ANNUITIES: The Advisor's Conundrum
When you come to a fork in the road, take it.
- Yogi Berra
Editor's Note: This is the first in a series of articles on annuities by Mr. Sterling. These articles will be published monthly here at the Wealth Strategies Journal.
A conundrum is a question or problem having only a conjectural answer. It is a logical postulation that evades resolution; a dilemma. Its close relative is the enigma, which is a perplexing, baffling or seemingly inexplicable matter.
Together, their meanings warrant special consideration to our understanding of annuities and their place in the financial and estate planning process.
For some, the annuity represents the ultimate income generating tool. Others draw an analogy to the "Swiss Army Knife" with its endless array of features and applications. Then there are those inclined to view annuities as "gimmicks" manufactured and sold to fill company coffers and the retirement accounts of selling agents.
Regardless of your view and possible underlying agenda, annuities have an important role to play in the financial lives of our clients and their families. There is hardly an aspect of a contract owner's financial life that is not germane to the annuity's prowess.
OUR CHALLENGE
As legal, tax or financial advisors, we are called upon to demonstrate the expertise and assume the responsibility to counsel our clients and provide solutions to their questions of who gets what, when, why, and how. The premise is simple; it's execution not so.
Acceptance of this assignment confronts us with an array of challenges which accompany the client engagement and planning process. A representative sample may include:
□ regulatory and legislative compliance,□ multidisciplinary applications,□ IRC sections, IRS rulings and case law developments,□ professional ethics and practice management constraints,□ overlapping and competing business agendas,□ client personality conflicts, resource limitations and behavioral inclinations, and□ the lack of requisite expertise and technical skill competencies.
Increasingly at the center of financial and estate planning engagements are the advisory challenges presented by complex financial assets. Few are more ubiquitous than the annuity. Though hardly analogous to screaming "fire" in a crowded theatre, mere mention of the product is bound to stir the flames of controversy and debate - often emotionally charged.
THE RODNEY DANGERFIELD COMPLEX
"Misrepresented, misunderstood and maligned" are words that come to mind when considering the volumes written about annuities. Much of the press surrounding annuities has created a fundamental misapprehension--the idea that annuities serve the same purpose as investment products like mutual funds, stocks and bonds. But these comparisons are tenuous at best and disingenuous at worst.
Annuities are not the culprit. They are unique instruments or tools designed to perform particular functions to render solutions for particular needs and to achieve desired results. However, this rather simple characterization does little justice to the annuity's versatility and often unrealized potential.
Side Bar. There is much to be said for a product that offers these prospects:
Tax Deferral
Guaranteed Lifetime Income
Guaranteed Lifetime Income
Probate Avoidance
Capital Preservation
Capital Preservation
Cash Flow Management
Social Security Income Tax Management
Social Security Income Tax Management
Estate Distribution and Stretch Planning
Enhanced Trust Management
Enhanced Trust Management
Creditor Protection
Long-term Care and Medicaid Planning
Long-term Care and Medicaid Planning
But offering a prospect is not the same as delivering it. Critics of annuities have much to learn about their unique and distinguishable attributes. The same can be said of those who manufacture, distribute, promote and sell them.
LEGAL CONTRACTS
Annuities are complex legal contracts possessing unique dispositive and distributive provisions which dramatically impact the financial lives of our clients and their loved ones. Their design and function will continue to evolve as their presence in our clients' financial and estate plans continues to grow.
Beginning with wealth accumulation and continuing through wealth utilization, preservation and distribution, annuities will continue to figure prominently as compelling financial solutions.
Query. Should an advisor present a contract for the client's signature if that advisor had not read the contract, understood its terms or the implications of its application?
Annuities are not promoted and sold in a vacuum. Annuities are sold within the context of the distinct attributes comprising our client's financial resources. The illustration shown below and titled "Annuity Ownership Context" is from a presentation I had conducted on behalf of the American Bar Association at its 2010 Joint RPTL/Tax CLE Conference.
This illustration provides a basic overview of the ownership arrangements that impact the value and viability of annuity transactions. Each structural element possesses distinguishable features, which must be understood and reconciled if the annuity contract is to perform as promised during the sales process.
Alignment and Integration. Wealth structures and ownership elections are important. Would any advisor speculate that the implications of individual ownership compared with trust ownership are of little consequence to your client? Consider the implications of per capita compared with per stirpes distribution patterns or the ramifications of forced 5 year distribution periods compared with extended "stretch" distribution time lines.
Context and placement matter!
WALL STREET, MAIN STREET & MADISON AVENUE
Why demonstrate and prove that something is possible when a potential buyer can otherwise be persuaded?
Madison Avenue has as much a controlling influence on promotion and sales of financial services and products as Wall Street and Main Street; perhaps, more so. If perception is reality, what prognosis can we make of the annuity owner's ownership experience? The due diligence criteria for sales suitability will soon integrate performance measurements governing the owner's experience and assessment of promises delivered.
The slide shown below provides a general overview of annuity contract designs, structures and function. As you review the slide, avoid the tendency to absorb the information in the isolated context of a product description. A true understanding of an annuity's value and potential contribution to our clients' financial well-being can only come within the context of our clients' financial resources and ownership experience.
Side Bar. It is within the context of your client's financial portfolio and personal management inclinations that an accurate assessment of the annuity proposal can be made. If you acknowledge the multi-dimensional elements and the varied contract features and applications of annuities, can you acknowledge the multi-disciplinary variables (financial, tax and legal) accompanying annuity transactions?
Critics of annuities are well advised to broaden their understanding of annuities and their potential contributions to investor success. Annuity performance is as much a function of contract structure, design and application as it is the measurement of net returns or earnings reported from the underlying financial and investment portfolios.
Query. Of what value is your knowledge of product features if you lack the expertise and technical skill competencies to assess the prospects for your client's successful ownership experience?
Design, Structure and Function. This illustration is intended to provide a basic overview of contract types and functions.
Annuity structures include non-qualified and qualified contracts. Non-qualified contracts are funded with after-tax dollars and are generally owned individually or under trust.
Qualified contracts are funded and created through retirement plans; the most common being the IRA.
The two basic annuity types are deferred and immediate annuities. Deferred contracts hold or defer payments until a future, whereasimmediate contracts begin payments within one year of purchase of election.
MAYHEM AND HIDDEN OPPORTUNITIES
Advertising works. Consider what "mayhem" is doing for the "good hands people." Regardless, the fact remains; when has complexity, confusion and even controversy failed to contribute to an advisor's bottom line?
The "Red Zone" Proposition. As clients age, their needs become more complex and require greater professional expertise and counseling skills from their advisors. Counseling is not to be mistaken for therapy.
This "red zone" is quite different from that presented by product manufacturers and distributors. It represents a period of life when confusion and chaos become the norm, not the exception.
It also represents a period in our clients' lives when advisor collaboration and cooperation should be the norm and not the exception. Unfortunately, evidence suggests otherwise.
Side Bar. Regarding your clients' purchase and ownership of annuities, there are two considerations which are germane to their ownership and advisory relationship experiences. These will be discussed in greater detail in subsequent articles; however, as you imagine the variables, also imagine your value propositions and the opportunities to provide meaningful and profitable service.
The first consideration is the likelihood of efficient and productive contract administration during the contract ownership period. The second is the likelihood that clients will receive competent and continuous guidance. Assess the probabilities and imagine the impact on clients' lives.
A CAST OF CHARACTERS
Clients are not one-dimensional and should not be "type cast." Yet, the more advisors turn to excel spreadsheets and computer generated financial models or rely on third-party document preparation services, the more removed clients will be from personalized solutions.
Scalability is a business construct that dominates the financial services industry and the promotion and sale of products. The desirability of accelerating revenue while minimizing the twin burdens of operational execution and expense drives business models toward simplicity and duplication. One size may not fit all, but it certainly contributes to the bottom line.
This view may be cynical but not when juxtaposed against the challenges of integrating annuity contract design, structure and function within the context of clients' personal financial lives. That is to say nothing of the expertise required to optimize contract administration and management within the context of: (1) their legal appointments and respective duties; (2) their intellectual and emotional capacities; and (3) their behavior tendencies and advisory resources.
The "Red Zone" proposition illustrated in the previous slide has a direct bearing on our advisory roles and capacities to serve the interests of our clients. The following slide entitled Client Profiles portrays the "reality" of these advisory challenges and demands.
Client Profiles provide a broader context and realistic framework for evaluating the "suitability" of annuity transactions.
There exists an array of governing variables and administrative imperatives that will impact annuity contract performance and the fulfillment of expectations created during the sales process. Agent fulfillment of due diligence requirements are currently restricted to "point of sale" analysis and provide little insight into the client's ownership experience.
REGULATORY COMPLIANCE OR INFORMED DECISIONS
It should not be challenging to determine how these outcomes may be mutually inclusive or exclusive. In a perfect world it would be a "moot" point. However, "perfection" is an endeavor when considering the world of financial service and products, somewhat analogous to the application of the client's "best interests" standard of care.
Reference to the "best interests" standard was by design and intended to frame further discussion regarding the value attributes and appropriateness of annuity transactions. To better prepare advisors are encouraged to obtain a copy of an article which appears in the January 2007 issue of Trusts and Estates.
The title of the article is Keep Up With Your Client by Charles L. Ratner, National Director of Personal Insurance Counseling at Ernst & Young, LLP. Mr. Ratner raises an important point about the lack of meaningful counsel provided to clients and their resulting inability "to make informed decisions about [insurance] products."
I concur; and, in the context of annuity promotions and sales, the evidence is overwhelming. Informed decision-making requires a great deal more than advisor compliance with stated adopted "sales suitability" rules. Somewhere in the formula there must exist a measurable scale for assessing and improving the client's prospects for success.
THE ROAD AHEAD
Where will this lead? That is for you to decide. However, in an effort to brighten an otherwise dimly lit highway, subsequent articles will shed light on what should prove to be intriguing traffic patterns and challenging road conditions.
Query. When you "strap" your client behind the wheel of the next annuity contract, will you do so with the assurance of delivering a safe and rewarding driving experience?
Charting the course - markers and guideposts:
This series, which will be published monthly at the Wealth Strategies Journal, will cover the following topics.
To raise the awareness of financial, tax and legal advisors regarding the impact of annuity transactions on their distinct disciplines, in order to better counsel their clients. To introduce advisors to recent developments and emerging trends regarding the promotion and use of annuities in the financial and estate planning process. To provide advisors with an overview of recently enacted rulings, regulations and legislation governing practice standards and annuity applications. To alert advisors to professional liability issues and to examine the value of strategic alliances. To enhance advisor understanding and appreciation of annuities for their unique attributes and the distinct value propositions they offer clients and their families.
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