Financial Idea's Blog

All Annuities Are Bad, Right?

This is a tricky one for most people, and for a couple of reasons.

One is that people like Suze Orman tell us that they are bad, and therefore they must be. Keep in mind that Suze Orman used to have a federal license for the securities industry, and that she let it lapse. The reason for that only she knows, but one characteristic of having such a license is that you are obligated to tell the objective truth or face possible civil or even criminal charges while perhaps even being barred for life from the industry. If you’re not licensed, you can say whatever you want within 1st Amendment rights. Why she says it is a different story which I won’t speculate on.

A second reason this is tricky is because many of them really used to be bad. While it’s not an absolute rule, it’s true in many cases that annuity contracts written prior to about 2003 lacked some of the really great features that are now available. We’ll get to that in a second.
A final reason comes down to how a professional advisor explains them to you, and whether they fully explain the four basic types of annuities, so that, if one is appropriate for you, you’ll know which type best fits your needs.

So, what is an annuity basically? It is an insurance contract, written by an insurance company, and like with most insurance policies, the company is betting that you won’t live as long as you think you might. This insurance contract guarantees either a specified amount of money which will come to you every month for the life of the contract, or it guarantees a minimum income or a minimum withdrawal which you could, but don’t have to, take every month. The contract runs typically for your life and the life of your spouse, but that’s just one of many choices. You could choose a reduced benefit if only your spouse remains, or no benefit, or you could choose to have a benefit which lasts for your life plus 10 years to any named beneficiary, or even just have it last for ten years and that’s it, even if you’re still alive.

Which choice you make depends on your purpose for the money. Is it to supplement other sources of income, which is most often, or might it just tide you over for ten years after which you plan to sell some rental properties and get income that way? Only a professional advisor, who is preferably not tied to one particular provider, can help you sort through all this.

Annuities are also offered as Fixed or Variable, where Fixed is a pure insurance contract in which you are guaranteed a return, typically small, like 3%, 3.5% or 4%, no matter what the market is doing. Variable can be better or worse than that, as they are based upon the performance of underlying mutual funds. You could have a negative 10% or worse year, or you could have a positive 20% or better year.

Here’s the bell and the whistle about the variable offerings though. In the last few years, many annuity companies have begun to offer “step-up” riders that say in essence, if we have a really good year, it’s all yours, and if we have a year that is less than 5% positive, even negative, we’ll guarantee you 5% positive. Guarantee! And if next year is better than 5%, you’ll get that. The first catch is that, if you have a number of down years in a row, and giving you that more than 5% would still leave them underwater, then they might restrict the gain for that year. The second catch is that, well, this whole guarantee costs money. Not a big surprise, and actually still quite worth it. Now, this is case-by-case, and not necessarily exactly what you should expect, but for example, if it costs you 4% of your total investment to get in to this annuity, it might cost you an extra ¾% to get the guarantee as well. That’s a pretty cheap guarantee in my book.

The next concept is Immediate versus Deferred. This is simple. Immediate means you put money in and you start getting it out next month. This is a frequent choice for someone already retired who wants to protect the money and guarantee a steady income stream. Deferred just means you’re starting to put money in now, but you won’t need it for awhile.

The last concept is something called “annuitization”. That seems kind of redundant, the idea of annuitizing an annuity, but that’s what it’s called. What it is, is electing to lock down the contract, to say, I will never contribute another dime, and I want to know exactly how much I’m going to get each month from now on, and there’s no changing your mind. That has its place, but it used to be the only option, which is one reason some people still think they’re bad.
With the reforms, you can now keep adding after you’ve taken some out, if an inheritance or other windfall comes your way, or you just change your mind. And you can choose to not take any for awhile, even if you’ve already taken some. You do this by getting certain types of annuities that don’t require “annuitization”.

There are a lot of moving parts here, and there are also some tax advantages, but the bottom line is that they can be a very good idea.
Want to know more? Let’s talk, and create a plan that’s right for you and your family.

Technorati Tags: annuities, annuity, Retirement

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