June is awareness month for one of the most polarizing products in the financial world … Annuities. If you listen to many “experts”, then there’s nothing polarizing, they are simply the worst product on the market. My issue with that assessment is that there is no magic bullet, no one size fits all solution for everyone in this country when it comes to their finances. I find an annuity to be a very useful tool in certain situations, particularly in this interest rate environment. I’ll dive into a couple ways to utilize them and then explain some of the advantages I see as well as the disadvantages
Annuities come in many different shapes and sizes, but I will focus on my two favorite uses, income and accumulation. When we start planning for retirement, I often like to look at what someone’s basic living expenses are going to be, their NEEDS. As a general rule, I like to have those expenses covered by guarantees. If social security isn’t enough to cover your household expenses, and you are like most of us and don’t have a pension, then adding an annuity to the equation can provide that pseudo pension. Having a guaranteed income stream for the rest of your life and your spouse’s can provide real peace of mind for people. It also covers a lot of risks that we face in retirement as it relates to the market risk, changing interest rate environments and longevity.
If people could tell me exactly what the stock market was going to do, exactly what the interest rate on the 10-year treasury would be and how long, to the day, they were going to live, I’m pretty sure I’d be out of a job. By adding a product that doesn’t care about those things, and is contractually guaranteed, I fail to see how it’s terrible. Income annuities will typically pay an income stream significantly higher than what any advisor would tell you is a safe spend down rate from your investments.
On the flip side of income, an accumulation annuity is a great way to take some profits off the table in your investments and protect that growth as you get closer to retirement. If the stock market is negative, you simply earn a 0% return. If there are positive stock market returns you participate in those gains up to a certain performance cap. All that is provided at no cost to the client, which I’m not sure a lot of these talking heads realize. Fees have historically been the biggest knock on annuities, and very accurate when it came to old school variable annuities. However, the newer generation of FIA’s (Fixed Indexed Annuities) are the opposite of that. In fact, they can be some of the most cost-effective products on the market. You have true market participation, full downside protection at potentially zero cost whatsoever.
So, what are the real downsides to an annuity? I mentioned one above in that they will cap your potential upside on stock market returns in order to fully protect your downside. For me though, the answer is a lack of liquidity. For the insurance company to guarantee you that 0% floor, they need to be assured that they will have your money for a certain period of time. Should you try to access it early (above the annual 10% free withdrawal that most provide) there is a surrender charge associated with that. That’s why when discussing and planning for annuities, it needs to be very targeted. How long do we have for retirement, how much money do we want to protect versus letting ride in the market and how much outside liquidity do you have should a cash emergency arise.
Like anything else in the financial world, I don’t believe there is a one size fits all solution. As I’ve written many times in the past, if someone shows up with a pre-packaged presentation and doesn’t know anything about you, run for the hills. The newer products being developed in the insurance and annuity space provide a transfer of risk opportunity at zero cost to you. Does that mean everyone needs an annuity? No. Can it provide a great option to satisfy some potential risks in your financial plan? Absolutely.
Please feel free to share this with someone you think may benefit. As always, call me or email me if this blog has brought up additional questions for you.