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Annuities as an Asset Class for Fee-Based Advisors l 7 © Envestnet 2022 Before digging deeper into different types of annuities, it is worth first focusing on how a basic life-only income annuity works and how it fits into retirement planning. A simple annuity can effectively replace bond holdings in a retirement plan that are earmarked to meet the lifetime spending goal. The question is why should a retiree hold any bonds in the portion of their asset base designed to cover ongoing retirement spending goals? Premiums for the income annuity are invested in bonds (the insurance company adds your premium to its bond-heavy general account). The annuity then provides payments precisely matched to the length of time they are needed. Stocks provide opportunities for greater investment growth. Individual bonds can support an income for a fixed period, but they do not offer longevity protection beyond the horizon of the bond ladder created. Bond funds are volatile, exposing retirees to potential losses and sequence risk while still not providing enough upside potential to support a particularly high level of spending over a long retirement. Risk pooling with an income annuity can support a higher level of lifetime spending compared to bonds. Stocks also offer the opportunity for higher spending, but without any guarantee that stocks will outperform bonds and provide capital gains during the pivotal early years of retirement. Income annuities can be viewed as a type of coupon bond which provides payments for an uncertain length of time in which the principal value is not repaid upon death. Another way to think about income annuities is that they provide a laddered collection of zero-coupon bonds that support retirement spending for as long as the annuitant lives. Much like a defined- benefit pension plan, income annuities provide value to their owners by pooling risks across a large grouping of individuals. Longevity risk is one of the key risks which can be managed effectively by an income annuity. Investment and sequence risk are also alleviated through the more conservative investing and asset-liability matching approach on the part of the insurance company for the underlying assets held in the insurance company's general account. The payout rates for an income annuity assume bond-like returns and longevity is further supported through risk pooling and mortality credits, rather than by seeking outsized stock market returns. Longevity risk relates to not knowing how long a given individual will live. But while we do not know the longevity for any one individual, insurance company actuaries can estimate how longevity patterns will play out for a large cohort of individuals. The "special sauce" of the income annuity is that it can provide payouts linked to the average longevity of the owners because those who die early end up leaving money on the table to subsidize the payments to those who live longer. Though it may seem counterintuitive to subsidize payments to others, this act can allow all owners in the risk pool to enjoy a higher standard of living than bonds could support. All annuity owners know that the mortality credits will be waiting for them if they do end up living beyond life expectancy. The Fundamental Logic of Annuities with Lifetime Income Longevity risk is one of the key risks which can be managed effectively by an income annuity.

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