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The Rise of Annuities – A Riddle Wrapped in a Mystery Inside an Enigma? [Podcast]

“A riddle wrapped in a mystery inside an enigma.” That’s Winston Churchill describing Russia in 1939. The words puzzle and paradox have long been associated with annuities, marking them as one of the most difficult financial products to demystify. Recently, there has been a significant increase in annuity sales, which has added to the enigma. Why are they suddenly becoming so popular? Estate planning attorneys should know at least some basics.

The Original Annuity Riddle

The original annuity puzzle (the annuity market participation puzzle) refers to the economic paradox where retirees rarely choose to annuitize their wealth despite theoretical models suggesting this would be optimal for lifetime consumption smoothing and longevity risk protection. Classical economic theory, particularly as developed by Yaari (1965) (1), suggests that risk-averse individuals without strong bequest motives should convert a substantial portion of their wealth into lifetime annuities to hedge against outliving their assets; this optimizes their economic utility. They benefit from the insurance aspect of an annuity. Payouts are generally guaranteed for a lifetime, but the contract is priced according to average life expectancies.

However, in practice, voluntary annuity participation rates remain remarkably low across most developed countries. This discrepancy between theoretical predictions and observed behavior has sparked extensive research into potential explanations, including behavioral biases, bequest motives, concerns about healthcare costs, mistrust of insurance companies, desire for liquidity, existing annuities through Social Security and pensions, and the role of family risk-sharing.

The disinterest in annuities seems to be changing. Figure 1 shows a very recent trend of significantly increased annuity sales.

Figure 1: Growth in Annuity Sales Volume since 2004. Data from LIMRA. © wealthcarelawyer.com

The New Annuity Mystery – Why are Annuities Suddenly so Attractive?

There is no definitive answer. However, it is interesting that growth is driven almost exclusively by fixed annuities. A fixed annuity provides a guaranteed interest rate and principal protection since the insurance company bears the investment risk, but it typically offers lower potential returns with simpler features and lower fees. This maximizes the insurance aspect of an annuity.

In contrast, the returns of a variable annuity are tied to the performance of an investment portfolio chosen by the owner who bears the investment risk. These annuities offer higher potential returns and associated downside risk but with more complex features, higher management fees, and optional features like guaranteed income riders.

Figure 2: The most recent record federal deficit increase (red) seems to precede the increase in annuity sales. In contrast, good stock market performance should reduce the interest in annuities.

Annuities are priced by calculating the present value of future payment obligations, adjusted for mortality risk, expenses, and profit margins. Insurance companies start with the principal investment and determine what payment stream they can provide based on current interest rates, actuarial tables (which predict how long they will need to make payments), their operating costs, and their desired profit margin. Higher interest rates generally allow for larger payments. In contrast, longer life expectancies, additional guarantee features, and higher expenses reduce the payment amounts the insurer can offer for a given principal investment.

In the first quarter of 2024, annuity sales reached a record $113.5 billion, marking the highest first-quarter sales figure in the 40-year history of Limra’s data tracking. While it is unclear what caused the sudden increase in the popularity of annuities, we believe that concern for the viability of Social Security because of the ballooning deficit may have contributed to it. LIMRA offers an alternative evaluation:

“Favorable economic conditions and demographic shifts have driven demand for investment protection and guaranteed lifetime income solutions that are unique to annuity products. During their discussion, Hodgens focused on the economic factors, such as higher interest rates and prolonged market volatility, which have enhanced the value and appeal of fixed annuity products, particularly fixed-rate deferred (FRD) and fixed indexed annuities (FIA).” (2).

It is also possible that current affluent baby boomers, as the sandwich generation, see value in diversifying with annuities: The annuity is considered spending money to help assure a certain standard of living, while investments are invaded only sparingly to allow for a growing legacy for the next generation. A guaranteed income stream from an annuity can provide psychological permission for retirees to spend more freely on themselves. Without an annuity, many retirees tend to be overly conservative with spending, worried about depleting their savings too quickly or not having enough for longevity and emergencies.

The Annuity Product Enigma

In an effort to make annuities more attractive, the industry has developed numerous products that address various concerns and preferences clients may have. As a general rule, many of the special flavors partially defeat the economic purpose of an annuity, which is utility maximization for persons without a strong bequest motive.

Figure 3: Some of the major annuity families and species. © wealthcarelawyer.com

Annuity contracts have evolved from basic guaranteed income instruments into complex financial products, each structured to address specific risk-transfer and income objectives. This evolution has produced three distinct primary classifications: Fixed, Variable, and Indexed annuities.

Fixed Annuities represent the foundational form. The Single Premium Immediate Annuity (SPIA) facilitates direct risk transfer through immediate income guarantees, leveraging mortality credits to enhance returns. Deferred Income Annuities (DIAs) modify this framework by introducing a time delay element, optimizing for future income maximization. Qualified Longevity Annuity Contracts (QLACs) emerged as a specialized adaptation to retirement account regulations, permitting Required Minimum Distribution deferral to age 85, subject to statutory limitations ($200,000). Multi-Year Guaranteed Annuities (MYGAs) provide fixed-rate guarantees over specified periods, offering liquidity features absent in traditional fixed annuities.

Variable Annuities evolved to incorporate market exposure through separate account structures. The basic Investment-Only variant provides tax-deferred market participation, while Living Benefit riders introduced protective features:

Guaranteed Lifetime Withdrawal Benefits (GLWB) ensure sustained withdrawal rates
Guaranteed Minimum Income Benefits (GMIB) protect future income bases
Guaranteed Minimum Accumulation Benefits (GMAB) provide principal protection parameters

Indexed Annuities represent a hybrid development, linking returns to market indices while maintaining principal protection. Structured/Buffered variants modify this framework by accepting defined downside exposure in exchange for enhanced participation rates.

Tax treatment bifurcates between:

Qualified: Pre-tax funding, full distribution taxation
Non-Qualified: After-tax funding, exclusion ratio calculations

Contract modifications across all variants may include:

Mortality benefit enhancements
Inflation adjustment mechanisms
Long-term care provisions
Premium return options
Distribution structure alternatives

This taxonomic framework provides the foundation for analyzing suitability, tax implications, and regulatory considerations across various client objectives and constraints.

Client Self Help

More information about annuities is not necessarily more helpful to consumers: “More complete, and therefore more complex information about annuity products leads to reduced attention and produces worse consumer choices. In an eye-tracking experiment comparing consumer response to a real, relatively brief annuity brochure and an edited and shortened version of the same brochure, we find that the more complex the materials, the faster attention declines.” (3).

This underscores the need for a learned intermediary to digest the information and to tailor it to the individual’s needs, preferences, and financial situation, who can ask clarifying questions to ascertain understanding.

Given a certain contract amount and their ages, many clients want to know what monthly or annual income they can expect given the current rate structures. The Annuity Calculator by annuity.org promises to do that. Others, such as Schwab, have similar annuity calculators, and results may differ.

How to Help Your Estate Planning Clients

The increasing complexity and popularity of annuity products present both opportunities and challenges for estate planning attorneys. Given the recent surge in annuity sales and evolving product complexity, attorneys must establish clear parameters for client discussions regarding these financial instruments.

Estate planning attorneys can appropriately address annuities by maintaining strict professional boundaries while providing valuable guidance. The fundamental framework involves three key components: permissible discussion parameters, professional referral protocols, and risk management considerations.

Permissible Discussion Parameters: Estate planning attorneys may appropriately discuss the theoretical foundations of annuities, including their role in consumption smoothing and longevity risk protection as established in classical economic theory. Discussions may encompass general tax implications, basic product classifications (fixed, variable, and indexed), and integration with estate planning objectives.

Professional Referral Protocols: Given the product complexity illustrated in the annuity taxonomy, specific product recommendations should be deferred to qualified specialists. Appropriate referral channels include:

Independent Annuity Brokers
Independent Insurance Advisors
Certified Financial Planners (CFPs)
Chartered Life Underwriters (CLUs)

Risk Management Considerations Documentation protocols should include:

Contemporaneous recording of annuity-related discussions
Specific referral documentation
Clear delineation of scope limitations regarding product recommendations

The attorney’s role should focus on identifying how annuity contracts may integrate with broader estate planning objectives while ensuring clients receive specialized guidance for product selection. This approach aligns with the current market dynamics where product complexity demands specialized expertise beyond the scope of general estate planning practice.

Professional network development should emphasize relationships with independent advisors who maintain appropriate licensing and demonstrate expertise in the evolving annuity marketplace. This network enables appropriate delegation of product-specific guidance while maintaining the attorney’s role in the overall estate planning strategy.

This framework enables estate planning attorneys to address the increasing relevance of annuity products while maintaining appropriate professional boundaries and ensuring clients receive comprehensive guidance from qualified specialists regarding specific product selection and implementation.

Podcast

References

Yaari, M.E., 1965. Uncertain lifetime, life insurance, and the theory of the consumer. The Review of Economic Studies, 32(2), pp.137-150.
LIMRA, Building on the Record Annuity Sales Momentum, LIMRA (May 22, 2024), https://www.limra.com/en/newsroom/industry-trends/2024/building-on-the-record-annuity-sales-momentum/.
Harvey, Joseph, John G. Lynch, Philip Fernbach, and Ji Hoon Jhang. “Information Overload in Consumer Response to Annuities: Eye-Tracking and Behavioral Evidence.” Consumer Financial Protection Bureau Office of Research Working Paper 23-01 (2023).

https://papers.ssrn.com/sol3/Delivery.cfm?abstractid=4394792

Form I-9 Software: Avoiding Unlawful Discrimination When Selecting and Using I-9 and E-Verify Software Systems

A recent employer fact sheet from the U.S. Department of Justice (DOJ) and U.S. Department of Homeland Security (DHS) provides guidance for avoiding unlawful discrimination and other violations when using private software products to complete Forms I-9 and E-Verify cases.

Quick Hits

Employers are responsible for selecting and using software products that avoid unlawful discrimination and comply with Form I-9 and E-Verify requirements.
Employers must not use software products that violate Form I-9 and E-Verify requirements or involve system limitations that unlawfully discriminate among workers.
DOJ and DHS advise employers to train staff on Form I-9 and E-Verify requirements, and to provide access to published government guidance on Form I-9 and E-Verify requirements.

Employer Compliance With Form I-9 Software Products

The fact sheet reminds employers to use the current Form I-9 and properly complete the Form I-9 for each new hire after November 6, 1986, with any acceptable employee documents. Form I-9 systems must comply with requirements for electronic signatures and document storage including the ability to provide Form I-9 summary files containing all information fields on electronically stored Forms I-9. The fact sheet confirms required software capabilities and employer practices to properly complete the Form I-9 and avoid unlawful discrimination.

Employers must ensure that any software:

allows employees to leave form fields blank, if they’re not required fields (such as Social Security numbers, if not required on E-Verify cases);
allows workers with only one name to record “Unknown” in the first name field and to enter their names in the last name field on the Form I-9;
uniquely identifies “each person accessing, correcting, or changing a Form I-9”;
permits Form I-9 corrections in Section 1 and does not complete Section 1 corrections for workers, unless completing preparer/translator certifications in Supplement A;
retains all employee information and documents presented for form completion; and
permits Form I-9 corrections in Section 2 and allows completion of Supplement B reverifications with any acceptable employee documents.

Employer Compliance With E-Verify Software Products

The fact sheet reminds employers to comply with E-Verify program requirements when using software interfaces for E-Verify case completion. The fact sheet confirms required software capabilities and employer practices for completing E-Verify cases. Employers must still:

provide employees with current versions of Further Action Notices and Referral Date Confirmation letters in resolving Tentative Nonconfirmations (mismatches) in the E-Verify system;
provide English and non-English Further Action Notices and Referral Date Confirmation letters to employees with limited English proficiency;
display E-Verify notices confirming employer use of E-Verify;
“promptly notify employees in private” of E-Verify mismatches and provide Further Action Notices. If an employee who has been notified of a mismatch takes action to resolve the mismatch, provide the Referral Date Confirmation letter with case-specific information;
delay E-Verify case creation, when required. For example, when workers are awaiting Social Security numbers or have presented acceptable receipts for Form I-9 completion, employers must be able to delay E-Verify case creation; and
allow employees to resolve E-Verify mismatches prior to taking any adverse action, including suspensions or withholding pay.

Prohibited Employer Activity When Using Form I-9 Software

The fact sheet notes that an employer that uses private software products for Form I-9 or E-Verify compliance is prohibited from:

completing the Form I-9 on an employee’s behalf unless the employer is helping an employee complete Section 1 as a preparer or translator;
prepopulating employee information from other sources, providing auto-correct on employee inputs, or using predictive language for form completion;
requiring more or less information from employees for Form I-9 completion or preventing workers from using preparers/translators for form completion;
improperly correcting the Form I-9, improperly creating E-Verify cases, or failing to report corrections in the Form I-9 audit trail;
requesting more or different documentation than needed for Form I-9 completion, or failing to complete reverification in Supplement B of the Form I-9; and
imposing “unnecessary obstacles” in starting work or receiving pay, “such as by requiring a Social Security number to onboard or by not paying an employee who can complete the Form I-9 and is waiting for a Social Security number.” (Emphasis in the original.)

Staff Training and Technical Support

The fact sheet warns employers against using software products that do not provide technical support to workers, and it notes that employers are required to provide training to staff on Form I-9 and E-Verify compliance. Resources for staff members using software products for Form I-9 and E-Verify case completion include I-9 Central, the Handbook for Employers M-274, the M-775, E-Verify User Manual, and DOJ publications.

DOL Announces New Independent Contractor Rule

On January 9, 2024, the United States Department of Labor (“DOL”) announced a new rule, effective March 11, 2024, that could impact countless businesses that use independent contractors. The new rule establishes a six-factor analysis to determine whether independent contractors are deemed to be “employees” of those businesses, and thus imposes obligations on those businesses relating to those workers including: maintaining detailed records of their compensation and hours worked; paying them regular and overtime wages; and addressing payroll withholdings and payments, such as those mandated by the Federal Insurance Contributions Act (“FICA” for Social Security and Medicare), the Federal Unemployment Tax Act (“FUTA”), and federal income tax laws. Further, workers claiming employee status under this rule may claim entitlement to coverage under the businesses’ group health insurance, 401(k), and other benefits programs.

The DOL’s new rule applies to the federal Fair Labor Standards Act (“FLSA”) which sets forth federally established standards for the protection of workers with respect to minimum wage, overtime pay, recordkeeping, and child labor. In its prefatory statement that accompanied the new rule’s publication in the Federal Register, the DOL noted that because the FLSA applies only to “employees” and not to “independent contractors,” employees misclassified as independent contractors are denied the FLSA’s “basic protections.”

Accordingly, when the new rule goes into effect on March 11, 2024, the DOL will use its new, multi-factor test to determine whether, as a matter of “economic reality,” a worker is truly in business for themself (and is, therefore, an independent contractor), or whether the worker is economically dependent on the employer for work (and is, therefore, an employee).

While the DOL advises that additional factors may be considered under appropriate circumstances, it states that the rule’s six, primary factors are: (1) whether the work performed provides the worker with an opportunity to earn profits or suffer losses depending on the worker’s managerial skill; (2) the relative investments made by the worker and the potential employer and whether those made by the worker are to grow and expand their own business; (3) the degree of permanence of the work relationship between the worker and the potential employer; (4) the nature and degree of control by the potential employer; (5) the extent to which the work performed is an integral part of the potential employer’s business; and (6) whether the worker uses specialized skills and initiative to perform the work.

In its announcement, the DOL emphasized that, unlike its earlier independent contractor test which accorded extra weight to certain factors, the new rule’s six primary factors are to be assessed equally. Nevertheless, the breadth and impreciseness of the factors’ wording, along with the fact that each factor is itself assessed through numerous sub-factors, make the rule’s application very fact-specific. For example, through a Fact Sheet the DOL recently issued for the new rule, it explains that the first factor – opportunity for profit or loss depending on managerial skill – primarily looks at whether a worker can earn profits or suffer losses through their own independent effort and decision making, which will be influenced by the presence of such factors as whether the worker: (i) determines or meaningfully negotiates their compensation; (ii) decides whether to accept or decline work or has power over work scheduling; (iii) advertises their business, or engages in other efforts to expand business or secure more work; and (iv) makes decisions as to hiring their own workers, purchasing materials, or renting space. Similar sub-factors exist with respect to the rule’s other primary factors and are explained in the DOL’s Fact Sheet.

The rule will likely face legal challenges by business groups. Further, according to the online newsletter of the U.S. Senate Health, Education, Labor and Pensions Committee, its ranking member, Senator Bill Cassidy, has indicated that he will seek to repeal the rule. Also, in the coming months, the United States Supreme Court is expected to decide two cases that could significantly weaken the regulations issued by federal agencies like the DOL’s new independent contractor rule, Loper Bright Enterprises v. Raimondo and Relentless Inc. v. U.S. Dept. of Commerce. We will continue to monitor these developments.1

In the meantime, we recommend that businesses engaging or about to engage independent contractors take heed. Incorrect worker classification exposes employers to the FLSA’s significant statutory liabilities, including back pay, liquidated damages, attorneys’ fees to prevailing plaintiffs, and in some case, fines and criminal penalties. Moreover, a finding that an independent contractor has “employee” status under the FLSA may be considered persuasive evidence of employee status under other laws, such as discrimination laws. Additionally, existing state law tests for determining employee versus independent contractor status must also be considered.

1 The DOL’s independent contractor rule is not the only new federal agency rule being challenged. On January 12, 2024, the U.S. House of Representatives voted to repeal the NLRB’s recently announced joint-employer rule, which we discussed in our Client Alert of November 10, 2023.

Eric Moreno contributed to this article.

Take Note: Social Security and Medicare Benefits Changing in 2016

Claiming Social Security Twice is Eliminated

Prior to 2016, some married individuals who were 62 or older had claimed Social Security retirement benefits twice. Previously, a person whose spouse was at full retirement age and was herself or himself at an early retirement age, age 62 to 65, could claim spousal payments and then switch to payments based on their own work, which would then be higher because they were claiming it at an older age.

As of this year, however, workers who turn 62 in 2016 or later will not be able to claim both types of payments, but instead one or the other. However, the younger spouse can still claim spousal benefits when he or she turns 66, and those individuals will continue to contribute to their own Social Security Retirement benefit until age 70, thereby receiving a higher benefit when they begin to receive their full retirement benefits 4 years later.

Stricter Rules for Suspended Payment of Benefits

In May 2016, the rules have changed for suspending your Social Security Retirement benefits until a later date when they would be higher, and this process will no longer be permitted. Previously, spouses and dependent children could claim payments based on your work record while your benefits were suspended and continued to grow.

This option is no longer available, however, as of May 2016. You will no longer be allowed to “file and suspend.” If the retired worker’s benefits are suspended, spousal and dependent benefits will not be paid.

Higher Medicare Part B Premiums for some Social Security Recipients

Most Social Security recipients will pay the same Medicare Part B premium in 2016, as they did in 2015. That amount is $104.90 per month. Increases in Medicare Part B premiums are tied to increases in Social Security benefits due to cost-of-living adjustments which did not occur this year. However, those individuals who are enrolling for the first time in Medicare Part B this year will pay a higher premium of $121.80 per month.

Article By Leslie A. Mitnick of Stark & Stark

Where do Social Security Payments Made by Undocumented Workers Go?

Many employers are familiar with the following scenario: You hire someone, put them on payroll and deduct taxes from their checks automatically – just like you do with all employees. You then find out through an audit by U.S. Immigration Customs and Enforcement (ICE) or by the employee coming clean that he or she is using a fake social security number. You consequently terminate employment on the grounds that they violated the company’s “honesty policy” or simply because he or she is not authorized to work in the United States. So what does Social Security do with the payments that the employee has made?

According to the Social Security Administration (SSA) unauthorized workers are paying an estimated $13 billion per year in social security taxes and are receiving about $1 billion in return. During an interview, Stephen Goss, the chief actuary of the SSA, estimated that there are approximately 11 million undocumented people in the United States and about 7 million of these people are working illegally. Further, out of these 7 million undocumented workers, approximately 3.1 million people are using fake or expired social security numbers. Goss noted that undocumented workers have paid around $100 billion in social security taxes over the last decade, which the SSA has treated as a positive cash flow without a home. Goss indicated that the $100 billion in unclaimed social security created by undocumented workers has been a key factor in allowing the SSA “to be paying benefits for as long as it now can.”

So, and in answering the headline question, the SSA puts all of these “homeless” contributions into the Social Security Trust Fund for Old-Age and Survivors Insurance (OSAI). This fund is used to ultimately pay out social security benefits to U.S. workers and retirees.

ARTICLE BY

Ian R. Macdonald

Greenberg Traurig, LLP

The Original Annuity Riddle

The New Annuity Mystery – Why are Annuities Suddenly so Attractive?

The Annuity Product Enigma

Client Self Help

How to Help Your Estate Planning Clients

Podcast

References

Further reading focused on Income Annuities

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Quick Hits

Employer Compliance With Form I-9 Software Products

Employer Compliance With E-Verify Software Products

Prohibited Employer Activity When Using Form I-9 Software

Staff Training and Technical Support

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Stricter Rules for Suspended Payment of Benefits

Higher Medicare Part B Premiums for some Social Security Recipients

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