You can spend all day and night reading articles espousing the goods and the bads about annuities. It’s for good reason, since there are many types of annuities, and it’s difficult to filter out all the fine print in many of them to understand what you are actually buying.
In our research, most of the data has us leaning towards annuities being a bad investment for the majority of people, but let’s take a look at some of the varying opinions, and try to understand who buys annuities, and the reasoning behind those purchases.
Annuities Are Insurance Products
This is a good principal to start off with, and something that should be kept in mind as you think about annuities. When you purchase an annuity, you are doing it to reduce your risk. In most cases to guarantee some form of income over a set period of time.
Annuities are an insurance product, and just like with life insurance which helps with cash if you pass away, an annuity can help reduce the risk that you will find yourself without an income stream in retirement.
If you’re looking for investment opportunities, then move on and look elsewhere (i.e. mutual funds, and ETF’s). But if you are looking to ensure cash flow for a period of time after retirement, an annuity is something to look at.
Some annuities do allocate some of your money to investment products within the insurance product. But if that’s your goal, there are more effective ways to invest.
Who Buys Annuities
According to a report by the National Association for Fixed Annuities, over 95 percent of annuities are sold to people over the age of 45. That makes a lot of sense because these are typically products with lower yields intended to bring security as you get closer to retirement.
To be more specific, according to an interview by thinkadvisor.com with the assistant vice president of LIMRA, Jafor Iqbal, he indicates they “see most individuals buying annuties starting at age 55, with the average annuity buyer at age 60. These individuals are at the height of their earnings – and their assets. They’ve accumulated a lot of assets for retirement, and typically, annuities are purchased as part of retirement income planning.”
Pros Of Buying Annuities
- Guaranteed income – The main reason to purchase an annuity is to provide some type of guaranteed income. You can achieve this with different types of annuities, but typically you will purchase one that immediately starts paying out, or a deferred annuity with income riders. Be careful to understand if you are purchasing an annuity that will pay out to your beneficiaries after your death. Some annuities stop payments immediately with no additional benefit.
- A form of life insurance – Let’s be clear from the beginning that an annuity cannot directly replace a life insurance policy. In the event you are not eligible for life insurance (or it’s too expesnive), then an annuity can be used as a tool to leave beneficiaries some monetary value. As with all annuities it’s important to shop around to find the product that best meets your needs. In this case you need a death benefit rider, or an annuity that continues to pay out to a beneficiary after your death. Be sure to have a qualified advisor help find the right annuity.
- Long Term Care Protection – As with life insurance, an annuity is not going to completely replace a good LTC policy, but it can help to offset some of the same costs. You can purchase a long term care annuity where expenses will be paid from your annuities accumulated value up to some maximum value. The amount of long term care expense that is covered is obviously governed by the premiums you pay on the policy. Again, please be sure to shop around to find the best product to suit your needs at the right price.
Why Not Buy An Annuity
- You don’t need income – Because annuities are typically purchased to offset any risk that you may outlive your current savings, if that is not a concern for you, then an annuity is probably not the right product. As long as you have a trusted financial advisor, and a robust financial plan that shows your current funds and investments will last well beyond your potential lifespan, then leave annuities alone.
- You want investment growth – Annuities are simply not growth products, and that’s not what they were intended to be. If you find yourself looking for investment opportunities that will provide decent growth returns, then look elsewhere. Because of the limited choice of investment mix on annuities, and the typically high fees, there is almost always a better product if you are looking to grow your money.
- Your financial risk is low – As with most insurance products, at the end of the day if you don’t need to transfer risk of some sort, then annuities are probably not for you. Check out Stan Haithcock’s article on MarketWatch, No all-in-one annuity cures; take a ‘PILL’ to get a more detailed take on the types of risks you are looking to manage with an annuity. His “PILL” acronym standing for Principal Protection, Income for life, Income For Life, and Long Term Care, is a good starting point when considering the types of risk you are trying to address with an annuity. If these areas of your financial plan have a low risk profile as determined by you and your financial advisor, then an annuity is probably not the product for you.
Different Types of Annuities
There are four basic types of annuities, deferred, immediate, fixed, and variable.
- Immediate Annuity – An immediate annuity begins to pay out as soon as you make the initial investment and are often purchased by people who are coming up on, or already in retirement.
- Deferred Annuity – A deferred annuity is one that does not make payments immediately, but otherwise is very similar to an immediate annuity. You pay some amount up front or over time, and in return start to receive paymnets at some designated time in the future.
- Fixed Annuity – The value of a fixed annuity increases over time based on the stated returns in the contract. These annuities typically offer a higher interest rate, and more flexibility on when you can start receiving payments, but also can have high penalties in the event you want to withdraw your funds early. So be careful before purchasing a fixed annuity that may tie up cash for a long period of time.
- Variable Annuity – A variable annuity is the closest you will get to having your annuity look like and investment as it is typically tied to a certain market index. While it gives the greatest ability for your money to grow with market success, it that’s your goal, there are better options out there than a variable annuity.
Final Thoughts On Buying Annuities
At the end of the day, you need to spend a lot of time thinking through whether an annuity is the right type of product for you. First and foremost, sit down with a trusted financial adviser and/or insurance expert who can walk you through how these products might fit into a retirement plan.
The reality is that Annuities are not necessarily a good product for the majority of people, but they can play a role for some. Just ensure you are are well informed about the specifics of the annuity you purchase, and that the benefits out-weight the costs from your perspective.