Why Some People Like Annuities
Annuities are considered an enormous and confusing topic. If you’ve searched “annuities” on the internet, you know that everyone has something to say about the topic. With the wild stock market swings in recent years, most people are looking for alternatives. As of right now, annuities are the best answer for a lot of people. At the same time, annuities are widely misused, which results in heated conversations about the product.
It doesn’t matter who you are or where you live, everyone wants to grow their money and can’t afford to lose it. Fixed indexed annuities can be the answer to both of those issues. Notice I said indexed annuity, not fixed annuity or variable annuity. There is a difference, but that’s a discussion for another article. If you’re interested, there’s plenty to read out there.
Just as there is no perfect financial tool, fixed indexed annuities are not for everyone. People should evaluate all of their financial options. This includes looking at planning without the use of annuities. People really want to be good shoppers, meaning they want to understand how to evaluate all possible options for their retirement goals. Here are a few reasons why some of my clients have grabbed ahold of the fixed indexed annuity craze.
1. The person is emotionally exhausted from the Wall Street roller coaster.
Unfortunately, annuities are becoming the mainstream message as a stock market alternative. This is neither good nor bad, but it does lead people to make emotional decisions about purchasing an annuity, which could lead them to leaving good ideas off the table, such as staying partially invested during retirement.
Let me be clear: I’m objectively advocating a partial jump into annuities for some people.
Fixed indexed annuities are not invested in securities, but the product does offer a crediting method that is tracked by a stock market index.
Making the decision to allocate assets to an annuity should be based on logic and math. Unfortunately, for the most part, decisions, especially around this topic, are never made by logic and math. The fear and pain of loss are driving the huge increase surrounding annuities.
So, why should you buy an annuity?
From an academic perspective, fixed indexed annuities could make a good non-correlated asset. In other words, it’s like owning a more diversified portfolio that’s not directly tied to the real estate and equities cycles. Imagine it like two separate lakes: If one lake gets infected, it’s not going to pollute the other.
2. The person values predictable and steady income for their basic needs.
Would you rather: A) shoot for the moon without protection, or B) cover your basic expenses with guarantees so that if plan A fails, you won’t end up on your kid’s front porch with your hat in your hand.
Annuities could allow a person to buy enough peace of mind so they can act like they’re 35 again. These people aren’t worried about losing the farm, so they tend to be more aggressive with their invested money.
A new study shows that most retirees continue to grow their nest egg halfway into retirement because they are afraid of outliving their assets. For some people, it really helps to know they aren’t in dire need of the invested portions of their plan because their expenses have been met due in part to owning their annuity.
3. They want simplicity. They want to set it and forget it.
Many people are asking, “How do I turn my 401(k) into a paycheck replacement for the rest of my life?” Often, they feel that annuities are the answer; however, annuities are not the answer to everything. So here are some instances of when to use annuities and when not to:
As a planner, I SHOULD advocate the use of fixed indexed annuities in an income-producing retirement plan:
- When annuities can be used to close the needed income gap. This gap is usually measured by Social Security and pension income subtracted from basic expenses. Be sure to remember that annuities should only be used in instances where there is plenty of liquidity and if the rates make sense.
- When considering how much time is left until the individual’s retirement. Time is of the essence when determining if an annuity is the best option for a client. Currently, immediate annuity rates are low, and deferring the annuity a few years usually gets a better result. Still, hesitating on the decision to purchase an annuity can also be a problem. I’ll show you why in a minute.
- When the client is extremely risk averse. Clients who are seeking protected gains with minimal risk should be considering annuities where their money can grow without risk.
I SHOULD NOT recommend the use of annuities in an income-producing retirement plan:
- When the client has plenty of stable income or most of their basic expense needs are met.
- When the client has little savings for emergency needs over the years. Annuities have limited liquidity, usually 10% per year after the first year. Early withdrawal penalties for annuities can be steep, and retirees should seek to avoid withdrawing this money if they want to avoid penalties.
- When clients don’t trust insurance companies. Hey, I trust most positively rated insurance companies, but some people don’t.
- When a client does not understand the complexity of the annuity product. This can be a big problem and can open the agent or advisor up to a lawsuit. It’s really important that the client understands the (dozen or so!) nuances of annuities. Make sure their eyes are wide open and they know what they’re getting into.
- When there is not enough time before income need. Clients need to decide if they’ll need an annuity 2 to 10+ years before they need to take income from that annuity; otherwise, they can get stuck with current money rates. If they get involved in the planning process at least a few years before retirement, then they have the opportunity to shop better rates.
Indexed annuities are like cooking in a Crock-Pot: The longer they cook, the better they get. The longer you own it before you take income, the better, thanks to interest and mortality credits.
Mortality credits are a scientific way of saying the older you are before you draw money out, more money will be available to you! The older you are before taking lifetime income, the higher the percentage of the contractual promise. In my opinion, this credit is what makes owning the right annuity a good choice. Annuities can produce stable income like no other tool out there right now.
However, you still need to proceed with caution before adding an annuity as part of your retirement income-generating plan. I would advise that you not only need to know everything about that product but should also consider how this decision will affect the rest of your plan. Don’t make decisions isolated from the rest of the moving parts of their financial picture. I talk more about that on my website www.stonebridgetx.com, where I lay out a method you can use to make this decision really easy.
 Ref. Michael Kitces, “Why Most Retirees Will Never Draw Down Their Retirement Portfolio,” https://www.kitces.com/blog/consumption-gap-in-retirement-why-most-retirees-will-never-spend-down-their-portfolio/
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