man selling annuity contract

Is An Annuity Right for Me?

No doubt you have heard of annuities. Maybe you have even kicked the tires on an annuity before, wondering about the downside to something that sounds so good.

If you are curious about what annuities are, if you are unsure if they make sense for you, and especially if an insurance agent who isn’t a Certified Financial Planner™ or fiduciary is pressuring you to buy one…pump the brakes.

Let’s think this through together.

Investing makes so much sense in theory but then, in practice, we have to pick from a supermarket of investment products to build a portfolio. Stocks, bonds, real estate, commodities, and cash are the basics. But Wall Street has been packaging and selling these basics for decades in structured products with disclosures longer than a Stephen King novel. If you are feeling speculative or fearful, there is a product for you, probably at a steep cost. Annuities, with all their complexity, are products that offer the most seductive of benefits during a down market: Safety.

The idea of adding safety in the last few months may seem attractive. But oftentimes safety is sold, not bought. There are financial advisory businesses built around selling high-commission annuities and insurance products to people out of fear. You have seen their ads, heard their paid-for radio shows, and received their invitations to lunch-and-learns. We are here today to start a conversation about annuities that is authentic, not slick. Let’s put the product in the context of financial planning, where it belongs. We will start in simple terms:

What is an annuity?

An annuity is a contract between a person and an insurance company. A guaranteed income stream is provided in return for turning over a single payment or series of payments. They come in different forms like fixed, indexed, or variable. Annuities provide security, especially for those people who know they have a defined income need. The problem is, we all feel the need for security sometimes and there is always someone willing to sell it to us, regardless of the cost.

The Case for an Annuity

There are times when an annuity could be appropriate. For example, it might make sense to use a portion of your savings to fund an annuity that turns a lump sum into a guaranteed income stream to cover living expenses. It would be like creating your own pension and would help manage the risk of outliving your money. Choosing to go this route would only make sense having gone through a process of understanding a family’s expenses and what could be the trade-offs with such a strategy.

The Case Against an Annuity

There are no free lunches. A guaranteed income stream, even if it makes all the sense in the world, will cost something more than the alternative. What would you be giving up to have a guarantee? Here are some of the less desirable features of annuities:

  • High Expenses: Annuities are insurance products which means that the insurance company is charging you to take a risk on your behalf. Mortality and expense fees, sub-account fees, and rider fees can add up to over 3% annually.
  • Locking in Losses: If you sell out of your investments at a loss to purchase an annuity, you may be limiting your ability to regain your portfolio value. You may have some appreciation in an annuity, but it will be a fraction of what the stock market will earn if returns are positive. The insurance company is investing to capture those gains and deliver a lower, guaranteed rate of return to you, the investor.
  • Flexibility: This may be the most valuable of all. In an annuity, your money is locked up. Either you turn it over permanently or you might have to pay a surrender charge to get your investment back for as long as 10 years. It’s important to think about how much you want to commit today and limit your options down the road.

“What Did I Just Buy?”

Even in the best case when an annuity does it’s job in a client portfolio, there are always lingering questions about what it is, how it is performing, and how it should be used. Here is an example of a common confusing trait about some popular variable annuities:

If you purchase an annuity with a guaranteed income rider, you may have two different numbers to track:

  1. Your guaranteed income amount.
  2. Your account balance.

You guaranteed income amount may be growing at a predetermined rate of 6% per year and then, at some point in the future, you can turn on an income stream that is a percentage of this higher value. But you are not entitled to that higher amount as a lump sum should you choose to take your money out of the annuity.

Your lump sum amount, if you want to cash out, is the account value. The account value may not have any guarantees and may be invested in the stock market and subject to the same ups and downs as any other investment. Except in this case, there are higher expenses and penalties for early withdrawals.

If you are investing for income from a piece of your portfolio, this can work out because that lifetime guarantee is valuable. However, if there is a chance that you need the principal, an annuity like this is an expensive way to invest.

The Real Issue

There are factual pros and cons to annuities that are worth debating. The truth is that annuities get a bad name because of the way this product gets to market. Annuities are often marketed and sold based on investor fear and promises of security. Emotional story-selling takes the reins from what might already be a solid financial plan.

We have encountered proposals from insurance-based advisors who assured their prospects that by purchasing an annuity (with most of their liquid net worth) they would gain access to a team of sophisticated financial planners. Does that seem a little backwards?

“Buy this product and our experts will then tell you if you need it.”

Their Plan

  1. Sell an Annuity
  2. Introduce an Advisor
  3. Create a plan
  4. Walk away

Fiduciary Plan

  1. Introduce a Certified Financial Planner™
  2. Create a plan
  3. Select the right investments
  4. Execute and monitor the plan

Placing the product ahead of the plan is a legacy of Wall Street’s sales culture. It is why annuities are controversial among fiduciary advisors and clients alike. Follow this sequence and you will lower the odds of being sold something that doesn’t fit with your plan.

A fiduciary advisor can help to determine what if any role an annuity might play in your plan. He or she will also be there to explain, assess, and implement such a product. There is so much more to discuss than I can cover here. If you are evaluating an annuity and have questions feel free to reach out to me at dmorton@mortonbrownfw.com.

Before investing in an annuity , consider the investment objectives, risks, charges, and expenses of the annuity and its investment options. Contact the product sponsor  for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. Guarantees apply to certain insurance and annuity products and are subject to product terms, exclusions and limitations and the insurer’s claims paying ability and financial strength. If you are buying a variable annuity to fund a qualified retirement plan or IRA, you should do so for the variable annuity’s features and benefits other than tax deferral. In such cases, tax deferral is not an additional benefit. Investing in a variable annuity involves risk of loss – investment returns and contract value are not guaranteed and will fluctuate. Deferred Income Annuity contracts are irrevocable, have no cash surrender value and no withdrawals are permitted prior to the income start date.