In the last two issues, I explained fixed and variable annuities.  Before we talk about the pros and cons of each, here is a brief recap of the last two articles:

Annuities are financial vehicles that can be sold only by insurance companies. Basically, an annuity is a contract between you and an insurance company which promises to pay you a future income in exchange for the lump-sum payment or premiums (payments) that you pay.

They can be fixed (like a CD) or variable (with investment accounts similar to mutual funds, called sub-accounts), and immediate (you start getting money right away) or deferred (you wait to let your money grow).

Fixed annuities pay a specific interest rate for a certain period of time.

Variable annuities are both insurance and investments and the value of the investment part can fluctuate because your money is invested in stock market securities.

All annuity guarantees depend on the claims paying ability of the insurance company!

Now that we know the difference between fixed and variable and immediate vs. deferred, let’s talk a little about when, if ever, you might consider using an annuity. 

We are living longer. When Social Security was enacted, a person could receive their social security payment beginning at the age of 65.  At that time, the life expectancy at birth was 58 years for men and 62 for women.  Our average life expectancy has increased tremendously so we need to think about what sources of retirement income we currently do have that we can’t outlive.  Pensions are one such source.  Unfortunately, most companies today do not offer pensions for their retirees; they offer 401(k)s instead.  Even in those companies that do offer a pension, they are only good if you work at the company long enough to qualify for it!  Most people will work in more than 4 careers in their lifetime so staying at one place long enough to qualify for a good pension is unlikely.  So, where can you get income that you can’t outlive?  Aside from pensions and social security, annuities and the stock market may provide that income.

Annuities, whether through annuitization or guaranteed withdrawals can provide income for your lifetime and your spouse’s lifetime (if you choose that option) but ONLY if the insurance company is still around to fulfill those guarantees.  That’s the catch.  To reduce the risk, you must use a company that is among the top rated insurers in the country and make sure that you don’t put all your eggs in one basket (i.e. put all your money with one insurance company). 

The stock market, on the other hand, can be less expensive and with the right portfolio construction and typical market returns, you may be able to provide lifetime income through a “total return” strategy.  The catch is that this approach has no guarantees. To reduce your risk with this strategy, you should use a qualified financial advisor to provide the portfolio that is suitable for you.

Having said all that, here are some of the typical questions I get about annuities:

Should I use an immediate annuity?

That depends on where you are in life.  If you are already retired and have basic expenses that are always the same, you might want to consider a fixed, immediate annuity that pays you for your life and the life of your spouse.  With the fixed, immediate annuity, you know exactly how much money you will get.  

I heard that indexed annuities have the same return as the stock market without the risk.  Is that true?

No, it’s not!  Indexed annuities are structured in such a way that they pay you interest based on the insurance companies’ formulas using the returns of a stock market index as its base.  They are extraordinarily difficult to understand and usually provide an interest rate that is less than half of the return of the stock market index.

How about a variable annuity?  When should I consider using one?

If you use subaccounts in variable annuities that are invested in the stock market, you have a better chance of outpacing inflation.  Combined with the guarantees, you may be able to weather a stock market downturn better in the variable annuity than in the stock market itself.  The catch?  You usually have to stay in the annuity for a certain period of years before you can access the guarantees AND it can be expensive! 

Keep in mind that annuities, especially variable annuities, have costs that mutual funds, stocks and bonds don’t have: the cost of guaranteeing you the return of your money, the death benefit or the guaranteed growth in your money. 

For more information, call me at (508) 636-6521 or visit my website at www.reynplans.com.