Phil Zins, 64, hasn't been retired for very long, but he, his wife, Mary, 62, and their adviser already have taken their retirement income plan back to the drawing board.
The problem wasn't with the strategy that Sarah J. Kaelberer, their adviser and owner of Business & Estate Advisers Inc. of Wayzata, Minn., drew up for them. Rather, the Zins, who live in Golden Valley, Minn., had to deal with the fact that they no longer would be able to contribute to the two MetLife Inc. variable annuities they owned — contracts that gave them a 6% guaranteed income stream — because the company has barred certain clients from adding new money to their contracts.
The Zins' annuities accounted for nearly half of their total retirement pot of about $2 million. They originally expected to get half of their retirement income stream from turning on the income benefit rider on the annuities. Mr. Zins had expected to retire at the end of 2013 and was going to move a portion of his retirement assets into the annuity, but he had to leave his post at Xcel Energy Inc. early and no longer has the option to add to his annuity. He now spends time on his labor of love, restoring vintage Fords. Ms. Zins, who plans to continue working until age 65, won't be permitted to make new contributions to her annuity contract, either.
When she initially recommended the MetLife VAs, Ms. Kaelberer warned the Zins of the possibility they would be locked out from contributing to the contracts in the future.
Still, the event is emotionally jarring.
“Mary made a comment that brings this to light,” said Ms. Kaelberer. “She said, "I can't see how it's going to happen now.' When we believed half of the income stream would come from MetLife, she could see us turning on the spigot and money going into the bank account.”
CONTRACT TWEAKS
The Zins' story is becoming more common these days as financial advisers and clients grapple with insurers' tweaks to in-force VA contracts. Low interest rates have increased insurers' cost of hedging the living benefits attached to the annuities, making the VA business capital-intensive and less profitable for the companies.
As a result, carriers are curbing their VA risk exposure by cutting off contributions into existing contracts and reducing the most aggressive investment options, among other moves.
“The variable annuity industry has been going through change and derisking in the last four years,” said Elizabeth Forget, senior vice president of MetLife Retail Annuities. “The industry is at an inflection point. It has to change because the fundamentals have changed.”
To contend with the changes and their effect on retirement planning, financial advisers are coming up with a Plan B in case their clients' contracts change.
“I've had quite a few cases where the insurers cut off the ability to make additional contributions, and in some cases, that's forced us to revamp the payment plan,” said Mitchell Kauffman, principal at Kauffman Wealth Services Inc., which is affiliated with Raymond James Financial Services Inc.
Those adjustments to existing contracts sometimes have required him to consider other annuities that don't have the rich benefits that had been offered in the past. That also means clients may have to downsize, albeit slightly, what they expected to get in the way of retirement income.
“These aren't significant changes [to clients' plans]; it could be less than a 10% adjustment in retirement income,” Mr. Kauffman said. “But there's a mentality of things being pared back, so you talk to the clients proactively to tell them they may not get the same opportunity as they had with prior money.”
In the Zins' case, there's little chance of finding a new annuity with a 6% income benefit. Their Plan B is to invest the money in a diversified portfolio of exchange-traded funds. The couple now expects to get about 25% of their retirement income from the annuities, instead of 50%.
“We're still figuring out how to adjust our savings habits to fit into the income stream,” said Mr. Zins, noting that they had already begun planning to be “a little more frugal” in retirement anyway.
NEW STRATEGIES
When insurers drop aggressive fund options inside a VA contract, they also sap the annuity's earning power, leaving advisers scrambling to come up with other ways to juice returns.
“We're allocated in Asia, exclusive of Japan. That's the game: Let's get the more aggressive asset classes,” said David Moskovitz, a senior vice president and adviser at RBC Wealth Management. He noted that when insurers cut off clients' ability to add money to these contracts, clients' existing positions are kept intact, though no new money can be added to a particular fund. However, clients can lose their positions if their allocations are automatically re-balanced, so Mr. Moskovitz manually re-balances the funds to avoid selling out of aggressive funds that are closed.
“If a carrier removes a 70% equities, 30% fixed-income allocation model, leaving the 60/40 model as the most aggressive, then significant equity exposure has been lost,” said Judson Forner, investment analyst at ValMark Securities Inc. It may make sense for younger clients to change to a contract that's more flexible, depending on the comparison of contract features, he said.
These developments raise the question of how to proceed if it appears likely that a client is vulnerable to being locked out of an attractive contract: Should the client consider adding more money?
START SUBTRACTING
The answer is counterintuitive.
“No, in fact, you should subtract,” according to Moshe A. Milevsky, associate professor in finance at the Schulich School of Business at York University in Toronto, Canada. He is writing an article, “Turn on Your Living Benefit Now,” to address this puzzle.
According to the paper, clients get the most value from their VA when the account value hits zero and the insurance company begins covering the withdrawals. Roll-ups and ratchets that build the income base in exchange for waiting to withdraw are not tempting enough.
“The allure of a higher guaranteed base — if you wait a few more years before turning on the income — doesn't offset the value that comes from depleting the account as soon as possible,” Mr. Milevsky wrote. This is especially true if the account value is underwater and the client is getting a roll-up in the 5% range, he wrote.
“The sooner you run down the variable annuity and get the account to ruin, the quicker you start living off the insurance company's dime and stop paying insurance fees,” Mr. Milevsky noted.
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