(TheStreet) - Fixed rate annuities, also called multi-year guaranteed annuities (“MYGAs”), can be a powerful addition to a fee-based portfolio, despite suggestions to the contrary.
MYGAs currently offer yields that are attractive on both a relative and absolute basis when compared to other lower risk investment strategies, and fee-based MYGAs typically offer yields that are higher than the more traditional MYGAs. While a financial advisor may charge additional fees for managing assets that include MYGAs, reducing the net realized return by the investor, this fee typically includes additional services beyond simply managing the portfolio (e.g., financial planning) and research suggests that financial advice can more than pay for itself.
Therefore, not only do I think fixed rate annuities should be considered for fee-based accounts, but I think all fee-based financial advisors should more actively consider annuities for their clients!
Allocating to MYGAs
MYGAs are relatively straightforward as far as annuities go, whereby they provide a guaranteed return for some stated period, typically between two and ten years. They are comparable to CDs where the quoted yield includes all fees, although the yields for MYGAs have been notably higher than CDs historically.
While I’ve been actively researching MYGAs for a while now, they’ve become especially popular recently. For example, 2022 fixed rate annuity sales totaled $113 billion, which was more than double the sales in 2021, according to LIMRA.
More traditional MYGAs typically include a commission of around 2-3% of the premium. These commissions effectively reduce the quoted yield, since the commission is amortized over the duration of the contract. In a fee-based product, there is no commission paid to a financial advisor (and technically it’s possible to purchase fee-based MYGAs directly), so the guaranteed rate in a fee-based MYGA is typically higher, although the difference is going to vary over time, by term, provider, etc. It’s also technically possible for an investor to be better off with a fee-based MYGA, even after factoring in the financial advisor fee, if the advisor fee is lower than the difference in rates.
While in theory an investor could “come out behind” from buying a fee-based MYGA if the additional financial advisor fee results in a lower return than if a more traditional MYGA were purchased, for many financial advisors the scope of services extends well beyond purchasing a product or managing a portfolio. This is important simply because while compensation is linked to the assets (i.e., the entire portfolio), the actual services commonly extend well beyond just investing. While the services provided are going to vary materially by advisor, I’ve done research suggesting that financial advice can provide a significant amount of “alpha” when it comes to achieving financial goals, a concept that Paul Kaplan and I labeled “Gamma” in past research.
A fee-based advisor should consider allocating to a MYGA if he or she believes allocating to the MYGA will increase the risk-adjusted return of the portfolio. Holding a MYGA in a fee-based account really isn’t that different than holding a portfolio of mutual funds or ETFs that doesn’t change much over time. I don’t think value should be defined as activity, rather value should be defined as helping investors achieve better outcomes, for which I think a MYGA could definitely prove beneficial.
Welcoming Everyone to the Annuity Party
Annuities have features that simply aren’t available in more traditional investments, in particular with respect to explicit guarantees as well as potential tax benefits*. For example, the ability of an annuity to generate income that is protected for life is something that is impossible to achieve from a more traditional portfolio (that does not include an annuity).
There are also many behavioral benefits to annuitization. For example, Michael Finke and I find in some recent research that retirees who have a higher share of their wealth in longevity protected income are more comfortable spending in retirement (i.e., annuities give retirees a license to spend).
In closing, I think the rise of fee-based annuities is an exciting innovation for investors and more financial advisors should be actively considering annuities for clients.
By David Blanchett, PhD, CFA, CFP®
April 11, 2023
About the author: David Blanchett, PhD, CFA, CFP®
David Blanchett, PhD, CFA, CFP® is a Managing Director and Head of Retirement Research for PGIM DC Solutions. In this role, he develops research and innovative solutions to help improve retirement outcomes for investors. Prior to joining PGIM DC Solutions, David was the Head of Retirement Research for Morningstar Investment Management LLC. He is currently an adjunct professor of wealth management at The American College of Financial Services and was formerly a member of the executive committee for the Defined Contribution Institutional Investment Association (DCIIA) and the ERISA Advisory Council (2018-2020).
Editor's Note: Recently, Retirement Daily published an article by annuities expert Ken Nuss, in which he argued that fixed-rate annuities are simple products that do not belong in a fee-based managed portfolio. He claimed that investment managers charging fees for managing these products are misleading clients. We heard from two other experts who see this differently. This is the second of the responses we received. The first is here.
