Before You Buy an Annuity, You Need to Know This!

Are You Being Sold on an AnnuityPurchasing an annuity might be a huge mistake for you! I’m not saying annuities are bad products. In fact, I occasionally recommend fixed index annuities as part of a balanced portfolio to provide retirement income and protection against market swings. I believe annuities can sometimes be a solid choice, depending on a client’s situation.

However, there are some serious considerations you should be aware of before purchasing an annuity. All too often I see people SOLD on them by an advisor that seemingly has no regard for the client’s needs. Safe money is a great catch phrase, but an agent that is in a rush to lock up a client’s capital, may be negligent. A true fiduciary financial advisor would analyze if an annuity might fit in with the entire plan, while consulting on many factors.  Only in such circumstances where such a product helps achieve the overall goal, should they recommend an annuity.

Here are some of the considerations I take into account when I investigate annuities as part of an overall financial plan.

Fees – There are two distinct types of annuities, fixed annuities and variable annuities. In addition, a Fixed Indexed Annuity (FIA) is considered a subclass of the fixed annuity. 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. 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. I will also note that the fees are typically much lower on an indexed annuity than a variable annuity.

Due to fees and uncertainty, I wouldn’t recommend variable annuities in any circumstance. If I am trying to create a guaranteed income stream, a variable annuity does not fit. Therefore, I’ll be focusing on fixed-index annuities in this article.

Purpose – Often I come across people that 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. Every financial vehicle should serve a specific function in achieving an overall financial goal. I would not recommend moving forward with an annuity without a thorough analysis and projection of how this change would affect your 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 this case, 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 could last over 30 years, most retirees are going to need some growth in their investment portfolio over this span. Having adequate growth in retirement is crucial for most to avoid outliving their retirement. It’s important to analyze how an annuity will stand up to inflation, taxation and increasing health-care costs. I agree that protecting money from market-fluctuations and guarantees are attractive, but only as part of a balanced portfolio that often can benefit from market gains. I wouldn’t recommend investing in these financial vehicles without such projections.

The Optimal Annuity – Let’s assume that purchasing an annuity is a great idea. How do you know the annuity you’re being sold on is the best one for your situation? There are many variables when it comes to annuities, having a plethora of attractive features, while often the pitfalls are hazed over. Here are just some of the options to consider:

The Insurance Company – Annuities are not FDIC insured but backed by the strength of issuing company. Although there is a level of protection with the State Insurance Commission, there are limitations. All insurance companies are rated for financial stability. An annuity salesman 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 – Ever 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 so 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. A financial planner can help select such annuity and show financial projections that include all income and wealth.

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? So what’s the right length of an annuity? That depends on retirement goals, and if done outside of a financial plan, it’s guesswork.

All too often people are making an emotional decision when it comes to purchasing annuities. Often, financial advisors will play up the fears of a volatile market, leading to a rash decision. I will agree that as people approach retirement and beyond, they should reduce some of their market exposure and re-allocate investments. And I even agree that often, annuities are a great way to provide retirement income while shielding money from market risk. However, my strong recommendation is to only proceed forward as part of an over-all allocation plan that is based upon carefully calculated projections. Only when making a decision based upon all of the facts and data, can you be sure that it’s the right choice.

If you’ve read this far, chances are you’ve been considering an annuity. It might be a good idea and I applaud you for doing your research before jumping in. Sometimes it makes sense to seek a professional advisor, and this is one of those times.

At McBeath Financial Group we provide guidance when it comes to making important financial moves. We have a financial planning process that can provide real-data projections based on your individual financial situation. Based upon that, we can advise on the optimal amount, if any, to invest in ‘safe-money’ while balancing the overall portfolio. And, if after carefully calculating, an annuity does make sense, we can utilize our advanced software in identifying which one best matches your goals.

Learn More About McBeath Financial Group

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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