Annuities have been used by retirement planners for years to provide tax-deferred growth and guaranteed income. But one of the biggest knocks that most critics cite against these products is that they are not liquid instruments. Contract owners are often required to keep at least the majority of their funds inside the contract for anywhere from five to 20 years, depending upon the carrier and the product. Annuity carriers therefore created an alternative form of contract known as hybrid annuities that are structured to provide both growth and income for their investors. These vehicles can in fact serve many purposes, but the question is, how well can they really perform each of these functions?
How They Work
As the name implies, hybrid annuities are simply a combination of two or more basic types of annuity contracts. Most products combine a fixed and a variable annuity contract that are housed inside the same chassis. Those that have a variable annuity in one segment are designed to allow a portion of the client’s money to grow in the mutual fund subaccount portion of the contract while providing guaranteed income that the client cannot outlive on the fixed side. Other types of hybrid contracts pair a fixed annuity with an indexed product in order to provide a complete guarantee of principal in both segments. Like all other types of annuities, they can be either immediate or deferred with fixed or flexible premiums. They can also contain the standard litany of other annuity features commonly offered today, including living and death benefit riders and accelerated payouts for chronic illness or long-term care expenses. (For more, see: Longevity Annuities Arrive in 401(k) Plans.)
There are also hybrid contracts that are designed specifically for charitable funding or as longevity contracts that do not have a cash value and will not pay out before the client reaches an advanced age. And, of course, they also offer tax-deferred growth with a range of payout choices for those who choose to annuitize their contracts.
Who Should Use Them
Although there is no absolute definition of who should own a hybrid annuity, they are generally most appropriate for retirement savers who are seeking a combination of growth and income. Those who are more oriented towards getting a stream of income that will keep up with the pace of inflation over time may also want to take a look at these instruments. The amount of risk that they are willing to take on the growth side will determine whether they should use a product with a variable or indexed segment. (For more, see: Advising FAs: Explaining Annuities to a Client.)
Some advisors say that they would not use these products for younger clients because those who have decades to go before retirement will probably come out ahead by investing directly in equities for the long term. Clients who are well into their retirement years may not be good candidates for these products either, as they may not get the chance to profit adequately from the growth portion. For them, a simple immediate annuity contract may provide a better payout with no risk to principal. But clients who are more sophisticated and thoroughly understand how annuities work may be a good fit regardless of their age, although the same restrictions may apply to them as well.
Pros and Cons
Hybrid annuities offer a couple of key benefits to clients in addition to the standard features found in other types of annuities. Their dual nature can provide guaranteed increasing income to clients because the growth portion provides them with a hedge against inflation. Contracts that combine a fixed and variable annuity can also provide clients with a lower level of downside risk than a variable annuity by itself, because the fixed portion will continue to pay out regardless of the performance of the variable subaccounts. (For more, see: Passing the Buck: The Hidden Costs of Annuities.)
But while hybrid annuities claim to be one-hit wonders that can do almost everything, many critics feel that they are overdesigned and too expensive. The dual chassis model makes these products especially complicated, and many clients are not capable of understanding all of their technical features or limitations. Many planners have also hawked these vehicles as being one-size-fits-all products that can be all things to all people. This of course is not true, but a material percentage of prospects are not able to see this-which means that there is a good chance that a substantial percentage of the hundreds of millions of dollars that are poured into these products every year may be misguided. Many hybrid products also come with extremely high fees and back-end surrender charge schedules that clients may not see clearly at the time of purchase. They also often pay inordinately high commissions to planners, which can easily sway them to show clients these products in lieu of something else that may be a better fit.
A final criticism of these products by many pundits is simply that they are not really what they claim to be. The “hybrid” phrase was coined a few years ago by the marketing segment of the insurance industry in an effort to capitalize on the recent success of the hybrid car movement. But any type of annuity can provide both growth and income in some fashion, as virtually all variable and indexed annuity products today come with guaranteed income riders and other features that allow investors to lock in a stream of guaranteed income and still enjoy some form of upside potential. Nevertheless, hybrid annuities are still able to package two complete annuity contracts into a single product that can essentially perform two different functions at the same time. (For more, see: How to Buy Annuities When Interest Rates Are Low.)
The Bottom Line
Although hybrid annuities represent the fastest growing segment of the annuity industry since the Great Recession, their true value remains unproven to many skeptics. Their ability to combine two complete products into one vehicle is their greatest selling point, but the jury is still out on whether they are genuinely able to provide a level of benefits that cannot be matched by their traditional cousins. For more information on hybrid annuities, visit AnnuityFYI at www.annuityfyi.com or consult your financial advisor. (For more, see: Annuities and Baby Boomers: The Pros and Cons.)