Are annuities in retirement a good idea or strategy?
Whether investing in annuities during retirement is a good strategy to have or not is what we are discussing today. As we look across the landscape of all the investment products and different ways that a retired person or family can invest their money, we see that annuities are more controversial than any other type of investment product. We have to be careful using the word investment with the word annuity because it is an insurance product. Unlike stocks and bonds that are securities, an annuity is not, it is only issued by insurance companies.
Types of Annuities
A person can invest in all kinds of annuities and use them to reach the goals that they want to for their own retirement. One of the most common ways that people use annuities in retirement is to produce an income. They will put an initial amount of money into the annuity, and the annuity will begin making payments; oftentimes monthly, to the person or couple for a certain amount of time, it could be for a fixed period of years, for example, five, ten, or even twenty years, or the annuity could make payments to the couple until one of them dies, or until both of them die.
There are other types of payouts as well with different strategies to receive these payments from the annuities. For example, you could have the annuity pay until one of the spouse dies and then pay the remaining spouse 75% of the benefit that the couple was receiving when both of them were alive. You could also have a situation where the annuity is paid while both couples were alive, and if all of the principal was not used, the beneficiaries would receive that amount which was left over and was not used, to make sure that the couple does not just lose any of their unused original principal.
Let’s say the couple put a large chunk of money into an annuity and they died the next year, and now all this money is left on the table and the insurance company gives it back. This is particularly dangerous for couples that buy annuities in their 60s, especially life annuities.
Life Annuity
A life annuity is where someone is going to be paid or a couple is going to be paid for their entire life, for the husband and the wife’s life. So if you buy a life only annuity and both the husband and the wife die the next year, then that is going to be a tremendous amount of money that has gone unused, which of course will be detrimental to the estate for the heirs. So, using an annuity to produce income is quite common and oftentimes helpful to a person’s retirement strategy. Now at this time, I would like to take a moment just to explain how we operate with annuities.
I am a fee-only fiduciary, financial planner and wealth manager, so I do not have any insurance licenses. I do not sell life insurance or annuities. However, I do recommend them and manage them for some of my clients.
I do not receive commissions on the sale of any type of products of course, including annuities. As a fee-only planner, the only payments I receive are from my clients directly, and my business is in the business of selling advice and not financial products.
So as we look at annuities, as I mentioned earlier how controversial they can be, we have some very respectable and top experts that have some negative things to say about annuities, for example, Clark Howard. We hear these negative things about annuities, and the question is, are they warranted? And I would say, it depends on what it is.
For example, are all annuities bad? No, not all annuities are bad.
Expenses
Are some annuities expensive to own and sold in situations where it is not good for the client? Absolutely, they are. There are some annuities that have tremendously high commissions that can go from five all the way up to 9% commissions, plus even contain to pay the insurance agent or broker or financial advisor for the life of the annuity.
So what we want to look at is what type of annuity are we getting. In certain situations, people can be sold an annuity that is inside of an IRA. This can be damaging as well. An annuity is tax deferred, an IRA is tax deferred as well, so why would you want to put an annuity, which has cost to it inside of an IRA?
Some examples of the costs are the M&E (mortality and expense) cost that you have, you have administrative cost, and so all annuities have cost to them that you typically would not have inside of an IRA at a place like Charles Schwab or Fidelity. Or even an IRA at your bank. So when you have an annuity inside of an IRA, you want to make sure that this annuity is achieving an extremely specific purpose for you that you could not otherwise get using an annuity.
There are situations where they make special annuities, particularly ones that have downside protection, that you cannot get inside of other products with IRAs. Now, they are beginning to make non annuity products where you can get downside protection using principal protected notes and other types of investments, we will call them financial products. These type of products can give you the downside protection that annuities do inside of an IRA without you having to go and purchase an actual annuity.
One of the most important things to understand with an annuity, or any investment for that matter, are the expenses.
What are the internal expenses on the annuity that you are thinking about purchasing?
I remember years ago, a client of mine came on board. She was a single woman, divorced. She had been married for many years. She also had many years of service as a teacher. So she came to me from a large and well-known brokerage firm that almost everyone has heard of which has done many types of investing or looking into financial companies. And I remember with her annuities and the fee she was paying her financial advisor, it ended up being, she was paying about 3.75% a year, and that is completely unacceptable. We got her transferred over to me and began working with our team and having her money over at Charles Schwab, and her fees were greatly reduced. We reduced all of her fees, including internal expense ratios, by more than 50%. So she is still a happy client today, 10 plus years later. But as you are looking at annuities, you want to go in and look at each and every single item on how much the insurance company is going to charge you for their particular annuity.
The great thing about working with a fee-only financial planner is that they will be able to show you annuities that have no commission to get in, no commission to get out, no penalties, and have extremely low expenses for annuities. Understanding how much a financial advisor makes is important in this process. They will have access to the lowest cost annuities in the world. They also have annuities that do not have long time periods that you have to hold them for five, seven, nine, eleven years, you have to be in these annuities. And if you work with a fee-only fiduciary, they, he or she, should have access to an annuity that does not have these long holding periods that you have to stay in them and cannot get out without a hefty withdrawal penalty, or what they call early withdrawal penalty. So that is another thing that is especially important to keep in mind when you are determining whether or not buying an annuity in retirement is a good idea or strategy. It is impossible to answer the question if an annuity is good for you or not, if you do not know the expenses. That is a huge component in determining whether or not you want to buy an annuity.
All the research that Morningstar has done shows us that expenses of the underlying financial products that you have has a direct one-to-one correlation to the performance that you will experience. So for explanation, they broke it in for mutual funds, they broke them into five categories, the top 20% most expensive, and the lowest 20% most expensive. And every single category showed that the most expensive annuities had the worst performance. The number four most expensive that were the percent from the 60th to 80th percentile where they were more expensive, had the second worst performance. And it went all the way down to where the mutual funds with the lowest expenses had the best performance of those five quintiles of mutual funds. And this was a study done over thousands of mutual funds. This same principle can and should be applied to annuities when you are determining whether or not you want to purchase them.
When you work with a fiduciary financial planner, they should know this and make sure that they recommend to you one of the lower prices, if not the lowest cost annuities that they can find for you, so your money can be worked without being slowed down by expenses.
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Set up a 20 minute call with Thomas Cloud, Jr., CFP(R) to determine if annuities are good for you and your financial situation. What type of annuity is best for you if at all? Is your current annuity worth keeping? What are its costs? Tommy can help you answer these questions in a 20 minute no cost no obligation phone call. Click here and schedule it now: https://calendly.com/thomascloud/retirement-ready-success-call.
Also I encourage you to watch my free retirement video: https://go.thirdactretirement.com/strategy