No-Commission Annuities as a Substitute for Low-Yielding, Investment-Grade Bonds

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In a low-yield environment, advisors need to use financial planning tools like no-commission annuities to improve after-tax, after-advisory fee bond returns.

A large bond allocation has long been the staple diversification tool for advisors to hedge market risk in their equity portfolios – especially for clients nearing retirement. In high-yield environments, this is an excellent tool. Advisors can either hold the bonds to maturity and benefit from the high fixed income yield, or they can sell the bonds as yields decrease, thereby allowing for capital appreciation on the assets. In a high-yield environment, bonds are great assets by themselves, independent of the diversification benefits they provide.

But in a low-yield environment, the value proposition is the opposite.

Low yields don’t justify the AUM fees advisors charge on them. Furthermore, the high ordinary income taxes owed on bond gains makes the net, after-tax, after-advisory fee yields for the client abysmal – particularly if this client is the ideal HNW client in a high tax bracket. In the low-yield environment we’re in, after the client pays taxes and fees, he or she makes significantly less for owning the asset and taking all the interest, credit, and liquidity risk than the RIA earns for managing them.

As a result of this low-yield, high tax-rate dynamic, clients have a better chance of meeting their retirement goals (and passing more money to the next generation at death) using a 100% equity strategy than a 60% equity/40% bond strategy.