Annuities are the curse word of the financial industry. Because of decades of bad selling practices, annuities have earned their bad reputation as “too good go be true” products that aren’t what they were pitched to be by the typically aggressive annuity agent.
This negative stigma is unfortunate because annuities have their appropriate place in a lot of portfolios if you fully understand how they work, and how they should be allocated to compliment your current holdings. The past is the past, so let’s take a look at the good, the bad, and the truth when it comes to annuities.
Annuities should not be related in any way to Wall Street
Let me make this very clear, annuities should not be considered for the growth portion of your portfolio. Yes, I said it…..and it is factually true. Even though the vast majority of annuities sold today are variable annuities, most people that own those contracts have not realized the dream that was sold to them. The average annual fee of variable annuities is around 3%, and when you add benefits or riders to the policies, most contracts limit your investment choices. This is a prime example of the need to live in Annuity Realityville, because there is no “too good to be true” annuity product out there. The best variable annuity on the planet is a no load, no fee offering that allows you to take advantage of tax deferred growth in a non-IRA account. However, even those no load variable annuities have limited choices, but are as good as it gets in this category.
To continue on the theme of annuities having nothing to do with Wall Street, the newly hyped indexed annuity (sometime inappropriately referred to as “hybrids”) was originally designed to compete with CD’s, not the stock market. Yes, CD’s! Regardless of this actual product design fact, most agents still mistakenly connect indexed annuities to stock market returns, which only leads to client dissatisfaction when the contractual realities of the policy always and eventually reveal themselves.
Indexed annuities are fantastic products when you realize how they work, and your return expectations are in line with the realities of the product design. The bottom line with indexed annuities is that you will never lose your principal, and you have the opportunity to outperform CD returns. That’s an acceptable benefit package to most rational people looking to protect their money. In addition, you can add income or death benefit riders (attached benefits) to the policies to achieve other specific goals.
Annuities transfer risk
Most annuities are used to solve for “longevity risk”, which is a fancy way of saying that you will not outlive your money. Whether it’s an immediate annuity to solve for income right now, or income riders or deferred income annuities for lifetime income starting at a future date, these strategies allow you to “transfer the risk” of outliving your money to the annuity carrier. That’s a good thing, and annuities are the only product on the planet that can offer that specific type of risk transfer benefit.
So you need to ask yourself…..how much risk are you willing to shoulder? and how much risk are you willing to transfer? Once you figure out how much risk you are looking to transfer, then you need to pinpoint what exact goal you want the annuity to contractually solve for. Principal protection? Lifetime Income? Legacy? Long Term Care? In essence, ask yourself what you want the money to do, and then see if an annuity can contractually solve for that specific need. Annuity planning is really that simple.
An easy to remember acronym that I came up with to see if you even need to consider an annuity is the word P.I.L.L.
P stands for Principal Protection
I stands for Income for Life
L stands for Legacy (i.e. leaving money to your beneficiaries)
L stands for Long Term Care or Confinement Care
If you don’t need to contractually solve for any of the P.I.L.L. items above, then you probably don’t need an annuity. It’s really that simple. Notice that there is no “G” for growth because, in my opinion, annuities should be primarily owned for their contractual guarantees. The annuity world eagerly defers the entire growth category to our friends on Wall Street who live in the world of risk. Always remember that annuities transfer the risk.
So when it comes to annuities, drop all of your preconceived notions and “what you’ve heard” about them. Annuities can be fantastic products if place appropriately within a portfolio, and if all of the guarantees and limitations are fully understood. Take your time and decide what you want the annuity to solve for, and if the contractual guarantees can cover that base for you. There’s no urgency, so be as thorough as needed and learn all of the details before signing that application.
*If you have a question for Stan The Annuity Man, please send your question to firstname.lastname@example.org. He will answer all questions directly, and might include yours in his next Annuity123 “Ask Stan The Annuity Man” blog.
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