Morningstar - Q4 2021 - 36

Spotlight: Guaranteed Income
State and federal governments can address
some of the obstacles and complications
retirees face if they want to annuitize part of their
retirement savings. Industry innovation,
such as the inclusion of annuity products within
pooled vehicles, can mitigate other barriers.
We discuss what must be done in a recent white
paper.1
Until these problems are solved,
financial professionals have a large role to play in
educating clients on the retirement benefits
of GIPs and steering them toward the right kinds
of annuities inside or outside of their retirement
accounts. In this article, we discuss how
investment professionals can help clients
overcome the legal and operational barriers that
investors typically face in purchasing annuities
for retirement.
A Short History of Annuities
Some form of annuity products has been
around in the U.S. since the 1800s, but it wasn't
until the decline of multigenerational households
in the early 20th
century that demand for
annuities significantly grew. A growing
insurance industry was eager to meet the demand,
and applying scientific and actuarial principles,
it began to create annuity products. By
the mid-1980s, insurers' overall product mix was
almost evenly distributed between traditional
insurance products and annuities.
In its modern form, the term annuity refers to
a wide and confusing array of products, including
but going far beyond GIPs. While we support
the use of a variety of annuities in the marketplace
and agree that investors who are sufficiently
sophisticated should have choices to customize
their retirement plans, we do not believe
that public policy should encourage all types of
annuities regardless of their benefits.
GIPs, however, can provide a relatively simple,
appealing solution for retirees looking to
ensure lifetime income or protect their invested
principal. GIPs provide a guaranteed stream
of income with a fixed or variable rate of return
with some protections.
The best example of a GIP is a single-premium
immediate annuity. With this type of annuity, an
investor exchanges a lump sum of money
in return for a stream of income for the rest of his
or her life. The annuity can be fixed or variable,
meaning that the income can be a set amount or
can vary based on portfolio growth. While
immediate fixed annuities will pay out a consistent
sum of money each month, immediate
variable annuities provide income that can grow
over time and keep up with inflation. These
annuities are particularly useful products
for investors seeking a regular income payout.
Unlike most annuities, they do not have
an accumulation phase, meaning investors receive
immediate payments of their funds
upon purchase.
Another GIP is a deferred-income annuity. Here, an
investor exchanges a lump sum for a stream of
income payments that begin at some point in the
future and continue for the rest of his or her
life. If a deferred-income annuity is purchased in a
tax-qualified retirement plan, it is called a qualified
longevity annuity contract. Fixed-interest
annuities can act similarly to a deferred-income
annuity; they provide a guaranteed interest
on a contract value-for example, 5% annually on
a contract of $100,000-beginning at some
future point through the rest of the investor's life.
Use of Annuities Today
While data on annuities is limited, it is clear
that most people saving for retirement do not use
them. According to the Federal Reserve's
2020 Survey of Consumer Finances, fewer than
5% of American families held an annuity in
2019. Morningstar data shows that $87.1 billion
in variable annuities were sold in 2020. The
Investment Company Institute's 2020 Fact Book
says that about $500 billion of an estimated
$11 trillion of IRA assets were held in annuities
other than variable annuities as of 2019; an
additional $2.3 trillion in non-IRA assets were
held in annuity reserves. None of these estimates
gives us a sense of how much is held in GIPs;
typically, VAs would not fall into this category.
A key reason why GIPs are not widespread
is their lack of availability in employer-sponsored
plans. According to the Plan Sponsor Council
of America's 63rd
Annual Survey of 600 plan
sponsors, less than 10% of employer plans offered
an annuity option in 2019. Morningstar
estimates that only 1.5% of employers who filed
the Form 5500 for their retirement plans-
generally employers that have more than 100
participants-offered annuities. The significant
discrepancy between these numbers is
likely due to the limited nature of the insurance
data reported on Form 5500. The actual
percentage of plans offering annuities is probably
between these two numbers but is most
certainly low.
One might expect that the decline of definedbenefit
plans would increase demand for
some type of guaranteed income at retirement.
Social Security fits that need for many Americans.
The Social Security formula would replace
50% of income for those with average wage
earnings equal to the median income of just under
$36,000 in 2019. For the bottom two quintiles,
it would replace approximately 84% and 55% of
income, respectively, based on income data from
2019. Furthermore, Social Security benefits
are indexed to inflation, meaning that benefit
payments fluctuate in step with the Consumer
Price Index for Urban Wage Earners to
account for inflation losses, while commercial
annuity payments are usually fixed. On the
other hand, those at the top two quintiles in 2019
would have approximately 47% and 38% of their
income replaced, respectively. Consequently,
for those for whom Social Security is not
sufficient and who have funds to purchase other
assets, GIPs are an opportunity to fill the
void of guaranteed income.
Legal and operational barriers are largely
responsible for the depressed use of
GIPs as retirement investments. As we discussed,
government action is required to solve
some of these problems. Until that happens,
financial advisors can step in to help clients
1 Sethi, J. 2021. " Should We Have More Annuities? " Morningstar White Paper. July. https://www.morningstar.com/lp/annuities-in-retirement
36
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Morningstar - Q4 2021

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