart:  Following up on that last point about inflation. Inflation has reached the highest levels in four decades. Steven, how do historically high price levels threaten retirees' purchasing power?

Steven Sweeney:  Yeah. Inflation has always been an issue for retirees, but probably today more so than ever before or certainly than it's been in a long time. So just for context, we should understand that for the past 30 years, inflation has been somewhere around between 2% and 3%. However, last year it was, as most of us know and it's gotten a lot of headlines, closer to 7% or even more. This is the highest it's been in 40 years.

Steven Sweeney: A personal experience that I often share to tell this story and to underscore how much attention it's getting. I was recently in New Jersey and I was racing between meetings and had just a minute of time. I was going to pick up a bottle of water at a hotdog cart, a hotdog stand. And I got my bottle of water, and then I noticed that the kid there was probably 17 years old and he was selling hotdogs for $13. And I had to, I asked him, I stopped myself. I said, "How can this be $13 for a hotdog?" And he looked at me and he said, "It's inflation, man." And so when you have a 17 year old kid at a hot dog stand talking about inflation, I think you know it's getting a lot of headlines. But really what it represents is how inflation risk really reduces purchasing power, and really what that is is the chance that investment income won't be worth as much as it will be in the future or as much in the future.

Steven Sweeney:  And so inflation is typically measured by the CPI, the Consumer Price Index, which essentially compiles monthly data on prices consumers pay for a representative basket of goods and services, and for the last 40 years or so, these prices have averaged, the price increases have averaged in the CPI about 2.6%, almost 2.7%. Now another thing that we have to bear in mind here regarding inflation is that it's a statistical analysis of an enormous sample size of individuals across a very broad spectrum, and it's not necessarily indicative of the actual experience an individual or smaller subset that we might be trying to help actually has.

Steven Sweeney:   And so it's with that in mind that we should consider more specific measures to certain segments of the population that we serve when we're thinking about inflation. So for example, the CPIE, the Consumer Price Index for the Elderly, is more in alignment with the experience that the elderly might be, that people over 65 might be dealing with. And so the prices paid for goods and services that the elderly are purchasing have increased closer to 2.9% over that same period.

Steven Sweeney:  Now that might seem like a small difference. 30, 40 basis points might not seem like a big difference, but over an extended period of time, that can have an enormous impact, and particularly when we peel back the layers here and discover that the reason inflation tends to be higher for these folks, for retirees, is due in large part to healthcare costs having increased significantly more during the same timeframe, even more than 4.5% since 1982.

Steven Sweeney:   And so as a result, inflation creates an increased demand on income and is most damaging to those that are most vulnerable in their later years, in the later years of retirement in particular. So even if inflation were to moderate to say 3.5%, it would still reduce purchasing power by than 50% over the course of 20 years, and this means a dollar today will be worth just 49 cents in two decades.

Steven Sweeney:  And this is of particular concern when we consider that advisors are often helping clients prepare for retirements that could last 30 or even 40 years, and one way to hedge against this risk is through equity exposure. The market historically outperforms inflation, and often substantially, and today's annuity solutions can incorporate that into their value proposition, and this comes in the form of income options that could potentially see increases if market conditions were to be favorable.

Jenna Dagenhart:  And Jared, I've seen you nodding your head a few times. Anything you'd like to add.

Jared Nepa: Yeah. I think you make a lot of great points, Steven. You hit on a critical one there. The fact of the matter is when we've seen inflation this high, it has a negative impact both in the fixed-income market and the equity market. So the question is, where do you go for protection?

Jared Nepa:  And I think that inflation is a critical point because the CPIE is critically important to distinguish that between retirees and pre-retirees because they do spend money differently, particularly focused on healthcare. So Mike was talking about it earlier with the sequence of return risk, but if you don't have mark exposure... Market exposure alone puts you at a higher risk without protection.

Jared Nepa:  If you're able to layer in a level of protection through an annuity and making sure that that income guarantee has an adequate amount of equity exposure, that's really your best chance to keep pace with inflation over a 25, 30, 35 year retirement income cycle. So I think you hit on some great things, like you said, there's a lot of different options out there in the industry. Many of the income benefits today, some focus heavily more on the investment selection, some not, but I would encourage anybody when they're looking at their investment portfolio that equities are absolutely critical or a portion of equities are critical to align that with your income component that an annuity can provide.

Jenna Dagenhart: Yeah. And in the face of $13 hot dogs, as you mentioned earlier, Steven, the Fed is starting to hike interest rates to protect consumers from further increases in inflation. We're still in an extremely low-rate environment though. What kinds of challenges does this pose to retirees?

Steven Sweeney:  Right. It really is an interesting inflection point, and most would agree that interest rates today are still relatively low, and this creates additional pressure for the average retiree to create the income that they need. In the past, many could rely on interest rates of 5% or even more from fixed income securities and what would be considered safer options. In fact, the 10 year treasury was about 5% from 1968 to 2002. We so quickly forget that sometimes, and was over 7% from 1975 to 1993.

Steven Sweeney:  Now with interest rates at those levels, obtaining what might be considered a decent return on retirement dollars was often as simple as going to the bank and purchasing CDs. However, with the 10 year treasury closer to 2% or 3%, retirees may be forced to withdraw more from their savings account to make up for that shortfall caused by this low interest rate environment, or potentially invest more aggressively and take on that corresponding risk in search of greater yield that can help them achieve their retirement objectives.

Jenna Dagenhart: And Jared, could you explain why a portfolio that includes protected income through annuities makes sense for a variety of different market conditions?

Jared Nepa:  Yeah. I think we've hit on a couple key topics here, and I would go far as just to say protection in a portfolio is absolutely critical moving forward. We talked about fixed income. What's funny is fixed income is at historically low interest rates, but it's up almost over a 100% since the recent bottom.

Jared Nepa: So we've seen this interesting dichotomy of rising rates, which are putting pressure on fixed income returns, but yet let alone, we're finding the amount of return you're getting, even in an increased interest rate than comparative to what it was a year ago, is still significantly below what people may need to live on their retirement.

Jared Nepa:  So what we believe here at Lincoln is that there is a dilemma out there today, not only just in constructing fixed-income portfolios, but more importantly, there's a dilemma around what people have used to conceptually protect portfolios, and we call it the diversification dilemma. Rewind 5, 7, 10 years ago. The 60-40 portfolio has served people well, 60% in equities, 40% in fixed income. There's an opportunity there to capture equity exposure while fixed income kind of softens the landing in some cases. One part of the portfolio zigs while the other is zagging to ultimately give an investor a better overall experience moving throughout their retirement.

Jared Nepa:  But if you look at the different components of what's going on in the market today, certainly inflation and the impact that's having in the rising interest rate environment, if you're not layering in a portion of your assets to a protected strategy, I think you're missing an opportunity. And the way that we like to think about it is there's two types of protection. There's conceptual, which I just talked about, which is really this idea that has been ubiquitous across the investment landscape, which is the diversification, but then there's this idea of contractual protection. So conceptual protection works great. You back test it, but it's past-looking, not forward-looking.

Jared Nepa:  If you think about contractual level of protection, that's partnering with a third party, in this case, an insurance company who has an agreement to where they're either going to get guarantee you a lifetime income that you can outlive, or they're going to guarantee that either you can participate in zero losses, maybe through a fixed index annuity or you can offer a risk share if you're willing to capture more upside but not participate as much on the downside through a buffered or a registered index length annuity.

Jared Nepa: So when I'm looking retirees today and I'm challenging advisors to say that 60-40 may have worked in the past, but it's not necessarily going to be the same story moving forward, based on where we are in equity evaluations and the rising interest rate environment. So would you consider for a portion of your portfolio incorporating this idea of contractual protection for 10%, 15%, 20%, 30% of the portfolio to give you equity-like returns with a historically a fixed-income-like risk profile.

Jenna Dagenhart: And now the SECURE Act 2.0 is making it easier for plans to offer annuities, to qualify, to plan participants. Mike, what's the reasoning behind the SECURE Act 2.0,

Mike Sosnowski: The SECURE Act 2.0 has been in the headline., they were supposed to vote on it yesterday. It's just waiting Senate approval, but really the main reason, the rationale behind some of the provisions in that SECURE Act 2.0 is really piggybacking what I'd mentioned earlier.

Mike Sosnowski: Today's retirees are stuck in that YOYO environment, and what I mean by YOYO is that you're on your own. You're responsible for converting this lump sum of lifetime savings into a lifetime of income. It used to be that individuals could rely on their employer for retirement income. Unfortunately, that's not really the case anymore, and converting that lump sum of savings into an income stream, well, individuals need help.

Mike Sosnowski:  And here's a couple more stats. So right now, 15% of private sector workers have access to a defined benefit plan or a pension plan. I think Jared mentioned this earlier. So maybe you happen to be one of the lucky ones that are in that 15% club, but more likely than not, you're in the 85% club and you don't have that pension as a guaranteed source of income, and so now we're relying on Social Security and then now we're relying on our own savings, our own accumulation of our lifetime of earnings.

Mike Sosnowski:  With those individuals that do participate in a defined contribution plan, which is most, currently only 6% of 401ks offer any up of retirement income product in there, so it's that SECURE Act 2.0 and some of its provisions that want to change that. And the idea really here is to make it easier for retirees to have access to that guaranteed income. That way, the responsibility of generating a lifetime income is going to be the responsibility of the insurance company and not that plan participant.

Jenna Dagenhart:  Now, does it make sense, Mike, for using a deferred annuity in an IRA since retirement accounts already provide an account owner with tax deferral? And I would also love to hear your thoughts on where they fit into irrevocable trusts as well.

Mike Sosnowski:  Oh sure. So with IRAs, again, this is a, I guess a common objection that we hear. IRAs provide tax deferral, annuities provide tax deferral. Why use the annuity in the other? Well, for starters, most individuals have most of their retirement savings in retirement accounts, and that makes sense. And as I mentioned earlier, there's that shift in the whole retirement landscape.

Mike Sosnowski: If you retired in the 20th century, that's when you had an opportunity to rely on that employer for that income. That was the landscape that you had going into retirement. 21st century retiree, not so much. That's that YOYO retirement. That's the responsibility on your shoulders. So YOYO, it's not the ups and downs of the market. It's because of the greater responsibilities, and YOYO meaning you're on your own.

Mike Sosnowski: So retirees not only responsible for saving for that comfortable retirement, but they have to convert that savings into a sustainable income stream for the rest of their lives. So that's really where the annuity can create that predictable and reliable, guaranteed income stream from that savings, from that lump sum value.

Mike Sosnowski:  And so annuities make sense in the IRA because that's most likely going to be an individual's largest asset, especially specifically retirement asset. So we can forget about that tax deferral for a minute and just really focus on those guarantees, because again, the annuity's going to provide predictable income as well as downside protection, and that's significant. We already talked about this a couple times, but that market risk exposure that individuals will have, recouping a loss when you're in a distribution phase of life is almost impossible, so it's that downside protection, which is significant.

Mike Sosnowski:  And really, as an added benefit when we look at IRAs, most withdrawal benefits or living benefits that are provided on annuities are RMD-friendly, meaning that the accounts that house most of clients' assets are going to require distributions. Now it's age 72. It used to be 70 and a half. Who knows, it could be 75 with the SECURE Act, but either way, these accounts are going to require distributions. And these distributions exceed 4% by the age of 75 and 5% by age 81. How sustainable is a withdrawal rate that's above 5%?

Mike Sosnowski: So these living benefits that annuities provide, they're RMD-friendly, and what that means is that if the RMD happens to exceed that promised withdrawal rate, it's not going to have a negative impact on any of those contract guarantees. So RMD-friendly is significant. That's traditional IRAs. If we're looking at a Roth IRA, Roth IRA rules will trump annuity rules. So if you're using an annuity with a death benefit for example, that could be a tax-free inheritance to beneficiaries. You can't use life insurance in an IRA. You can't use life insurance in a Roth, but you can use an annuity.

Jared Nepa: One point to add. I think Mike makes a great point. If you're looking at an IRA, you certainly want to have an annuity benefit to be additive outside of just tax deferral, so that's number one. But he makes a great point. There's a reason why all investors, not all, a significant majority of investors' largest asset tends to be an IRA, because it's either their 401k or a traditional or Roth IRA.

Jared Nepa: And what do both Roth IRAs, traditional IRAs, as well as 401ks have in common? Your cap. You're limited in how much money you can put into them. And the reason why they tend to become the largest asset is because you're not paying taxes on that tax-deferred growth, so when you think about an annuity as a younger investor, this is an opportunity to, if you're meeting your whatever, 6,500, or your catch-up provision, or the 17 or 18 or 20,000, whatever the limit is any given year on your 401k, if you're exceeding those limits and you have additional assets and don't want to pay taxes on those assets, there is no limit in regards to how much you can put into an annuity on an annual basis.

Jared Nepa: So I just want to put that out there. They tend to be largest assets because they don't pay taxes all the way through, and that we deem that to be a benefit. If you run over your limits, obviously you you can put as much as you'd like into the annuity to grow that tax deferred for future income as well, either within your 401k with the new SECURE Act 2.0 or outside as its own investment.

Jenna Dagenhart: And building off of some of your comments Mike, Steven, what would you say is a safe and sustainable withdrawal rate?

Steven Sweeney: Yeah. This is something experts in our field have been examining and debating for a long time, and the answer one might get really depends on who you ask and when. In the 90s, Peter Lynch thought 7% was safe. For a long time, 4% was considered a safe or sustainable withdrawal rate. Now, many experts in our field agree that it's closer to 2.5%.

Steven Sweeney: But here's the challenge. What accounts do retirees usually take these withdrawals from? As we've already pointed out, IRAs and other qualified accounts like 401ks and so forth. And at a certain point, the IRS will dictate your withdrawal rate, and while there have been proposals to push this required beginning date back for RMDs and there have been recent changes to the tables that are used in determining what that withdrawal rate is, right now, shortly after you turn 72, you're required to take a little over 3.5% out of those qualified accounts, unless some other exception is met.

Steven Sweeney: So furthermore, as you get older, that RMD will increase, and retirees are being forced to take distributions rather than wanting to take distributions, which leads to a taxable event, of course. And it's designed, these accounts really are designed to deplete the account as much as possible over the life expectancy of the account holder, and the big reason is the IRS intends to generate revenue from these accounts that have yet to be taxed.

Steven Sweeney: And now often, it's the spouse that holds most, the surviving spouse that, or excuse me, a spouse that holds most of the retirement accounts, and that creates a risk that the RMD will be depleted or will deplete the account over the life of the initial owner, leaving little left for that surviving spouse. So to help address this concern, some insurance companies have created annuity solutions that provide spousal protection and can address the market inflation, longevity and timing risks that might be inherent in these qualified accounts, as well as provide protected income over the lives of both spouses.

Steven Sweeney: I think it's also worth mentioning though, and sort of double clicking on one of Jared's comments about non-qualified annuities as well. We really are seeing a reversal in some distribution strategies for this very reason that people are taking RMDs because they have to, not because they want to, while folks who have maybe parents who are experiencing that are starting to think about ways to distribute their assets that might be a little bit more tax efficiently. For example, taking some distributions from qualified accounts earlier and maybe funding or leaving non-qualified annuities untouched for as long as possible, because of course, non-qualified annuities during the lifetime of the original owner don't have RMDs. This is a really interesting time in our business that we start to reexamine the best approach that should be taken as it relates to how we address all these different concerns that we've been discussing here today.

Jenna Dagenhart: And as we've been discussing, investor needs are constantly changing and evolving over time. Jared, how can financial professionals stay ahead of the curve and how do providers stand out when investor needs are constantly changing?

Jared Nepa: Yeah. That's a great question. I can tell you the only constant in our business, in the financial services world, is change. And I'm going to take this a question from two different approaches. First from the advisor, financial professional perspective, and then from a distributor or product provider perspective.

Jared Nepa: So first, from a financial professional perspective, the key thing is the best financial teams out there, the best financial professionals out there have a proactive communication plan with clients. It's too late. When they're already bringing you a problem, you're almost behind the eight ball. If you're having a proactive plan, reaching out to your clients, and it starts with really three things.

Jared Nepa: Number one, you have to solicit them with really thought provoking questions, maybe they're relevant and timely in today's marketplace, maybe they're relevant to a strategy that you think is in alignment with their investment needs, but come to them and the question could be something as simple as in an email, what are the two or three things that are keeping you up at night? Or if you're having a client come in, being proactive and setting a client meeting agenda before the client comes in to say, what are the two or three things we need to accomplish in the time that we are sitting down together to make our time most useful? So it's great questions when you engage with a client.

Jared Nepa: The second piece is really focused on listening. And the idea here is to listen with the intent to learn and understand, versus an opportunity to present an option. If you do that effectively, we call it this idea of conversation double Dutch. We've seen it all before where people are just waiting to kind of jump in for their opportunity to speak.

Jared Nepa: If you take an unanxious presence, you have great questions, you sit back, you're using confirmation bias to ensure that you're understanding what your client looks for. Now, at that point, in the last call it 10% left of the meeting, if you've asked great questions, they told you what their concerns are, now you're in better alignment to offer a recommendation than maybe you would have been in the past. And the idea today is is that if financial professionals need to consistently challenge themselves through resources like you provide Jenna and the show provides, is that there are different strategies out there today than there were three years ago, five years ago, 10 years ago. If you're not keeping up on your continuing education inside of the industry, you're missing an opportunity to potentially meet the need of a cohort of your clients. So number one, proactive communication plan for clients.

Jared Nepa: Now as a distributor who focuses in the retail space or broker dealer space, I will tell you, it's a firm strategy that we have here at Lincoln to continue to offer a diversified portfolio of products. And if you think about the diversification that we try to offer is there's account value protection, there's income protection, and then there's legacy protection, and there's different components of each type of benefits that we offer that fit within that.

Jared Nepa: But when you truly think about the life cycle of a retiree, they go from growing their assets to then distributing their assets and then putting plans in place for any loved ones or beneficiaries that they'd like to lead to. So I think the days of being a provider that offers one specific strategy, at least from our perspective, those days are over. If you truly want to take a consultative approach when you're sitting down with a financial professional, it's the same thing that we have to do.

Jared Nepa:  As distributors, we have to ask great questions. We have to obtain feedback from our financial professionals and retail clients, and then go to work and manufacture products that align to those needs, and fortunately or unfortunately, there isn't one product. There's no silver bullet. And what we try to do at Lincoln is to make sure we have identified a marketplace, compete in that marketplace to offer a consultative approach to our advisors, and then while carving out some time to continue to innovate, to think about what's next in the business. Are there different investment strategies we need to be looking at? Is there different types of risk share profiles that we can be creating? So this idea of R&D is always in the back of our mind, but we're not doing that without making sure that we're covering the needs of 80% to 85% to 90% of the market that's out there today, so that's kind of our thought process here on our end.

Jenna Dagenhart: Well, I'm afraid that's all we have time for. Everyone, thank you so much for joining us.

Steven Sweeney: Thank you, Jenna, for the chance to share some of these ideas with you.

Mike Sosnowski: Yes. Thank you, Jenna. Appreciate the opportunity.

Jared Nepa: Thank you.

Jenna Dagenhart:  And thank you to everyone watching this Asset TV annuities masterclass. Once again, I was joined by Steven Sweeney, a Director, Advanced Planning Retirement and Life distribution at Prudential Financial, Jared Nepa, Vice President and National Sales Manager of Annuities at Lincoln Financial Group, and Mike Sosnowski, Director, Advanced Markets at Transamerica. I'm Jenna Dagenhart with Asset TV.


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