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Annuities are neither good nor bad.
But you wouldn’t know that given how most people, including financial planners, react when the product is discussed as a potential part of a retirement plan.
Such products, critics say, are nothing but a way for salespersons, some of whom have engaged in unethical sales practices, to make a hefty commission — and that’s the family-friendly version.
Planners and others also frame these products in the worst light. They label income annuities as an investment rather than as a guaranteed way to fund spending in retirement, as a way to manage the risk of running out of money in retirement, which is often cited as the No. 1 concern of nearly all preretirees and retirees.
And those critics tend to focus only on the negatives associated with annuities. They say, among other, things that you give up control of your money when you buy an annuity.
Meantime, there’s been a significant decline in consumers’ perception of the value of guaranteed lifetime income during the pandemic, according to a report, Diverging Attitudes About Lifetime Income in the COVID-19 Era, published by Greenwald Research and CANNEX. The percent of consumers who considered guaranteed lifetime income to be highly valuable fell from 71% in February to 63% in August, the lowest point this statistic has been in the last three years.
For his part, Michael Finke, professor at The American College of Financial Services, attributes some of the annuity hatred to opportunistic messaging from some who see them as a competitor to managed investments.
And still others believe that annuities aren’t so much hated as misunderstood. “I don’t think they hate what an annuity can do for them within a financial plan,” said Tamiko Toland, director of retirement markets for CANNEX. “I think there is a lot of confusion over the different types of annuities and the broad range of value propositions they provide. This can be compounded by poor understanding of the actual value that they offer and the real cost and risk of offering them.”
But under the right circumstances, annuities can be appropriate.
For instance, an annuity could be appropriate for those who don’t want to outlive their assets. Depending on the type of annuity purchased, an account owner would receive income for as long as they live.
Yes, this does mean that some annuity owners will receive more income than others. But the real value of annuities comes from something called “mortality credits.”
Those credits, according to AnnuityFYI, “are created when people die sooner than expected and don’t receive as many income payments as they would have if they had lived their full life expectancy. That money goes into a pool that will then pay lifetime income to those people who live longer than their life expectancy.
It’s worth noting that those who choose to own only investments — stocks and bonds — as a way to generate income in retirement don’t receive mortality credits.
“Think of simple income annuities as taking bonds from your savings account and handing it over to an insurance company that will pay you an income as long as you’re alive,” said Finke. “The alternative is paying your own expenses from these bonds, but the problem is that you don’t know how long you’ll live. You can either spend very little to make sure you never run out, or you can spend more and risk outliving savings. An annuity is priced so that the income is about equal to the amount you could otherwise spend if you were to withdraw money with interest from savings to your expected longevity. An annuity allows you to spend more without worrying about running out.”
Simple income annuities also work if you’re trying to match guaranteed sources of retirement income, such as Social Security and defined-benefit pension plans, (both of which are annuities) with your essential expenses.
Today’s retirees can’t rely on pensions to provide a basic lifestyle, said Finke. This means that there is often a gap between how much you have to spend on necessities and how much you’ll receive from Social Security and, if you’re lucky enough to have one, a defined benefit pension.
If you are looking to match your guaranteed sources of retirement income with your essential expenses and there’s a gap, you could plug that gap in one of two ways: with income from your investments or with an income annuity.
And if you subscribe to what’s been called the four-box strategy you’d know that those two tactics come with very different risk-management objectives.
In the case of using income from investments — say the 4% rule — you’d be able to provide income that, on paper, keeps up with inflation. But that tactic offers no guarantee that you won’t run out of money, or more accurately, have a lower standard of living if you live a long time.
By contrast, an annuity manages the risk of longevity; you won’t ever run out of money. But the income from such products will not keep pace with inflation, unless of course, you purchase an inflation rider.
So, what’s a person to do?
Best case, when building a retirement-income plan you ought to have all the tools in the toolbox, and use them appropriately. No carpenter ever shows up on a job without a hammer and screwdriver. So why should you build your retirement-income plan without all the tools available to you?
So, for instance, you need not purchase an annuity if you have enough assets to fund your desired standard of living over the course of your life.
On the other hand, you might consider an income annuity if you want to guarantee a minimum desired standard of living. Or you might consider using a deferred income annuity or a qualified longevity annuity contract, which would allow you to use an income-from-investments strategy to age 85, for example, and an annuity strategy to manage the risk of longevity. Or maybe you might consider a “period certain annuity” or one with other riders that provide income to a surviving spouse, or return of principal.
And it doesn’t have to be either/or. It could be a combination of risky assets and income annuities. Again, we’re neither not advocating for using annuities all the time nor all of the time. Rather we’re arguing for an open mind; that income annuities be used when the facts and circumstances dictate that such products would be appropriate.
Of course, there are reasons why you might not use such products in the current environment. At the moment, the income from an immediate annuity might be low. For instance, a 63-year-old plunking $100,000 into an immediate annuity, with a refund at death, today could expect to receive $400 a month for the rest of his/her life, or $450 without a refund at death.
However, Finke notes that annuity prices are fair compared with the cost of creating an income from other safe investments like CDs or bonds. “We find that annuity prices are very competitive, with guaranteed income slightly higher than the cost of building income to one’s expected longevity using Treasury bonds. There’s simply no getting around the fact that safe income today is expensive whether you use annuities or bonds. At least annuities allow you to spend your savings without the worry of running out.”
So, how might you investigate further whether an annuity might make sense for you? How can you find a safe/reputable place and/or person to buy them? What should you watch out for?
First, reframe your view of annuities. “If we called income annuities ‘personal pensions,’ which is what they are, people would feel more comfortable buying one,” said Finke.
Next, spend some time learning more about annuities. Some websites to check out include:
- The Alliance for Lifetime Income, which recently published the second edition of its Annuities Language Glossary;
- Stan “The Annuity” Man;
- Blueprint Income;
- Income Solutions.
Three, think about the retirement-income goals you are trying to achieve, and the risks you are trying to manage and mitigate.
Ask yourself what you want from an annuity, said Finke.
Do you just want a personal pension? If so, he recommends, buying an immediate annuity now or buying a deferred annuity that starts when you’re 75 or 80 to make sure you don’t run out of cash.
Do you want access to your cash and the opportunity for growth, but possibly higher expenses? Then consider, said Finke, a variable annuity, although their complexity means that you should shop around.
And if you’re working with a financial adviser, Tolland said there are two items to consider: Understand the role of the financial professional providing a recommendation and their obligation to you as well as the function of any annuity within an overarching plan.
And no matter what, said Finke, “never buy a product you don’t understand.”
