Before You Buy an Annuity, You Need to Know This!
Many people purchase annuities as a way to provide income during retirement. An annuity is a contract between you and an insurance company that is designed to meet retirement and other long-range goals. You make a lump-sum payment or series of payments and in return, the insurer agrees to make periodic payments to you beginning immediately or at some future date.
However, purchasing an annuity might be a huge mistake!
Although annuities can sometimes be a solid choice, there are some serious considerations you should be aware of. All too often I see people sold on them by an advisor who hasn’t analyzed all the factors to determine if an annuity fits in with the comprehensive plan and helps achieve the overall financial goals.
Considerations For Retirement Plans With Annuities
Fees – There are two distinct types of annuities, fixed and variable. Variable annuities can come with an assortment of fees that are often less than transparent. The account values fluctuate with the market and income payments may vary based upon the performance of subaccounts. Due to fees and uncertainty, I don’t recommend variable annuities. With fixed index annuities, typically the only fees would be in the form of riders. These riders are optional, such as a guaranteed income rider which, when chosen carefully, can help meet retirement income goals. This article is focused on fixed-index annuities.
Purpose – Every financial vehicle should serve a specific function in achieving an overall financial goal. I often come across people who have several annuities sold to them by various advisors through the years. They often feel frustrated that they have money everywhere without a cohesive plan. This is because they were sold on a product, not a plan for goal achievement. I would only recommend moving forward with an annuity after a thorough analysis and projection of how it would affect the entire financial picture, as well as comparing it to other options.
Liquidity – Having access to an adequate portion of your income is important for emergencies, opportunities or even to be able to enjoy what you’ve earned. Annuities are contracts that ‘lock-up’ the bulk of that investment for years, with stiff penalties for surrendering. When considering allocating funds to an annuity, realize that future market and interest environments could make the policy look less attractive in the future. However, future market considerations are less relevant if it fits within a plan for income, safety, tax or estate planning. In these cases, the vehicle has a specific purpose it was designed to fulfill.
Growth – While a fixed index annuity can protect from market drops, they typically will not share in the full upside of the market. The ‘spread’ or ‘cap’ can limit growth on the annuity. While some annuities might return 5+% annually, the average annual S&P 500 growth has been over 10% since inception. With retirements that may last over 30 years, most retirees are going to need some growth in their investment portfolio to avoid out-living their income. It’s important to analyze how an annuity will stand up to inflation, taxation and increasing health-care costs. Protecting money from market fluctuations and guarantees are attractive, but only as part of a balanced portfolio that can also benefit from market gains.
Options to Consider Before Committing to an Annuity
Let’s assume that purchasing an annuity is a good idea. There are many variables and the annuities may have a plethora of attractive features, but the pitfalls are often hazed over. How do you know the annuity you’re being sold on is the best one for your situation? Here are just some of the options to consider:
The Insurance Company – Annuities are not FDIC insured but are backed by the strength of the issuing company. All insurance companies are rated for financial stability. A person selling annuities is not required to only sell annuities from highly rated companies. It’s my policy to only represent the largest carriers with the highest and most stable ratings.
Annuity Selection – Every insurance carrier will have an assortment of annuities available. Variations between annuities include bonuses, how growth is calculated, index options, income options, death benefit options, long-term care allowances, surrender charges and much more. Each of these factors combined can make a real impact on the investment and your quality of life in retirement. That’s why it’s important to choose an annuity that aligns with your financial goals.
Annuity Contract Length – The commitment can range in length from one year up to ten years or more, with most common being 10 years. Whereas returns on a one-year product aren’t strong, committing funds for a lengthy period may mean passing up opportunities or needed liquidity along the way. For example, what happens if inflation sky-rockets and your 10-year annuity isn’t keeping pace with inflation? The right length of an annuity depends on retirement goals. If done outside of a comprehensive financial plan, it’s guesswork.
Many people make emotional decisions about annuities, swayed by fears of market volatility. Annuities can offer a shield from market risks, which may be wise if you are nearing retirement. But it’s crucial to make informed decisions. Be sure that any choice is grounded in a comprehensive allocation plan backed by thorough projections to ensure its appropriateness.
Including annuities as part of your financial strategy is a decision that can have long-lasting impacts on your financial well-being, therefore, thorough research and consideration is imperative. Given the complexities involved in choosing the right annuity, consulting with a financial planner who can provide real-data projections specific to your financial situation is a solid strategy to help determine if an annuity is an appropriate option for YOU!
Krista McBeath is an Investment Advisor, Chartered Financial Consultant, a Licensed Insurance Advisor, a Fiduciary, and an experienced tax advisor who specializes in financial planning, investments, and insurance.
She utilizes advanced tools for in-depth calculations that analyze tax and retirement scenarios to help their clients avoid a future tax time-bomb. Whether this means enjoying more of your hard-earned money in retirement or passing along assets to loved ones with less tax burden, planning makes the difference.
Her new book, The Generational Wealth System outlines a holistic approach to preserving lifestyle, wealth and legacy.
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