MASTERCLASS: Annuities - June 2021

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  • 54 mins 07 secs
With a new administration in Washington, taxes are top of mind for many investors. This panel explores tax, liquidity, and complexity misconceptions that some people might have about annuities and uncovers how new policies and regulation could impact the asset.
Three experts share their perspectives and offer examples of some of the creative ways annuities can be implemented to help clients with their unique needs and goals.

  • Adam Lalla, Vice President, Competitive Market Solutions - Lincoln Financial Group
  • Brad Crawford, Divisional Sales Manager - Transamerica
  • Brandon Buckingham, Vice President, National Director of Advanced Planning - Prudential



Jenna Dagenhart: Welcome to Asset TV. This is your annuities masterclass. With the new administration in Washington, taxes are top of mind for many investors. Today, we'll look at the potential impact of different policies, and explore how annuities can help with estate planning, retirement, wealth transfer, and other unique client needs. Joining us now to share their perspectives are Brad Crawford, divisional sales manager at Transamerica capital, Adam Lalla, vice president, and head of competitive intelligence and advanced sales at Lincoln Financial Group, and Brandon Buckingham, vice president and national director of advanced planning at Prudential Individual Solutions Group. Everyone, thank you for being here with us, and Adam setting the scene for our viewers, what are annuities?

Adam Lalla: That's a great statement. There are a lot of things, but if you look at the official definition of what an annuity is, if you looked at Investopedia or whatever, they'll tell you it's either a set of payments or a payment to give you a contract between the insurance company and the client to give set payments for their lifetime. At some point either immediately or in the future. Now, obviously that's more than canned what is an annuity, but annuities are so much more than that. There is guaranteed lifetime income for some people while still having access to control cash value, which is different from what I just spoke about.

Adam Lalla: They're grown protect strategies like buffered structured, registered index, linked annuities that allow a client to see some growth of their portfolio and at the same time offers some downside protection from market loss. Their asset preservation strategies, their fixed annuities, fixed index annuities that can offer alternatives to savings account for CDs. Their legacy planning tools. Their ways of leading may be a beneficiary, a guaranteed death benefit in the future, particularly for those that are not insurable. There's ways and strategies that leave income for multiple generations with annuities as well.

Adam Lalla: So when you say, "What is an annuity?" There is that very basic term, but there is so much more to what annuity is. It's a financial planning tool that can help solve a lot of different needs particularly with the innovation that's been happening over the last several decades.

Jenna Dagenhart: Yes. Annuities can be many different things as you highlighted. Brandon, what are some of the popular uses of annuities?

Brandon Buckingham: Well, kind of echoing Adam's comments. You're seeing a lot of people buying these annuities for the protective features by having the ability to participate in the market, have the upside potential of the market, but have protection against market loss and market volatility. Think about somebody who maybe five to 15 years from retirement. They want to participate in market. They want the upside potential, but they really can't afford to lose a big portion of the retirement assets as they transition into retirement. You're also seeing people buying annuities for the tax benefits, especially now.

Brandon Buckingham: We're in a changing, uncertain, likely rising tax environment. So, some of the tax benefits like tax deferral become that much more compelling. We're seeing greater interests with entities. I know Brad's going to talk about some of the benefits of using annuities and trusts. We recently opened up our index variable annuity to entity ownership. So, think about certain businesses, nonprofits, foundations endowments. We've had a lot of success with endowments, because endowment many of them historically have really underperformed the market. So, here's an opportunity for that endowment to participate in the market, but have those protection features that so many annuities come with.

Jenna Dagenhart: And we'll certainly talk more about taxes later in the program, but before we get there, Brad, what are some of the more creative ways that you've seen annuities used inside of trusts?

Brad Crawford: Jenna, that's a great question. And trusts are one of the staples of where we use a lot of the annuities, especially with the advanced planning side of dealing with planning as a financial advisor. A couple of ones that I see most common when I'm talking about the trust planning is one that just came up earlier this year. Trust had about 50 million in assets, but that advisor that was managing it realized that he had a problem. The trust was retaining way too much of the retained earnings. As soon as you retain more than $13,050 inside of a trust, it automatically pushes anything that's retained up to the top tax bracket, which is that 37% plus the 3.8 surcharge for over a 40.8% total taxation. So obviously if a trust is retaining the earnings and you're losing 40% of that right off the bat, that's poor planning as far as the advisor and the tax planning goes.

Brad Crawford: So what we did is we shifted several of the investments inside of the trust that were kicking out distributions that were being retained inside of the trust. And shifted them about 10 million of it inside of the annuity. Right off the bat by doing that, the nudity you control when the distributions are going to take place. And if the advisor or the client wants to shift between bonds back to equities over to sectors, you can do that inside of the trust, I'm sorry, inside of the annuity without ever generating a taxable event or retaining any of the earnings.

Brad Crawford: So typically if you think about a couple, it will take about 628,000 of earnings before you get pushed up to the top tax bracket like that with the trust at $13,050. That's a pretty low hurdle to hit. So, it's simple strategy, is just put anything that's kicking out income distribution side of the trust inside of the annuity, and you eliminate a large portion of that tax bill. So, in that particular case, I think we ended up saving the client probably a couple of hundred thousand dollars in taxes that they're going to be paying just for 2000 at one alone. So that was a great use of the strategy.

Brad Crawford: The second kind of advanced planning trust case that we typically see is we saw about a $50 million case come through at the end of last year where the client was saying, you know what? Ultimately, I just want to keep these assets tax deferred and growing as long as I possibly can. So, we set it up as a pass in kind strategy where the trust is the owner, the beneficiary of it was listed as the new attend, which typically the beneficiary is going to be the kids of the parents. By doing that, what we did is let's say the parents live for another 20 years, they pass away. The trust would dissolve. The assets would then be shifted over to the ultimate beneficiary, which was the new attend or the kids.

Brad Crawford: It'd become a non-taxable event at that case. Let's say the kids live for another 50 years and then they pass away. Then we can pass on those assets to the grandkids, and potentially do a trust, I'm sorry, a stretch for them at that point. Ultimately, we were able to look at maybe 70 years of tax deferral growth for the client versus keeping it in a non-taxable, I'm sorry, in a fully taxable capital gains distribution type mutual fund. So those were just two simple ways that I generally see annuities used inside of trust that advisors out there might want to take a look at if you have that situation.

Jenna Dagenhart: Adam, I see you nodding your head.

Adam Lalla: Yeah. I can't agree more with Brad said. I'm sure Brandon would agree as well on the call. We see cases like this, these transferring kind cases all the time, and this is why you see a lot of these trusts funded by municipal bonds. That spin off that prompted that is in a low yield environment. What do you get in that? What's the value is very low and then of course in a very low interest rate environment, when interest rates go up, what happens to bond prices? They go down. So having an asset like an annuity as a robust investment platform built inside there, then that spin off taxes as Brad said is huge.

Adam Lalla: They do it with maybe unique type of asset classes, they to do it with... we're starting to see companies including Lincoln and others start to come out with unique growing protect strategies, like buffer ETFs that are similar to resident index, linked annuities inside these annuities that help protect while not spending off the taxes. So can't agree more

Jenna Dagenhart: Brad, what's the difference between living benefit riders and accumulation riders or buffer annuities?

Brad Crawford: That's a great crest to Jenna. All the different features and benefits out there tend to be a little bit confusing. Generally speaking, when you hear the term a living benefit or sometimes referred to as a GMWB, a guaranteed minimum withdrawal benefit, that's talking about providing a lifetime income stream over the course of somebody's rest of their life. So, typically we see 55-year-old, 60-year-old, 65-year clients that are purchasing these as they get within five, 10 years of retiring that are looking for guaranteed income streams for the rest of their life. Even if the asset goes to zero, the insurance company will guarantee that at a certain minimum level, they continue to get an income for the rest of their life.

Brad Crawford: On the flip side, we tend to see other products like GMABs, something that Transamerica offers, our Transamerica principal optimizer that's offering a guaranteed money back solution. Where somebody that maybe needs this asset 10 years from now for a pay for a college, to pay for a house, whatever the big purchase may be, but they're afraid of losing their investment. They can invest in a GMAB and get a certain level of protection so that if you put in a million dollars, and the market goes down, the insurance carrier will guarantee that they'll get their million back if they've held it for a certain amount of time.

Brad Crawford: The last one that we tend to hear out there in the annuity jargon is the term buffer or registered income link annuity. A buffer product is typically going to provide a layer of downside protection someplace in the 10 to 20% downside protection in order to give you a certain amount of upside. So, the insurance carrier may say, "Hey, we'll take the first 20% of downside risk away, in exchange we're going to cap you at X percent of upside game that you can participate in. So, it's allowing a client to take a little bit of the risk off the downside in exchange for potentially giving up a little bit of the upside. So, the nice thing is with all these different features and riders out there, the client can really find what's fitting for their needs and what solutions they're looking for. Then talk to the provider that can give it to them. Provide that product the best for what their needs are.

Jenna Dagenhart: Out of asset protection strategies have shown continued growth, do you see that growth continuing? And what innovations do you see with buffered structured annuities?

Adam Lalla: Yeah. I think everything Brad just said is a reason why you see the growth of valuations at all-time highs. What I think you said, right Brad? This is why. People recognize this, consumers recognize this, financial professionals recognize this as well, and understand though at the same time, as I mentioned earlier about the bond market, there's very low yield there. That's typically used as a diversifier, but there's actual real risk there. Now, I'm taking on a lot of risks with these bonds and get very, very little return at the same time. So, what are some other strategies available to, again, maybe I'm giving up some of that upside as Brad mentioned. Like, giving up the dividends and giving up a little bit upside by way of a cap, which is the most a client can earn in those products. The same time, give some reasonable upside and give very reasonable downside protection.

Adam Lalla: In this type of market, it is as I think invaluable. And that's why we see growth. As far as the innovation, I think you're going to see... you might see a little more exotic crediting strategies, different indices rather than just simply the S&P 500. We've already seen a lot of filings there. Some of the stuff we've seen too is even what I had mentioned earlier with Lincoln was doing was using structured ETFs inside an investment only variable annuity. So, more of a robust investment platform with some grow and protect strategies like to traditional Rialto. Brad mentioned the GMABs. His company, Transamerica does a great job with that as well, offering type of downside protection, but giving investment optionality at the same time.

Adam Lalla: So I think you'll continue to see that growth for sure. I hope that we don't lose sight of the guaranteed lifetime income though. I think that is still incredibly valuable for the same reasons that we need to have that protection because evaluations are all time high, and also pertains to someone taking life from income as well.

Jenna Dagenhart: Now that we've talked a little bit more about what annuities are, I want to spend a moment on what they are not. Brandon, annuities have had their fair share of distractors over the years. How do you respond to those critics?

Brandon Buckingham: That's a great question. First of all, annuities aren't for everybody, but they have served a critical purpose for millions of Americans offering them a level of security and alleviating some of the financial concern they may have about their future. Now that said, the objections I typically hear about annuities are costs, complexity, liquidity, and tax. So let me talk about the cost argument first. That's probably the biggest objection a year. That annuities are expensive. Compared to what though? Compared to losing 20, 30, 40% of your retirement assets, because you happen to experience a bear market at the wrong time. Compared to running out of money before you run out of breath. You really can't consider cost in the absence of value.

Brandon Buckingham: I think the real question should be the protective features that guarantees the benefits of those annuities of value to you. I think we have to remind people; we tend to... they're insurance products. Annuities are insurance products provided by insurance company designed to insure against known risks and retirement. And we tend to ensure our most valuable assets. We have car insurance; we have house insurance. Last year, there were 297 million cars on the road. Last year, there are 6.7 million car accidents. So, there was a 2.25% chance you're going to end up in car accident, but we're going to have car insurance. We're going to have collision and liability insurance.

Brandon Bucking...: Homeless for many people, that's their most valuable asset. Last year, there's 127 million occupied homes. Last year, there's 362,000 house fires. So last year there was less than one-third of 1% chance your house would catch on fire, but we all have house insurance. We have fire insurance. What about our retirement accounts? Right now, there's nearly $32 trillion in retirement accounts. And for baby boomers, this may be their most valuable asset. Now, you take an average 65-year-old couple, assuming they have at least a hundred thousand dollars of investible assets. On average, 40% of their assets are going to be retirement accounts. Should they consider you showing some of those assets? Of course, there's a cost of doing so, but you can't conserve costs in the absence of value.

Brandon Buckingham: Now that all said, as Adam and Brad alluded to, we're seeing a kind of a trend here going towards these accumulation focused products. A lot of them will have lower fees. Some have no explicit fees at all. So that really takes away the cost argument. But even if there is a cost, you can't consider costs in the absence of value.

Jenna Dagenhart: Brad, what are the biggest misconceptions around annuities in the general public?

Brad Crawford: I think Brandon, did a great job of touching on the most important is that there are some fees associated with annuities typically depending on the GMWBs, GMABs or the rialto. A higher fee isn't a bad thing if the value isn't there. So, I think one of the biggest misconceptions out there is that I typically hear from the distractors that they're high costs, and Brandon hit it dead on that, that cost is only important if you're not getting the value out of what you're paying for it. If you're paying for some enhanced protection, then that cost is probably going to be worth it for the client that's looking for that protection. Somebody summed it up best for me.

Brad Crawford: I used to live in the Annapolis, Maryland area, which was right next to the Bay Bridge that goes across the Chesapeake Bay over there. It's a beautiful bay. And if you could pull it up to that bridge and they said, "Hey, we have two lanes. One side of it is basically toll-free. You can drive across, but we took the guardrails down. The other side, you got to pay a dollar and you can drive across, but you got to pay a dollar and the guardrails are up." I would speculate that probably 95% of people would still pay their dollar and drive across the one with the guardrails up just because you never hit them. But imagine how nervous you'd be sitting half mile up, over a full ocean body of water without having guard rails next to you, most people get too nervous in that situation, and might end up making a mistake. Same thing that generally happens with their portfolios.

Brad Crawford: Without that protection, sometimes people make mistakes. Behavioral risk is probably the number one risk to somebody not having a fulfilling retirement. The other thing that I tend to see in the general public as misconceptions is it's interesting that I still... and again, my parents, their friends, when they say the word annuity, a lot of times people immediately jump to what is an immediate annuity. What essentially where they used to give us a lump sum check. We pay them out for the rest of their life, but if they die, the money stays to the insurance carrier. It's amazing to me that people still believe that that's what an annuity are in their mind. In fact, less than probably 1% of all annuity sales go into immediate annuities. But I would say that probably 30 to 40% of the general public believe that that's... when they hear the word annuity, that's what they believe they're going to be getting in and out of it.

Brad Crawford: So again, there's probably a lot of misconceptions and what exactly they are, what the cost is compared to different equivalents out there. But at the end of the day, I would say that if you're trying to strategically use this asset to fit a need of the client, then they're probably going to be a great fit. You can't just do an apples-to-apples comparison of this. ETF it costs less than this annuity, and that means it's better. You can take a look at the ultimate benefit and risk reward of it. So, thanks, Jenna.

Jenna Dagenhart: Yeah, those are all great points. I would have to say that I would probably be part of the 95% of people who would like the guard rail on the bridge, but Adam, over to you, anything you would add.

Adam Lalla: Yeah, actually I would. First of all, great analogy of Brad and Brandon. You made the point of the car insurance and homeowners’ insurance. Think of it another way. What if there was no chance of even having guard rails? Would you ever use the bridge? If you couldn't have the car insurance or couldn't have the homeowner's insurance, would you use those? What would be the utilization of it? So, think about what these guarantees offer a client's portfolio. It allows them to utilize them the way they were attended to. Whether it be actually spending retirement and enjoy your retirement. Whether it be protecting that retirement, it gives you utilization. Because I can tell you if the guard rails weren't an option, Brad, I wouldn't go on that bridge period. If that wasn't an option.

Adam Lalla: If there was no option to even have car insurance, I'd be very reluctant to even take the car out of the driveway. Having these types of insurance plans, whether it be a grow and protect strategy, whether it be lifetime income, allows your clients to take that income and feel safe about it and know that they're going to be all right. They can actually utilize it the way it's intended to.

Jenna Dagenhart: Brandon, any misconceptions out their surrounding complexity, liquidity, and taxes that you'd like to address anything else?

Brandon Buckingham: Yeah. So let me briefly touch upon each of those, because those are other objections you hear about annuities. One that they're complex and yes, they can be more complicated when you compare it to other investments, but they are designed to solve for more complex needs. They're designed to help manage and mitigate common risks in retirement. Whether it's longevity risk, market risk, a sequence of return risks, investor behavior risk, or withdrawal rate risk. On liquidity, that's another objection a year. First of all, annuities really are for your mid to long-term investments. They're not short-term investments. If you've got short-term needs, you might want to be in something a little bit more conservative, a little bit more liquid. Now a lot of annuities will have surrender charges. Not all. Some have no surrender charges, some are fully liquid, but a lot will have surrender charges.

Brandon Buckingham: And by the way, the surrender charge really serves two functions. One is an incentive for the contract owner to hold the contract long enough to reap the benefits for which it was assigned to provide. And then two, should they prematurely liquidate the contract then the insurance company can recover some of the costs. But again, annuities are for your mid-term to long-term needs. And thinking about mid-term needs, we've talked about this. Those folks that may be retiring in six to 10 years, and they want to protect those assets against loss. Long-term needs might be lifetime income. I would suggest to your lifetime income there's a long-term need. So that is a consideration. And the last thing I want to touch upon Jenna is taxes.

Brandon Buckingham: We talked briefly about some of the tax benefits of annuities. One of the objections you hear from annuities is the gains when they are distributed are taxed as ordinary income rates, not long-term capital gain tax rates. That's true, just like distributions from other retirement accounts like IRAs and 401(k) accounts are typically tax ordinary income, but the tax deferred benefits of annuities and other retirement accounts could outweigh the potential benefits of long-term capital gain taxes. What I mean by that is this is where you need to take a look at the tax efficiency of those investments. Take a look at the mutual funds or the managed money accounts. What's their turnover ratio. What's their tax drag. By the way, Morningstar tracks is where every fund out there. The average equity based mutual fund will have a tax drag of 61%. I'm sorry, a turnover ratio of 61%. A tactical bond fund 124%.

Brandon Buckingham: So what does that mean? That means the fund manager is buying and selling, buying and replacing 61% of their underlying investments in a given year. Now, the higher the turnover ratio, the more likely those gains are being distributed are going to be taxed at short-term rates, not long-term rates, ordinary income rates. Now, by the way just because I protect our investment has a high turnover ratio, high tax drag, it doesn't mean it's not good investment though. It might be a great investment owned as part of a well-diversified portfolio. The question becomes where do you want to own it? And that gets to the art of asset location. Maybe I want some of those tax inefficient investments, those investments that have high turnover ratio, high tax drags, actively manage investments, alternatives region. Maybe I want that I tax favorite account, like a retirement account or an annuity. And then that gets may last point, Jenna is the benefits of tax deferral.

Brandon Buckingham: By having money in a tax deferred account, especially now in this changing rising tax environment, likely rising tax environment, I'm in a much better position to control my taxes. Control the timing of my taxes, be able to grow and compound those assets on a tax deferred manner, which allows it to grow perhaps more quickly tax bracket management, but also, I'm deferring income until I'm retired when I'm the most likely in a lower tax bracket. I've asked people this question, are you paying taxes on income you're not spending? If you're paying taxes on income, you're not spending, you might want to think about some of the benefits of tax reform.

Jenna Dagenhart: Let's spend a little bit more time on taxes here because they seem to be the topic to show they're always important, but especially now, Brandon, do you think the new administration will raise taxes and how could that impact annuity?

Brandon Buckingham: The answer is yes. It probably shines a more favorable light on, on certain tax favored accounts like annuities. So, a couple of the proposals are covering really quickly. There's a proposal to raise a top tax rate from 37 to 39.6%. That would be an increase typically for those people who make over 400,000 as a joint filer. There’re proposals to reduce the value of certain deductions or cap the value of those deductions. There is a proposal that cap deductions at 28%. Now, what does that mean? If I'm the 37% tax bracket, and I paid $10,000 a mortgage hindrance, the value in dollars of that deduction to me is 3,700. 37% times 10,000, this capital reduce it to 28.

Brandon Buckingham: There's also a proposal to reinstate what's called the Pease limitations, where the value of my itemized deductions will be reduced by 3% to the extent exceeds that threshold of 400,000. The more I exceed that threshold, my income exceeds that threshold, the bigger reduction in value of that deduction. Then the last proposal has to do with capital gain taxes. Right now, the top long-term capital gain tax is 23.8%. 20% long-term gain tax plus that 3.8% Medicare surtax. There is a proposal to increase long-term capital gain taxes for those that make over a million dollars. Where if you made over a million dollars, your long-term gain tax will be taxed as ordinary income rates, which would be 39.6% plus at 3.8% Medicare surtax.

Brandon Buckingham: You're looking at a federal, long-term gain tax rate of 43.4% that makes over a million dollars. So again, highlighting the benefits of tax deferral, tax control and tax timing. There's something what I call tax diversification. Now I have no idea what the tax department's going to look like when I decide to retire. So over time I want to tax diversify my retirement portfolio. I want my tax bucket, my stocks bonds, mutual funds, managed money. I tax deferred bucket. Those are my retirement counts, my IRAs, my 401(k)s by non-qualified annuities and my tax-free bucket. That would be muni bonds, Roth accounts, and cash value life insurance. And by having a tax diversified retirement portfolio, I'll be a much better position to manage my taxes in retirement.

Jenna Dagenhart: Adam, how do you see the newly proposed tax plans potentially affecting the annuity industry?

Adam Lalla: Yeah. I think it can have huge for everything, Brandon just said. A higher marginal tax bracket. First of all, the tax deferral makes a lot of sense, and as Brandon said, not all asset classes are created equal. Some have more higher turnover than others. Some are spinning off income that as Brandon said, folks might not be using. So clearly the annuity could be very valuable there. And of course, if the long-term gains capital gains rate is change. Again, this is where annuity start looking even more favorable because the long-term gains rate might be for some clients the same as their ordinary income rates. Where there is no advantage of a non-qualified stock, for example, versus a similar type of investment inside annuity.

Adam Lalla: There also part of the proposal is maybe not having stuff that basis upon death. If that part of that proposal also comes into play as well, again, this is where annuities again, are more level playing field compared to some of these other non-qualified assets where that stepped-up basis won't matter, because it doesn't simply doesn't exist in that situation. So, I think if a lot of these new tax laws come into place, certainly the annuities are going to be very, very favorable. Particularly in the investment only variable annuity space where you can you see that robust investment platform, low costs, lower cost solutions for those types of clients.

Jenna Dagenhart: Yeah. Brad, do you expect annuity sales to increase in response to the current administration's tax proposals that we've been discussing?

Brad Crawford: Jenna, based on Adam and Brandon's previous answers of what we're expecting to change over the coming years in the tax proposal, there's no way that annuity sales don't continue to go up. Anybody that is exposed to potential the loss of the step up of basis, potential capital gains being converted over to ordinary income, it's an absolute no brainer for somebody in a high-net-worth situation that's facing that tax bill. That at least start considering annuities as part of their investment portfolio if they have not already. So how much? I'd only be speculating, but I got to imagine that part of the arsenal for high net worth planning is going to become focused very closely on how annuities can help a lot of those portfolios. It's interesting. One of the ones I think Adam mentioned is the step-up in basis.

Brad Crawford: I know a lot of people have shunned away from using annuities as part of a non-qualified portfolios because mutual funds get a step on basis where annuities typically hadn't. I bucked the trend a little bit with my own family. One of the things that we had in my family is my dad got towards retirement and wasn't in a very healthy situation. So, what we had done is we had shifted a large portion of his retirement portfolio over towards enhanced death benefits. Because that's what my mother was really going to need for that. When he passed away a few year... part of the reason we did that is because that was around 07, 08, 09, when everybody had just experienced the mortgage meltdown, 40% drop in portfolio values. So, the first instinct for everybody after that is to just go park it in bonds, park it in cash. Again, typically we get scared, we protect our assets.

Brad Crawford: We knew that wasn't the right thing to do. So, what we looked at doing is shifting it over towards using death benefit enhancements. So that five years later when my dad ultimately did pass away, instead of using mutual funds that he was afraid to use, we used annuities with enhanced death benefits. Regardless of the fact that the step up, sorry, step up basis wasn't going to take place. But when he did pass away and ended up out in about 300, 400,000 to the account that ultimately my mother then was able to move into an income benefit for herself, because her parents live towards a hundred years old and then we focused on the income planning side of it. So, again we definitely think annuity sales are going to go up, do their tax planning. But again, we're ultimately looking at what is the goal of the client, and it's so different for each individual client. We can tailor annuities to their specific need.

Jenna Dagenhart: Thank you for that personal example. So sorry about your dad. Brandon, final question on taxes here. Are there any potential estate tax changes that could benefit annuities?

Brandon Buckingham: Yeah. Let me briefly touch about three potential changes. One is to the estate tax exemption. Right now, the federal state tax exemption is 11.7 million per person. So, a married couple has a combined exemption of $23.4 million. If your state is less than that, there is no federal state tax. There's a proposal to reduce that exemption down to three and a half to $5 million. There's a potential increasing the estate tax itself, which is now at 40% if your states above that exemption amount by increasing that to 45%, maybe even 65% for your larger estate. Then the last major change, and this has been alluded to by both my colleagues, Adam and Brad, is just stepped up in cost basis. There's a proposal to eliminate that.

Brandon Buckingham: So what does that mean? If I held a wrong highly appreciated asset, I hold off that onto my death. The cost basis steps up the fair market value, which basically means the beneficiary of that panel have to pay tax on that appreciation. There is a proposal to eliminate that, which means the beneficiaries will have to pay tax on that appreciation. Now, the question becomes when? Is it when they let her sell that asset or upon debt? There's upon debt, think about the implication of that change. That could force a lot of beneficiaries to have to liquidate that asset to pay the resulting tax liability. If these are assets the family wanted to keep in the family, right? Think about family businesses, family, real estate, or some asset they want to keep in the family that could frustrate that purpose, right?

Brandon Buckingham: Because now that could force the beneficiary would sell that asset to pay the resulting tax liability. I think more people buy life insurance for that purpose. So how does this affect annuities? It doesn't. Annuities, as Brad mentioned, and Adam they do not get a step-up on a cost basis. As a matter of fact, retirement accounts generally don't, whether it's a 401(k) account or IRA. An asset that typically benefits from a set and cost basis is going to be long-held individual stock and real estate. What about mutual funds and manage money?

Brandon Buckingham: Keep in mind, they're paying taxes along the way, which increases the cost basis, which reduces what could eventually be stepped up at death. But again, to Brad's point, a lot of people really are buying annuities for the protective features they offer. It's not really a concern that doesn't have a step up in cost basis. Now, if the step-up in cost basis does go away, then it'll be on equal footing with other investments. So those are the three big changes but then think about the legacy benefits. Again, Brad, I think you did a great job talking about the legacy benefits. So, some people might buy a new lease for those protective features as Brad, you mentioned. Also, think about some of the flexible distribution options, stretch for instance. Not qualified newbies, the non-spouse beneficiary. You can still stretch that tax liability over a lifetime.

Brandon Buckingham: Now, the Secure Act change that. Secure Act change that for IRAs and 401(k) costs, but not non-qualified annuity. So, now under the Secure Act non-spouse beneficiaries of IRA and 401k accounts have to take that distribution within 10 years. Now, why did Congress make this change? They made it because they thought they can raise money. They thought they can raise $15.7 billion by modifying the stretch payout. I highly doubt that by the way, Jenna. I think most people, when they hear an IRA, they spend that money right away on the way to the funeral if they could. But I think for those places that have very large retirement accounts, and their IRAs and 401(k) accounts getting rid of the stretch option for the non-spousal beneficiaries forcing a 10-year payout. That's going to be a massive acceleration of taxes, and likely forcing those beneficiaries in a higher tax bracket.

Brandon Buckingham: With non-qualified annuities, that stretch option is still available. And by the way, a lot of annuities will allow you to force a stretch there. Kind of a restricted beneficiary form. So, there are a lot of legacy benefits in addition to the tax benefits we all talked about earlier.

Jenna Dagenhart: Thanks, Brandon and turning to a risk management here. Out of equity markets have risen to all-time highs as we mentioned. What risks do you foresee for investors and how can I help solve for them?

Adam Lalla: Yeah, I think it was a lot of what we've already said. I know there was a caterer study out there that said just even about a year and a half ago, 42% of people were willing to take on more risks to get increased returns. That's dropped to like 12% in that same study when we look at more recent time. So clearly these annuities can help not only alleviate people's concerns that maybe we are all time highs in a correction about the how can, while allowing them to get some growth. While allowing them to get reasonable returns and see that growth of that portfolio at the same time protecting them. So, helping them stay the course for sure.

Adam Lalla: And again, I think this is where the registered index linked annuities, buffer structure annuities, other guaranteed protection options like Brad mentioned earlier. Like Brandon mentioned earlier, I think are going to continue to grow. I think you're going to see maybe even a little more optionality with that going forward. But again, this is where I think the annuities are going to play a big, big part.

Jenna Dagenhart: Brad, how do you market fluctuation affect insurance carrier’s ability to price and sell annuity riders?

Brad Crawford: That's a great question, Jenna, because I think one misunderstood by a lot of people out there. A lot of people believe that the market going up and down is really the determinant on what an insurance carrier can offer. When in fact most of the market fluctuation is actually hedged out of these products at this point. Now, I've been doing this for about 25 years, and I can go back 20 years ago where that wasn't the case. A handful of carriers were basically taken out of the industry because they decided not to hedge, but all of the major players in today's industry, Prudential, Lincoln, Transamerica were pretty much fully hedging or majority hedging all of these porta portfolios and products that we're selling regarding to market fluctuations.

Brad Crawford: Now, one of the things that will affect our ability is the volatility or the [vicks 00:37:24] because that affects how much protection we can really purchase. So, during periods of really high volatility where the market's tendonous whipsaw left and up and down, that tends to be a little pricier to hedge these portfolios. But generally speaking, the Vicks over a period of time will always come back down to a medium and market fluctuations really have been eliminated. The thing that really is probably the most important for insurance carriers now, is really the long-term interest rates. Being able to match up long risk portfolios such as living benefits, or maybe even the shorter ones like the Rialto that we're looking at maybe a six-year time period. So, the ten-year treasury is probably the better indicator on what types of products are going to be coming out from a lot of these insurance carriers.

Brad Crawford: I can tell you that it was good to see that the tenure really has risen over the last six months compared to where historic lows were during the Coronavirus bottom back in the summer last year. So, the good thing is though most of the market fluctuation is taken out. I know Transamerica is about 98% hedged on the fluctuations right now.

Jenna Dagenhart: Now, Brandon, you mentioned the benefits of annuities to help mitigate market risks. How have annuities evolved to manage those risks?

Brandon Buckingham: I think out of it, and Brad alluded to this earlier, I think there's been a trend to more accumulation focused products that provide a protection against market loss. Now, historically annuities offer these guarantees. These protective features through a lifetime income rider, whether it's a new attire-based rider or a guaranteed minimum withdrawal benefit. But basically, to avail yourself of that protection, you had to take a lifetime income option from that annuity. Now, there's a focus more to accumulation of benefit and these type of products like index variable annuities allow you to have the upside potential of the market. Sometimes that's cap, sometimes it's uncapped.

Brandon Buckingham: So you have all the potential of the market. Then you got downside protection, either offered through floors or buffers. And that was mentioned earlier. Like a 10% buffer for instance, and it's often about on a point-to-point period, and typically a one three- or six-year period. At the end of that period, if the index is down let's say 9%, while I have a 10% buffer, my accounts not impacted at all. If the index is down 11%, well, then my account will be down 1%, but I got that downside protection. I got the upside market potential. Again, these are usually offered on a point-to-point basis of one-, three- or six-year term. I'll just talk about the six-year term.

Brandon Buckingham: That seems to be one of the more popular pointed point of strategies and take a look how that performs relative to the market. So, you take the last 30 years for instance. So, let's go from 1990 to the end of 2020. During that period of time, the average six year rolling return is 64%. During that 30-year period of time on a monthly rolling basis, there are 289 different time periods. During those 289 different time periods on a six-year rolling basis, the market was up 246 times. It was down only 43 times. When it was down more than half the time, it was down in less than 10%. So again, they bought that 10% buffer protecting you. Matter of fact, during that 30-year period of time, the 10% buffer what fully protect you 88% of the time.

Brandon Buckingham: So keep in mind how these protection or protective features work the average investor. You have that investor that's nearing retirement. They're afraid that they're going to experience a bear market in retirement. And by the way, on average, our retirees are going to experience three to five bear markets in retirement. You go back to 1945, we're up in 12 bucks bear markets with a 20% loss or greater. Last year we saw a bear market of 34% waltz. The average bear market will last 17 months. On average it takes 25 months to recover from the average bear market.

Brandon Buckingham: By the way, the average bear market loss was 35%. So, if I retire and I experienced an average bear market loss of 35%, what am I need to recover in that loss? A lot of clients will say, "Hey, if my account's down 35%, I need 35% to get back to even." That's not true. The mathematics of loss is a little bit different. If I have a 35% loss, I need 53% to get back to even. Above the 20% loss, I need 25% and above a 50% loss, I need to double a hundred percent gain to get back to even. So, you've got to protect against that loss. That's what these features do. It allows people to stay invested in the market so they can take advantage of the recovery, because too often times I experienced a bear market like that, or investors do they make rash decisions.

Brandon Buckingham: That's because we're controlled by our emotions. Those emotions might be excitement create euphoria, fear or panic. Last year, we were in the fear and panic stage. And because of these emotions, we tend to make bad decisions with our investments. We tend to get into the market after the market's already gone up, we tend to get out of the market after market is already gone down. And the foundation of behavior finances that we are impacted twice as much from loss as we are from gain. That our version of loss keeps us from staying invested during volatile times.

Brandon Buckingham: Did he take a look at the average investor? Oh, go back to last 20 years, they used to be 500 average about 6%, the average investor 2%. The average investor under reforms every single asset he has excluding maybe inflation. But products like this one, will protect against those losses, especially in that retirement red zone. When I'm about to transition to retirement, I really can't afford. Those are big loss but allows me to also stay invested during volatile times. Keeps me from making rash decisions when I transitioned into retirement.

Jenna Dagenhart: Yes. As we've seen throughout history, emotions and investing don't always mix well. Now, Adam, how have interest rates played a role in annuity product innovation?

Adam Lalla: Yeah. Certainly, it's a challenge at times. Brad talked a lot about this. Very simplistically put if you think intuitively, if I'm offering a guarantee the insurance company has put reserves aside to make good to make guarantee. Well, the less that pile of money sitting aside could earn, the more reserves they have to set aside putting pressure for return of equity for that insurance can be. So, it's very intuitive in that respect. So how are ways that they can control that or still offer some value in a low interest rate environment? First of all, having products like the rivals were just talking about that. Not always completely dependent on interest rates, more in the volatility they'll offer rates.

Adam Lalla: Diversifying the portfolio is another way of doing that as well. And also offering more certainty of outcome can help. For example, we have one benefit out there that just has one sub account, and it offers some of the higher guarantees in the market space. We're able to do that by controlling the investment outcome by knowing and narrowing down what that's going to be. Even if you think of like an immediate annuity where the client's given up ultimate control of cash value, that there is no cash value, you typically see very high payouts. Why? Because there's no ability for that client to invest in different ways where it might have a dramatic drop and now, we have that net amount of risk that Brad was talking about some companies while ago where they didn't hedge for.

Adam Lalla: So I think it's the product design. It's being effective with also re-insurance with also product diversification. It's a sum of all the parts that allow the insurance company to be able to offer guarantees today even in a challenging environment that we've been seeing.

Jenna Dagenhart: Brad, how will the secure act passage change the way the industry uses annuities inside of retirement 401(k) plan?

Brad Crawford: Oh, that's a great question, Jenna. It's been a stumbling point for advisors in the industry for a long time, because so many of the assets are locked up inside a 401(k)s. I live here in Colorado and one of the biggest producers out here actually makes a living talking to people that are about five years away from retiring and asking them a simple question. Would you have to postpone your retirement if the market dropped 20, 30%, and you left all the money in your 401(k)? Typically, the answer for a client is yes, they'd have to postpone their retirement. So, he's made a living doing non hardship in-service withdrawals, pulling the assets out by being able to put protection on them. Whether it's through a TPO, GMAB may be the trans offers Rialto, or income benefits.

Brad Crawford: With the passage of the Secure Act, it hasn't happened yet, but we're expecting that you're going to see more annuities, and more features being put inside of these retirement plans. Because what the Secure Act effectively did is it took a little bit, not all, but took a little bit of the burden off the trustee of the plan for picking an insurance carrier to be soluble throughout the life of the plan. That's been one of the biggest stumbling blocks as well as the portability of putting some of these features inside of 401(k) plans, where the clients could take advantage of them while they're still at work, and for their company. Where historically we've always waited to them. Where historically waited so they got close to retirement and did a non-hardship, or we waited until they actually retired and then did a rollover to an IRA.

Brad Crawford: So it's going to be interesting to see what the industry does with the passage of the Secure Act and seeing how much of the annuity features do get put into these retirement plans. A feature that we are seeing a big explosion in right now though, is we are seeing more fee-based annuities coming to market. I know for both Lincoln and Transamerica and Prudential, the idea of being able to invest in fee-based annuities, where historically they were six-year, seven year for your different products. A lot of advisors are finding that more appealing, where they can wrap the annuity just like their managed portfolio, and still get the features that we've been discussing throughout this conversation. So that is an area that we're seeing explosive growth, but I do expect the 401(k)s to come along here over the next few years.

Jenna Dagenhart: And Brandon, you want to pick that up?

Brandon Buckingham: No. 

Adam Lalla: I would say, yeah, no, absolutely. We at Lincoln even have a dedicated channel brand. I know Prudential just started a dedicated channel to the advisory market, our registered investment advisor market space. So, we have seen growth there. In fact, it's probably our biggest growing channel right now here at Lincoln, and we offer just about any type of product we have. We have an advisory "counterpart" type of product for that. So, I agree with Brad. I think that we'll continue to grow possible regulations coming in with the new administration too might force a lot of folks or at least propel them in that direction to go more fee-based, more advisory base. Which again, could also propel the growth that Brad is talking about as well.

Jenna Dagenhart: Brandon, anything you'd like to-

Brandon Buckingham: Yeah. You were saying the same thing. Oh, sorry.

Jenna Dagenhart: Go ahead.

Brandon Buckingham: Oh, we're saying the same thing here at Prudential, Adam and Brad. You're seeing the trend continued to the RIA Channel. I wouldn't be surprised Brad; you're going to see more of 401(k) plans offer annuity type products. So, we're definitely in that friend, and I think that market will continue to grow.

Jenna Dagenhart: Adam, as we wrap up this panel discussion, is there anything you'd like to add about living benefits?

Adam Lalla: Just the fact that I know we've talked quite a bit on this call about resident linked annuities, GMAB other growth and protect strategies. Not income planning. And I think the bull run we've seen many, many advisors, many, many retail consumers feel might have steered away a little bit from those living benefits, seeing the market continue to rise where they might be able to take systematic withdraws out of their portfolio and feel they're fine. That works until it doesn't. We know that the last several bulls run in the market after those bull runs, we've seen some significant pullback.

Adam Lalla: So if someone happens to retire when those unfortunate times are what I call like the peak of the mountaintop as the market's going down, they will most likely were not assets if they're taking systematic withdrawals. Particularly if they have some equity exposure in there. And of course, if they have bond exposure, they're probably spending down their assets already because as we've talked about earlier, interest rates are very, very low. So, all they want to say is that I feel that the need for guaranteed income, at least for a portion of a client's portfolio for many Americans is so critically important. And not to lose sight of the need of that just because we've had the long bull run that we've had.

Jenna Dagenhart: Brad, I see you nodding your head.

Brad Crawford: That's a great point, Adam made. I wholesale for many years and many of my best years as a wholesaler was at the bottom of the markets. Think of the 2003, 2004, 2005 after people had already experienced 40% losses, and then they're going out and trying to buy protection after they've already been down 40%. Same thing happened after 07, 08, 09. We saw this huge influx of annuity protection coming in in 2011, 2012, 2013. As a salesperson, you appreciated the business, but you know that a lot of people missed the window. The window was where you should have been buying the protection when everything was going great. But the problem is a lot of people are afraid of picking up their phone when things keep going up month after month, year over year, and trying to suggest that the client should make a change to their investment portfolio. I would argue now is probably the perfect time to look at some of these protection strategies.

Brad Crawford: Anytime that we're seeing Elon Musk talking about Dogecoin or moving markets left and right. And again, I think by every metric we're pretty highly valued. Now, I'm not going to get on here and say we're at the top yet, because quite honestly, if I could pick that, I'd probably should be doing something else. But I definitely know we're probably closer to the top than we are at the bottom right now. And that's probably a good indicator that people should look at putting some protection around the portfolio. So again, I would love to see an influx of products being purchased now at the top rather than waiting for a 20, 30, 40% correction, and then seeing the influx. Because I know by then most of the real protection these products can offer are going to be missed.

Jenna Dagenhart: Brandon, any final thoughts you'd like to leave our viewers with to say think about adding annuities to their portfolios?

Brandon Buckingham: Yeah. Just take a look at what's out there. As Adam and Brad alluded, there are a lot of different flavors and they serve a lot of different purposes. But right now, in a changing tax environment where the market is now to Brad's point, this might be a good time to consider taking some money off the table, lock it in, have that upside potential, but also avoid yourself of that downside protection. Especially for those people that are in the retirement red zone. Where were they going to be transitioning into retirement in the near future. So, there's a lot to learn. There are a lot of different flavors, a lot of benefits and features. But the trends are, I think it's an exciting time to be in this industry. I think it's time to really learn more about what they could offer and what they can offer your client.

Jenna Dagenhart: Well, everyone, thank you so much for joining us. Great to have you.

Brad Crawford: Thanks, Jenna.

Brandon Buckingham: Thank you.

Jenna Dagenhart: Thank you for watching this annuities masterclass. I was joined by Brad Crawford, divisional sales manager at Transamerica Capital, Adam Lalla, vice president, and head of competitive intelligence and advanced sales at Lincoln Financial Group, and Brandon Buckingham, vice president and national director of planning at Prudential Individual Solutions Group. I'm Jenna Dagenhart with Asset TV.