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I Hate Annuities!

I Hate Annuities!

April 21, 2017

I hate annuities!

Well, I really don’t. But I am amazed at how many people do. I heard this phrase just last week from one of our clients. I hear it all the time on the radio, on tv, from people who work in the financial services industry. The things is, I’m not sure why there is such universal hatred for a financial product. After all, that’s all an annuity is – a product that is manufactured by insurance companies. A complex product, by the way.

You see, there are fixed annuities, indexed annuities, variable annuities, deferred annuities, immediate annuities, single premium annuities, multiple premium annuities, longevity annuities, etc. Then there are all of the various terms associated with annuities: accumulation units, surrender period, accumulation phase, guaranteed withdrawal base, market value adjustment, free withdrawal, participation rates, rider, period certain, etc., etc., etc. And there are the expenses. Or are there? Well, it depends on the type of product: there can be mortality and expense fees, rider charges, administrative expenses and expenses of underlying investments. Or expenses can be built into the product so that you never see them - kind of like they are with a certificate of deposit at your local bank. *

I believe annuities are the most complicated retail financial product today. Because of this complexity, many people don’t truly understand them. People who purchase them don’t understand them, people who criticize them down don’t understand them, media personalities don’t understand them, and yes, the majority of people who work in the financial services industry don’t understand them either. And, I think that’s one reason some people “hate” them. So, how in the world are you, the client, supposed to wrap your arms around annuities and whether or not they should be part of your financial plan?

Maybe it would be helpful to understand what an annuity is. An annuity is issued by an insurance company. Insurance companies specialize in assuming risk for people who can’t afford or don’t want to assume risk. For example, you may have a homeowner’s insurance policy that will pay you a benefit to rebuild your home should it burn down. The insurance company accepts premiums from large numbers of households and “pools the risk” of claims. The idea is for the insurance company to collect more in premiums than they pay out in claims. If they do, they remain profitable and can pay your claim, should you have one. And, that is all you care about, right? Collecting benefits should you qualify?

As it relates to annuities, the risk assumed by the insurance company is longevity risk. The risk that you will live a long life. The promise is that the insurance company will pay income no matter how long you live. It’s that easy.

But, what about the ads on the radio proclaiming that you need an annuity to “protect you from the Wall Street casino!?” The implication is that the annuity will protect you if the value of your investments catastrophically fall. Ok, I’ll bite. That might be a secondary risk that the insurance company assumes. But, for most people, this secondary risk might only matter if you live a long life. So the main thing you need to remember is this: the primary job of an annuity is to transfer the risk of you outliving your money – to an insurance company.

As life expectancies are increasing, it seems to me that this is the biggest risk most us face in retirement. Oh sure, we planners talk about the risks of high inflation, high taxes, market volatility and sequence of returns. But, for most of us, these risks are a non-issue if we don’t live very long.

So how do you decide if an annuity should be part of your retirement income plan? Easy. If you are concerned about outliving your money and would like to have an insurance company assume some of this risk, then you might want to consider some type of annuity.

But, what about the commissions that annuities pay to advisors who place them? Shouldn’t we shy away from annuities because someone is receiving a commission? Maybe that’s another reason some people “hate” them? Even though most of us already work with people who earn commissions when they do business with us? Real estate agents? Car sales people? Your heating and air conditioning firm? Your property and casualty insurance agent? Annuities have a wide range of commission structures depending on the type of product placed. Some annuities warrant a higher commission to the advisor who places them. Why? Because they require additional licensing, additional training, additional paperwork, additional compliance and additional complexity.

Rather than commissions, I think it’s more important to focus on making sure your advisor has your best interest at heart. And, at the end of the day, it is your responsibility to make sure you want an annuity as part of your financial plan. As you are thinking about annuities, I would consider taking the following steps:

  1. Consider whether or not you would like an insurance company to assume some of your longevity risk.
  2. Hire a CERTIFIED FINANCIAL PLANNERTM to educate you regarding the various annuity options.
  3. Decide on a type of annuity that is best for you.
  4. Hire an experienced annuity advisor to help you find the most suitable product for your goals.
  5. Ask questions until you understand what you are buying. Repeat.

Annuities are nothing more than financial tools that are appropriate for some people and not for others. Are they something you should hate? Not at all! In fact, if you start with the suggestion that all annuities are bad, your mind will probably be closed to a product that, in your advanced years, you may indeed wish you had purchased when you were younger. Try to evaluate annuity ownership based on your goals, your existing retirement income sources and what provides you with financial confidence. As always, try to tune out the noise from people whose only goal is to try to sell you something. Plan, invest and protect.

After all, this is about your Second Half Strategy!

*CD’s are FDIC insured and offer a fixed rate of return if held to maturity. Annuities are not FDIC insured.

Annuities are suitable for long-term investing, such as retirement investing. Gain from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value.

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board's initial and ongoing certification requirements.