Opinion: Here’s what you should understand about annuities before you buy
October 4, 2016 by Phil Simonides
Annuities, despite promising guaranteed income during retirement, are widely misunderstood. Indeed, over the years some common myths about annuities have become accepted as fact.
Here are some of the most common misunderstandings about annuities, and how to avoid their pitfalls.
1: Annuities are expensive
There are fees associated with some annuities, just as there are fees to buy and sell a stock. And it’s important to consider all of those fees. Yet there are low-fee and even no-fee annuities. But to truly say whether an annuity is too expensive, investors need to first ask, “Compared to what?” Annuities can create an income that you can’t outlive. You’re paying for the safety of knowing that regardless of what happens in the stock market, you will have a guaranteed income in retirement, and for as long as you live. Nothing else like it exists for the majority of investors.
That said, investors need to weigh the costs and benefits of all options. Annuity companies are also getting better at figuring out how to mitigate costs for investors who want to buy an annuity but are hesitant because of higher fees. Many plans offer add-on services or features so investors can choose what they want to pay for, similar to how you would buy a car and pay only for the features you need.
2: Everyone should own an annuity
Annuities aren’t for everyone. Sure, they generally offer minimal downside risk, a potential tax deferral, and the ability to receive guaranteed income for life, but your individual situation may call for a different investment approach . For example, most financial professionals wouldn’t recommend annuities to recent college graduates or young professionals. Those groups likely have either a higher risk tolerance or less money to put toward an investment like an annuity. While annuities have a place in many investors’ retirement plans, they don’t work for everyone.
Read: 4 reasons why critics tell you not to buy annuities
3: Annuities are only for retirees
Many investors can benefit from annuities. Retirees are in that group, but investors should start paying attention to annuities in the several years leading up to retirement — especially in the current market environment. As people get older and closer to retirement, they need to rebalance their portfolio by slowly taking money out of equities and moving into more stable investments. Historically, bonds have been the answer. But with interest rates so low, bonds aren’t providing the level of safe income they used to. Annuities are an alternative to bonds — another asset class — that can give investors bond-like return, with less risk.
4: Annuities overvalue risk protection at the expense of return
Despite this perception, there are a group of annuities that seek to grow your money as much as they seek to protect it. More broadly speaking, though, not all annuities are the same. There are different types of annuities that serve different purposes, depending on an individual’s needs. Those purposes go beyond simply protecting your investment. People often get caught thinking that because one type of annuity doesn’t work for them, no annuity will. This couldn’t be further from the truth.
In terms of distribution, investors can choose between immediate and deferred annuities depending on whether they need income right away or if they have more time. Within the annuity structure investors can also choose fixed or variable annuities — or the aforementioned equity-indexed annuities, which combine elements of each. People want, and can find, annuities that offer more than just protection.
The ultimate financial myth: there’s a silver bullet
Many investors think that when it comes to planning for retirement, there exists a single solution. In reality, no one investment is going to cover every aspect of your portfolio. There are several utility players, or investments that serve multiple functions. But for a secure retirement, investors need to weigh all their options and make sure they’re getting quality advice. An annuity is a useful utility player that can offer a guaranteed return with low risk. By educating themselves about these annuity myths, investors can get a real sense of annuities and determine whether or not they fit their retirement portfolio.
Phil Simonides, CFP, is group vice president at investment manager McAdam, LLC, and is the Chair of Advanced Planning at the firm, specializing in strategies for high-net-worth individuals and families, and business owners.
