Rules of Thumb Can Smother Options

June 06, 2012

By Linda Koco

Many advisors and planners have decided that they must never recommend putting 30 percent or more of a client’s liquid assets into annuities.

It’s a rule of thumb that advisors use to help keep clients well diversified. It also helps insulate the advisor against accusations that they are pushing annuities onto clients just to make a sale.

But no one seems to be talking about the flip side of this annuity allocation guideline—that some people, depending on circumstances, might actually be better off with more annuity holdings that 30 percent. What is the advisor to do when working with such clients?

Address it head on

The question needs to be addressed head on. If it’s not, advisors will be forced into using protocols, and clients may not get the best advice and recommendations for their needs.

It should be remembered that this rule of thumb is not a law or regulation. It is a matter of industry practice, a recommendation that has emerged out of long experience in dealing with client finances.

But insurance and financial veterans know that rules of thumb often end up functioning, in everyday practice, as if they were regulations, insurance department bulletins or even laws. Many insurance review desks, outside advisors and others interpret rules of thumb as if they were written in stone and not subject to deviation.

Some regulators and litigators take the rules of thumb that way, too, at least mentally. So, if there is a deviation, that’s a red flag for a possible problem.

For the most part, this particular rule of thumb poses no problem, because not too many people want to plunk down 30 percent or more of their assets for an annuity. 

But what happens if, say, a healthy widow of sound mind, age 73, sells her home and moves into a condo that her children bought for her? This happens often enough to be a good example of the problem that can crop up.

In this example, the woman now has her cash proceeds, her other savings and her Social Security or other retirement plan benefits. She is not wealthy, but neither is she poor.  But she — and her children — want to be sure she has enough guaranteed income to cover her basic expenses. For instance, she doesn’t want to have to depend on her children for the monthly condo fee, food, clothing, utilities, transportation, medical, etc. And she doesn’t want exposure to volatility in the stock market.

Upon assessing her total picture, the advisor might reach the conclusion that, for this particular client, an income annuity, several laddered income annuities or a combination of deferred and income annuities could fit the bill nicely. He runs the numbers only to learn that, to accomplish what she wants and needs, the recommended annuity percentage would come to, say, 45 or 50 percent of her assets.

Now the advisor could be in a pickle, if the distributors or other interest adhere to the 30 percent rule of thumb and thus intervene to prevent the higher allocation.

The problem is unilateral application

The problem the advisor will have is not with the rule of thumb. After all, the guideline makes eminent sense from a cautious business perspective and a general consumer protection perspective.

The advisor’s dilemma will be with the unilateral application of the rule. It does not allow for the elasticity required when purchases come down to specific individuals, who have needs and preferences that point to solutions that go outside the rule of thumb.

Besides, since client finances are fluid and ever changing, the allocation percentage is a fuzzy matter anyway.

Then, there is the matter of commoditization.  If the rule of thumb is treated as an unbendable rule, the effect will be to commoditize, as it were, elements of the annuity sale. That is, it would make mincemeat of efforts to personalize transactions.

If the advisor encounters objections — from the client’s other advisors, say, or perhaps a distributor — the advisor can always come up with a new solution that gets the client at least close to where she wants and needs to be. This other solution may require use unfamiliar tools and strategies, partnering up with other advisors or distributors, or applications of differing formulas. Good advisors do this type of alternatives-searching every day.

But will the alternative solution be the best outcome for the client? The advisor will have a lot of factors to consider. They include not only the rule of thumb, but also the client’s age and stage of life, the available assets today and forthcoming, the presence of annuity-like assets, the wants and needs of client and family, the client’s risk tolerance, the economic conditions, and on and on.

It would seem that the advisor needs another rule of thumb, to provide guidance when deviations from the 30 percent rule of thumb seem the preferred route to take.

Annuity industry leaders could provide some valuable assistance here, by opening up the topic for robust discussion. No one has to pass a law or adopt a regulation to do this.  Just talk, consider the pros and cons, and see where it goes.

A related issue

A tangentially related issue is emerging at the federal level. The Insured Retirement Institute (IRI) last week gave testimony before the Internal Revenue Service’s public hearing on proposed regulations related to the purchase of longevity annuity contracts under tax-qualified defined contribution plans.

Speaking for the IRI, Michael Oleske, the chief tax counsel for New York Life Insurance Co., pointed out a few concerns that IRI has about the proposal’s 25 percent account value limitation on premiums that may be contributed to a qualifying longevity annuity contract (QLAC).  His comments go to the heart of the above issue, about the problems associated with applying a specific percentage on the amount of annuity purchases that can be made.

It’s important to note that the IRI concerns have to do with qualified plan guidelines rather than general retail annuity purchases, and with actual proposed regulations rather than a rule of thumb. Still, Oleske’s prepared remarks are so apropos to the problem above,  that they are worth running here in full.  Oleske said:

For participants who are paying QLAC premiums over a period of years or after retirement, the 25 percent-of-account-balance limitation may unduly restrict the ability to purchase this coverage.

“If a participant is withdrawing funds to pay for everyday living expenses, but paying longevity premiums to provide future income, the account balance may eventually fall to a level where the cumulative QLAC premiums exceed 25 percent of the account balance.

“We suggest that some flexibility be included in the proposed rule to address these types of situations.”

Let’s emphasize the last point: “We suggest some flexibility.” The same point could be made about the 30 percent rule of thumb.  It would be good for the advisor, and it would be best for the consumer, to use some flexibility in applying that 30 percent rule.

Linda Koco, MBA, is a contributing editor to AnnuityNews, specializing in life insurance, annuities and income planning. Linda can be reached at [email protected].

© Entire contents copyright 2012 by Inc. All rights reserved. No part of this article may be reprinted without the expressed written consent from



Comment on this article




Featured Offers