Are Inflation-Adjusted Annuities Right for Clients? The Product and Its Prospects
November 20, 2012
by Joe Tomlinson
Many economists and retirement experts favor inflation-adjusted single-premium annuities (SPIAs), but advisors and the investing public have never shared their enthusiasm. Detractors contend that the product is fundamentally flawed and will never gain broad acceptance. My own view is more optimistic, but significant obstacles will, nonetheless, continue to impede wider adoption.
After all an inflation-adjusted SPIA should be a natural fit for most retirement plans. In return for an up-front premium, the buyer receives lifetime income that adjusts each year in response to actual inflation.
It's like a do-it-yourself inflation-adjusted pension or an add-on to Social Security, which, for most people, does not cover basic living expenses. With defined-benefit pensions on the wane, this product could help fill the void.
I'll discuss details of the inflation-adjusted SPIA and its pricing – including prospects for that pricing to become more affordable with time. But first, we should begin by discussing the viability of these products.
The limited popularity of all types of SPIAs (inflation-adjusted, level-pay, those providing fixed-percentage increases) has been studied by many economists, who have tried to solve the so-called “annuity puzzle." For those who want a window into these efforts, financial planner and researcher Michael Kitces tackled the issue in a February 2011 blog post with the incisive title, “If Immediate Annuities Are Such A Great Solution, Why Doesn't Anyone Want to Buy One?” Kitces didn't offer any single answer to the question he posed, but he and his readers discuss a number of factors contributing to the unpopularity.
My own view is that the unpopularity is more a reflection of lack of advisor interest in selling the product, than SPIAs not meeting client needs. For advisors who depend on commissions, for instance, SPIA sales pay less than other types of annuity products, and, for advisors whose compensation is based on assets under management, the sale of a SPIA removes assets from investment accounts.
SPIAs are a better fit for the small minority of advisors who are paid hourly fees or retainers, but even that group typically favors systematic withdrawals over annuities of any type.
There are also competing annuity products to consider. The dominant products in the annuity market, variable annuities and fixed-index annuities, offer more sales pizzazz than the inflation-adjusted SPIA. Although inflation-adjusted SPIAs do a better job dealing directly with inflation and longevity risks, that’s not an easy message to communicate. Finally, the current low-interest-rate environment has a direct and transparent effect on SPIA prices, whereas for the more popular annuity products the effect may be hidden in product complexity.