Annuity Q & A

Last weeks’ column generated some great questions regarding annuities. I will try to answer some of the most common here.*
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Q – Why do you dislike annuities? A – I don’t dislike annuities. They have their place in the right situation. I dislike when annuity salespeople sell them inappropriately.

Q – In simple terms, what is an annuity? A – These are life insurance products that in addition to usually offering a death benefit, commonly include living benefits as well. These might include principal protection, monthly income, minimum growth rates, long term care riders, or others.

Q – When might an annuity be inappropriate? A – Many have higher fees and commissions than other investment options that will impact the rate of return, often significantly. Many also have high early surrender charges. Inappropriate use would be when a purchaser has unrealistic expectations of the products’ potential returns or outcomes.

Q – Why do many annuities have early surrender charges? A – The insurer incurs costs in marketing and issuing an annuity which it recovers over time with margin spreads and/or fees to the owner. If you cash it in early the insurer needs to recoup those costs.

Q – Give an example of a situation where you have recommended an annuity? A – I will give two. I had an individual ask how they might leave money to a wayward child. They feared the child would waste the money if they received it in a lump sum. I offered a couple of options and the one they chose was an annuity that paid a monthly lifetime payment to the child. I explained that I expected the returns to be significantly less than what they might earn in other investments, but that because the payment was guaranteed for life it might be better than allowing the child to waste the money. As a side benefit the child would have a lifetime monthly reminder of their parents’ love for them. A – Many years ago during a period of high interest rates we found fixed rate annuities that paid returns in the 8% range guaranteed for 10 years. It appealed to some of our clients to be able to lock that in.

Q – My agent said a Fixed Indexed Annuity is invested in a stock market index without risk. A – You can’t actually buy a market index. These often-complicated products use various methods to “tie” potential gains to a market index. The key is to realize they have limits on how much of the gain they can capture. Understanding those limits, and having realistic expectations of potential growth, can help you determine if these often-long-term products are suitable.

Annuities are inherently neither good nor bad. They have their place and they also have their time, like most financial products. The key is to work with a fiduciary who places the clients’ interests above their own in helping them decide if these products are appropriate for them.

*Annuities are complex products and should only be used under proper advice and after careful examination of the benefits and costs. Answers here are very generalized and simplified for educational purposes only.​