Are Annuities Good or Bad?
Is an annuity right for you?
There has been a debate going on for some time abut whether annuities are good or bad. The answer is not that easy. The fact is they are good for some and not for others. The question of whether they are good for any individual, his family or retirement is dependent upon their circumstance and the type of annuity. Those circumstances can vary dramatically.
So lets talk about just a few of those circumstances and the differences they make. What if a person or a couple are in need of a guaranteed income and cant take the risk of losing that income due to market fluctuations or crashes at the wrong time, or can't afford to suffer through variance's in their income due to the ups and downs from the market. Then an annuity may be for them.
Maybe... Because their are ways to hedge against loses tied to the market. There are advanced techniques that have to be performed by someone both knowledgeable and experienced in using hedges, or options like puts and calls. But there is still risk to this, but it can greatly reduce the risk to a client's portfolio. They could also have tactically and actively managed funds where their money manager moves them to safer alternatives if the market is crashing but moves them back when it starts turning around. This can give them the potential for good or great growth while reducing risk when the market crashes. I have seen this done where a very experienced and knowledgeable Investment Advisor managed to turn $100,000 into about 1 million form 2007-the end of 2015. That was remarkable, and he even turned a small profit in 2008. But he is the exception, and not the usual rule. Most mutual funds do not outperform the S&P500, where this Advisor (who has a PHD) has.
What if an individual needs liquidity due to near future or present need to use the money for other things like buying homes or cars or educational purposes etc. Then an annuity with surrender charges will probably not be for them. Some type of savings vehicle, checking or money market account may be better for them, but are not usually high performing .
CDs are marginally better but still have low interest rates and can have surrender charges similar to a short term annuity, and the short term annuity usually pays higher interest rates.
Short term bonds could be an option but can vary in value due to yields varying with the interest rate environment with its ups and downs, and could result in some loss of buying power if bonds are not held to maturity when and if rates are rising as they are now. So make sure if your considering bonds that your advisor knows your situation and time horizon for the uses of money.
Another lesser known, but sometimes better option and alternative for someone 59 1/2 or older would be a modified endowment contract. there are many types of "MECs", so make sure you get one with no surrender fees or a guaranteed return of premium. There are some MECs I'm aware of that have a 3% minimum guaranteed rate, and still buys options in the markets without putting individual's principal at risk. I have seen some of these, that even though they have a 3% minimum guarantee, are averaging 7-9% annual gains and locks in the gains every year. The insurance companies do charge a cost of insurance on these for the additional death benefit, that is more that the funds in the MEC, but its usually a lower cost in comparison to the regular purchase of life insurance due to the large lump sum of money put in up front instead of over a period of time. For that reason, it usually better to have a reasonably healthy person as the insured to keep the cost of insurance to a minimum so you can maximize your growth in your money until you need it out. I have seen 60-70 and even 80 years olds open MECs using their younger children as the insured and them as the owner. So they can then make the maximum interest and still have full access to the liquid funds, with them and then their grandchildren as the beneficiaries. But there are times when you want the coverage on someone who may be older or not as healthy. Such as to pass on sums of money where it can be tax free and avoid probate.
Also, keep in mind, almost all of these liquid options above have taxes on their gains, even though some are tax deferred and the bonds could be federal and maybe state income tax free if they are municipal bonds.
So when might an annuity be the right tool for the right job? What if someone is very or slightly risk adverse and is looking for an income for now or in the future, or is a spend thrift that needs a dependable and guaranteed income.
In the first case, a very risk adverse person, a variable annuity may not be for them because it can still lose and gain money, and they usually have higher annual fees than other investments or fixed annuities. But some have guaranteed income riders, so may still fit a need for the slightly risk adverse.
But for this risk adverse person, a fixed (single premium income/immediate annuity, SPIA) or a fixed indexed annuity may fit their need as an integral part of their portfolio. Because both are guaranteed to not lose money and both can guaranteed an income for a specific period of time or for life. Also the Fixed Indexed annuity can have a guaranteed income rider for life while still having the option of accessing your funds up to a limit per year without a surrender penalty that goes away over time (surrender free access is usually 10% annually, but some accumulate to greater amounts and so greater liquidity) and due to their indexing option, Fixed Indexed annuities add growth potential, since the insurance company can use some of the lower fixed interest they could have paid you, to buy options that can give you growth tied to an index in the market without you principal every being at risk of market down turns. For the person who needs the guaranteed income, some liquidity without fees, and still have decent growth potential. The FIA may fit their need as well. But the straight fixed income SPIA may be better if they have a tendency to spend it if they can get to it.
When might be another time Fixed indexed annuities or a SPIA be good. There may be an older but healthy person or couple who have a large amount of Qualified money (old 401K, IRA or TSP Plan or the like) and do not necessarily need it to live off of at this point in their lives. A fixed Indexed annuity with its guaranteed income or a SPIA could be used to pay the taxes as they money is drawn out and the rest to buy life insurance on one or both of the retired people in a second to die policy. Doing this will turn the fully taxable money to a usually MUCH larger tax free life insurance benefit their heirs will get when they are gone instead of a lump sum of money with a large tax bill attached to it that has to be paid up front or paid over time using an inherited IRA scenario. If you were going to inherit a large sum of money, would you like it to be smaller with a big tax bill, or larger and tax free. No brainier right? So if the owner of the qualified money uses an annuity combined with the life benefit, the combination can be a powerful tool that can do something few other options can.
So is an annuity, fixed, variable, SPIA or Fixed Indexed Annuity GOOD or BAD? For people who want the certainty of their income, a variable, and on the fixed side, their money and income is safe from market loses. An Annuity can be very good. And like a hammer or a drill, its not the right tool for every situation and job. But for many people and their particular situation and job they want done, it can be one of the best tools you can use.
Sam Talbert
Registered Investment Advisor Rep
Capital Market IQ, an SEC registered IAR
Arkansas Insurance License NPN# 1058750
870-917-5438
