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There are many opinions, emotions and ideas about annuities and whether they are an appropriate tool for people or not. In some ways, the quality of annuities may be the most controversial topic in retirement planning, and maybe in all of personal finance. There are many reasons for this, but a common theme running through all of the bad press is a misunderstanding of what annuities are and when they are appropriate choices. Annuities are by no means for everyone, and there have been abuses, but they are a proven option for protecting yourself against the deadly serious problem of outliving your savings. Everyone approaching retirement should consider them objectively. In this short guide, we’ll look at a few common objections to annuities and provide a rebuttal.
Before we dive into the controversies, let’s review what annuities actually are. After all, it’s always good to have an understanding of an asset before you make a decision about its appropriateness. To put it simply, annuities are insurance products that pay streams of income to the holder of the annuity. Annuities are either funded through a series of deposits (called premium payments) or from the deposit of a single lump sum.
Annuities have been in existence since Roman times, if not before, making them far older than stock shares, mutual funds or ETFs. Modern annuities began to be issued in the 1700s in both England and the United States.
There are several types of annuities, but they are mainly grouped by when payments will begin:
Deferred annuities are further distinguished by how interest is earned and credited. There are three basic types:
Each of these annuity types have their own ideal uses, benefits and features.
While annuities have been around for centuries, and for most of that time enjoyed favorable reputations, they have come under increasing attack in recent decades, especially since the 1990s. Although there are many different objections, they fall into three main arguments:
We’ll address these concerns and offer some arguments against them, but it should be said right from the start that annuities are not appropriate for everyone. Much of the problems encountered with annuities stem from a lack of education, either from the consumer or the insurance agent who sold the annuity. This brings up a critical point: It is imperative that people looking to have a secure retirement find a trusted, competent financial professional. If annuities are appropriate for you, they should be used as a tool that’s used as part of your overall retirement plan, and they should be considered long-term tools.
People often object to annuities by saying that they’re endlessly complicated; that they’re hard to understand. For starters, that’s plainly untrue. Immediate annuities are about as simple as you can get: You’re told ahead of time how much income the annuity will pay you. You deposit the premium with the insurance company. You begin receiving income payments. That’s it. Much simpler than understanding options theory or asset allocation methodologies.
It’s true that other kinds of annuities are more complex. However, beauty is in the eye of the beholder, and one person’s complexity is another’s feature-rich Swiss Army knife. In other words, the perceived complexities of annuities are actually opportunities to meet diverse needs in customizable ways.
Because of this, annuities can accomplish multiple purposes within the parameters of one contract. We already mentioned that annuities can pay a stream of income for life. How you receive this income is customizable, though. You can spread the payments out in one of several ways:
Besides these various payment options, how you accumulate funds and earn interest is customizable, too. While traditional annuities paid a fixed rate of interest, newer kinds of annuities known as fixed index annuities offer the opportunity to earn higher rates of interest based on the performance of various investment indexes. These annuities have a multitude of options, but the options exist to help you earn the highest interest possible, thus securing maximum income payments in retirement. In fact, these indexing options can help overcome another common objection to annuities which is that they don’t pay enough interest. With indexing, you can greatly increase the potential interest earnings in an annuity. Best of all, you can gain access to market gains while being protected from market losses. Fixed indexed annuities (unlike variable annuities or any other market-based investment) are guaranteed to protect you from loss of principal. While that might seem complex to some people, it’s a very valuable benefit only available from annuities.
Opponents of annuities often claim that annuities are prohibitively expensive. Like in most of life, there is an element of truth to this. Annuities definitely come with fees, and these fees are higher than you’d pay with an indexed mutual fund. However, when annuities are used in the proper way, much of the fees and charges don’t apply.
Probably the most bothersome fees are “surrender charges.” These charges are imposed when you withdraw money (usually all of your account value, but sometimes they’re imposed on partial withdrawals, too) before a certain period of time, usually 10 years. The surrender charge declines each year until it disappears entirely after year 10.
This kind of fee is not limited to insurance products, though. Certificates of deposit (CDs) usually impose an early withdrawal penalty. If you sell a stock before a dividend is paid, you don’t receive the dividend payments, and some mutual funds impose commissions on you when you redeem or sell your shares.
If you withdraw money during the early years of your annuity contract, you’re going to be penalized, unless the annuity has a free withdrawal available each year. However, doing this is evidence of a misuse of an annuity in the first place. Annuities should be a part of a long-term savings strategy. All too often, it turns out that insurance agents don’t counsel their clients about this. Instead, by working with a seasoned financial professional, you should understand the long-term nature of these financial tools.
If you avoid surrender charges, which you should definitely be able to do if you’re on board with annuities as a long-term strategy, the fees people complain about so much virtually disappear. You might pay a small annual fee, especially with variable annuities, but the amounts are comparable with other investments like mutual funds.
A last point to keep in mind is that an annuity can guarantee a stream of income for the rest of your life, no matter how long you live. Or, how long you and your spouse live if you choose a joint and survivor annuity. That’s a very big promise – and one that can give you a great deal of financial peace. It makes sense that there would be some fees associated with such a powerful product.
This argument states that you have to give up your nest egg to the insurance company, and you can’t get it back or do anything “productive” with it. Like the other myths, there’s an element of truth to this (we just talked about how annuities should be used as part of a long-term strategy). However, thinking about annuities like this is not the best way to get a clear picture of how they work and what they can do for your retirement.
It is true that you can convert your nest egg into a stream of guaranteed income for life when you purchase an annuity. It’s also true that when you do this, you get payments for the rest of your life (and your spouse’s life if you elect that option). When you pass away, the money is used up; there’s no account balance to pass on to your heirs. And, this seems uncomfortable somehow.
However, you should keep in mind that annuities aren’t necessarily the tool to use for passing on an inheritance – they’re a tool you can use to receive guaranteed income for the rest of your life, no matter how long you live.
It’s better to think of annuities as cash that’s locked away for you, dedicated solely to paying you income every month in your retirement. In other words, when you deposit your nest egg into an annuity, you’re funding monthly income to 70-year-old you, 75-year-old you, 85-year-old you, even 99-year-old you, if you should live that long. In an ideal world, you’d spend your nest egg slowly over your retirement if you kept all of your nest egg in cash, or some other “conservative” investment. If you’d spent the last penny of your savings on the exact day that you passed away, you’d probably feel like you put your nest egg to good use. This is exactly what annuities do, except that they contain an ironclad promise from the insurance company; no matter what the stock market does, no matter what bonds actually pay, you get your monthly income; no questions asked.
If asset preservation or passing on a substantial inheritance to your heirs is important to you, there are other vehicles than can be used to attain this goal. As part of a comprehensive estate plan, you might consider using:
You can use these products to achieve your estate planning goals. Let annuities meet your personal income needs and goals. That’s what they were designed for.
Remember, annuities don’t promise to help you maximize every single penny, but they do help you achieve the goal of living the best life possible, with the least financial stress possible. If you rely on a portfolio of “safe” investments, or if you leave some money in the stock market to try to eke out more income, what kind of stress does that put on you? What happens if those investments don’t pan out, or the market crashes? With annuities, none of those scenarios impact you at all. Rather than thinking about annuities tying your money up, think of annuities as products that not only pay income for life, but:
When you think about annuities this way, you’ll see that there is no other product available that can do what they do.
Despite some bad press, annuities are an excellent tool to help you live a quality retirement lifestyle. Annuities solve a number of problems facing retirees. Not only do they solve the crucial issue of outliving your money, annuities can also help you provide income for the life of your spouse, too, even using your IRA or 401(k). In short, annuities can help you accomplish several goals at once, and with much less stress than if you were relying on a portfolio of stocks, bonds and mutual funds to provide your retirement income.
Remember, when you use annuities to fund your retirement, it takes a sound plan. Working with an experienced financial professional is a critical component. The detractors of annuities do have some valid points, especially regarding charges and fees. Make sure that you’re committed to using annuities over the long haul, and you can avoid the pain of surrender charges. Instead, work with your financial professional, make a sound plan, revisit it as you get closer to retirement and stay the course. This is a recipe for a successful retirement.
Alliance America is an insurance and financial services company dedicated to the art of personal financial planning. Our financial professionals can assist you in maximizing your retirement resources and achieving your future goals. We have access to an array of products and services, all focused on helping you enjoy the retirement lifestyle you want and deserve. You can request a no-cost, no-obligation consultation by calling (833) 219-6884 today.
