Annuities – The Good, Bad and Ugly

Question:  Does an annuity make sense for a retiree?

Answer:  If you use it properly!  If it serves a specific purpose to help you have a better retirement, then yes, it makes sense.  Here’s the scoop on the right annuity for your retirement income planning.

The RIGHT Annuity

This is where the good, bad and ugly can be defined.  Have you ever seen the guy who spends millions on the ad:  “I Hate Annuities…”?  Well, he’s right, we all hate the annuity he’s talking about. So let’s talk about the four types of annuities and separate the good from the bad and ugly.

Annuity 1:  Single Premium Immediate Annuity:  SPIA

Hand ALL your chips over to the insurance company and receive income back each month for the rest of your life!  Doesn’t sound too bad but what if you die early?  With a single life, you may not even receive your entire premium back.  If you choose a period certain, say 10 years, the amount of gain is similar to a 5 year CD…not very exciting.  Talk to me when interest rates are back to 6 – 7%.  So with interest rates low and life expectancy long, the usefulness of this annuity is very specific. I recently helped an 82 year old who was running short on assets but needed cash flow, and she was able to generate nearly 12% cash flow from her investment that will last for her lifetime.  She was comfortable knowing she had a 9 year break-even, because beneficial interests were not a concern for this chunk of her money.

Annuity 2:  Fixed Rate – Multi Year Guarantee Annuity (MYGA)

It’s easy:  Think CD!  That’s right.  Like a Certificate of Deposit from your bank, this type of annuity guarantees a specific rate of interest for a specific period of time.  Other than the surrender charge ( like an early withdrawal penalty) there are usually no other charges. Instead of a bank, you place your money in a MYGA and sit back and count your earnings.  Will you get rich?  Probably not! But at least you will earn more than a similar term CD.  MYGA’s are issued for terms of 1 through 10 years.  One HUGE difference between CD’s and MYGA’s is tax treatment.  MYGA’s are tax deferred and CD interest is taxed as ordinary income.  Is this a benefit?  Maybe.  My opinion is that tax deferred is “tax control”.  You control when and how much you pay tax on.  Maybe you don’t need any withdrawals for 5 straight years!  Great.  All your interest for that period is not taxable. But then you are taxed on the amount you withdraw…and that may only be portion of the total interest you’ve earned.  Ah, but all good things come to an end (so they say) and tax deferral is no different.  Eventually you or someone else will need to pay the taxes owed on interest deferred.  I just like the element of control as to when, why and how.  You may too!

Annuity 3:  The Variable Annuity

“I hate annuities and you should too”, says Ken Fisher in his enormous ad campaign.  What is he referring to?  I’m sure he hates ’em all because none of them are a stock portfolio (where he makes his money), but his literature really focuses on VA’s.  Why?  Imagine you purchased a mutual fund portfolio then placed it inside an “insurance product” wrapper…Voila! You have a VA.  Sounds harmless, but the fees…fees for death, fees for life, fees for income, fees for investment performance, fees for cashing out, fees for buying it…WOW…that’s a lot of fees. The simple question is:  Could you replicate this product without the insurance company and all the fees?  Answer: Not entirely, but you have a fighting chance!

Annuity 4:  The Hybrid Fixed Indexed Annuity – FIA

The best thing since sliced bread?  NO.  Go buy one now?  NO.  A great retirement income planning vehicle?  Yes.  Here’s the skinny according to me.  It provides a nice basket of benefits and you’re not giving something up to own one.  If the “math” as just described makes sense then you may want to consider one.  The FIA blends the best attributes of all the other annuities into one package.

Can generate income.
If you purchase a rider, which usually has a fee of about 1 – 1.5%, you can obtain a rider which will guarantee an income you cannot outlive.  There are many, many variations of this rider and you will need to choose carefully.  This rider is called GLWB.  It has two functions:

1.  Accumulation of an income benefit base.
This is NOT a cash value, but rather a figure that will be the base of your income amount.  This is usually a guaranteed accumulation value which can make it very attractive for those postponing income for the future.

2. Distribution of the income base at a guaranteed rate.
Income will be based on the age you decide to take it and once again, there are many variations on income strategies.  The final takeaway is that once you begin to take income it will last for your lifetime or your joint live’s if you elect a joint income payout (which will usually be a lower income figure).

Safety and Guarantees

The most important takeaway is “guarantees relies on the strength and claims paying ability of the underlying insurance company”.  Needless to say, it is important to select a highly rated company to do business with. This should be no problem because there are many highly rated company’s who enjoy “investment grade” ratings and have very attractive solutions.
These products will provide a contractual guarantee of the principal, interest and income backed by the company.  As such, a market decline will not decrease the value of your account.  This is a critical benefit for a client interested in a safe place to park some of their retirement assets.