Dear Mr. and Mrs. Client, I have a great opportunity for you. It has zero fees, you cannot lose money even when the market goes down, and if you take income from it the company has to pay you for the rest of your life no matter how long you live. “I love it, what’s it called.” An annuity. “Oh definitely not I heard those were terrible.”
This is not an uncommon conversation in the world of financial planning. So in honor of Annuity Awareness Month, let’s go over some reasons that annuities have developed a bad reputation over the years and give you a better understanding of the value annuities can provide. First, in an effort to bring in additional assets, annuity companies were paying extremely high commissions to brokers. This led to annuities being sold to people who did not need them. In many cases, all these agents needed was an insurance license in order to sell these products meaning they were limited in what they could offer a client. Second, the most common annuity sold in the past was a “variable annuity.” These annuities can be very confusing as they have multiple moving parts as well as very high fees built inside of them. Because of these fees and the limited or mandated investment selections, it’s very hard to outperform the lower guarantees built into the contract. Third, annuities come with a surrender period. It’s essentially a lock up period for your money, similar to a CD, which restricts your access to the money without penalty for a specified period of time. Too often these surrender periods were not explained properly to clients leaving them in an illiquid situation.
These are all serious issues that have been a part of creating the bad reputation for annuities. For this blog, I will focus on the two types of annuities that I believe very strongly in, and give you the reasons why I do.
The first annuity is designed for accumulation while protecting your capital investment. Typically called Equity Indexed Annuities, these annuities accept a lump sum deposit in exchange for downside protection. These annuities are tied to a specific indices related to the market, the S&P 500 being the most common. They guarantee a 0% floor, meaning if you invested $100K and the S&P 500 loses 10% in year 1, you retain your initial $100K investment. Conversely, should the S&P 500 gain 10%, you will participate in that gain up to a certain amount known as a “cap.” These annuities are perfect for people who are nearing retirement and want to protect a certain amount of the nest egg they have accumulated.
The second annuity that I believe in strongly are Single Premium Immediate Annuities or SPIA’s. I find these to be a perfect complement to your retirement portfolio. A typical scenario would move approximately 20% of your assets you have allocated for retirement to an annuity company in exchange for a monthly paycheck for the rest of your (and your spouse’s) life. As with anything there is a trade-off. Yes, you are giving up liquidity, but you are doing so in exchange for taking some market risk out of your retirement plan as well as longevity risk. As we have seen with the market this year, it doesn’t always go up. My new retirees, understandably, are a little anxious. The performance of the market would have no effect on an annuity such as this. Neither would how long you live. Once the contract is in place, the annuity company is contractually obligated to pay you the monthly guarantee regardless of how long you live even after you exceed your initial investment.
Annuities (as I have written previously about long term care) have made great improvements over the last decade. Annuities, used correctly, are simply a means of risk management. As with any financial product, there is no magic bullet. And regardless of the likes of Boozy Gorman, there is no one size fits all answer for everyone. If you have additional questions regarding annuities, please don’t hesitate to reach out to me. Even if you currently own an annuity that is still in the surrender period, there may be options that are more advantageous.
Please share this with whoever you think could benefit.
Disclosure: Annuities are long-term investments designed for retirement purposes. Withdrawals of taxable amounts are subject to income tax and, if taken prior to age 59½, a 10% federal tax penalty may apply. Early withdrawals may be subject to withdrawal charges. Optional riders have limitations and are available for an additional cost through the purchase of a variable annuity contract. Guarantees are based on the claims paying ability of the issuing company