In a recent survey done by Allianz Life, nearly two-thirds of the respondents feared outliving their money more than they feared dying. With inflation and rising costs in the news, it’s understandable that the fear of running out of money is a genuine concern for many, especially for those nearing or in retirement. However, a study done by Center for Retirement Research at Boston College found that only about 10% of the population owns an annuity. This would indicate that there is a disconnect between a real risk (outliving one’s assets) and a way to mitigate some of that risk through a guaranteed lifetime income (an annuity). Since June is Annuity Awareness Month, I figured it would be a good time to review what an annuity is exactly and what are some common misconceptions about them.
What is an Annuity?
An annuity in its most basic form is a contract between you and an insurance company, whereby you give the insurance company a certain dollar amount, and in return, the insurance company agrees to pay a certain amount back per the terms of the contract. The payment from an annuity can last for a fixed period of time or a lifetime. There are two general types of annuities: immediate and deferred. An immediate annuity is pretty much as it sounds, you start receiving income immediately. A deferred annuity allows you to defer receiving income until some point in the future, sometimes decades.
Misconception #1: I Can Create a Lifetime Income from My Investments
While reviewing your sources of income and creating a plan on how best to take withdrawals from various retirement, investment, and cash accounts are important aspects of a well thought out retirement plan, aside from Social Security and maybe a pension (if you’re lucky enough to still have one), only annuities truly offer a guaranteed lifetime income. The markets are unpredictable and can be quite volatile, so there is no assurance that you won’t outlive your portfolio. However, an annuity is a contract between you and the insurance company that spells out an agreement on what guaranteed income the insurance company is going to provide. Regardless of how overall markets perform, the insurance company must honor the terms of the annuity contract.
Misconception #2 – Annuities are too Complex
There are several different types of annuities and there certainly is a spectrum of simpler to more complex options. Working with a financial professional who understands your goals and objectives can help you navigate the various types of annuities and determine which one (if any) may be best suited for you. A financial professional should review all the features of the annuity they are recommending, why they think it’s a good solution for you, and also any fees, taxes, withdrawal constraints, and surrender charges so that you can make an informed decision. Don’t be afraid to ask questions! You should fully understand what you are buying before you make a decision.
Misconception #3 - Annuities are Expensive
Again, this is not necessarily true. Some annuities have no explicit fees while others may be more expensive than traditional investment or retirement accounts due to their guarantees, features, or certain benefits. Again, the annuity universe is vast which is why it’s often helpful to work with a financial professional who can guide you. You should weigh the costs of any benefit or feature of an annuity against your personal goals and objectives and only pay for what you truly need. For one client, a variable annuity with a lot of bells and whistles may make the most sense for their situation whereas an immediate annuity paying a lifetime income may be a better fit for a different client.
Misconception #4 – The Insurance Company Keeps the Money When I Die
Unlikely. With deferred annuities, most are designed to pass the account value to your heirs when you pass away. With immediate annuities, you can choose from different options that would allow the income to continue to your heirs if you pass away prematurely. The most common scenario where the insurance company may keep a portion of your initial investment would be if you buy an immediate annuity an elect an income payout option called a single life or life-only payout. Under this scenario, the insurance company would make income payments to you for your lifetime only and then payments cease upon your death with nothing further payable your heirs. A hypothetical example would be a 65 year old man pays $100,000 to an insurance company and elects a single life payment. The insurance company agrees to pay him $600 per month in return for his lifetime. If, after 12 months, the man passes away, the payments cease. So he would have paid $100,000 and received only $7,200 in income payments. Not ideal, but had the same man lived to age 100, he would have received income payments of $252,000 on a $100,000 investment. Due to its riskiness, single-life payment options generally are the highest of the payment options the insurance company may offer, but for some people, this option makes the most sense for their personal situation. Again, a financial professional can review various immediate annuity income payout options and help you make a decision on what might be best for you.
Misconception #5 – Annuities are Sold by Salespeople Looking to Make a Commission
Unfortunately annuities have gotten a reputation (warranted or not) as a product that’s pedaled by slimy salespeople looking to make a quick buck. It’s important to take a step back and remember that an annuity at its core is a product designed to provide a lifetime income. If you decide to explore if an annuity is something right for you, work with a financial professional who takes time to get to know you and your goals. They should be able to explain their recommendation clearly and be transparent about any compensation they will receive. If you don’t understand the product that’s being recommended or the financial professional is being short on details, it’s ok to say you need time to think about it or completely walk away. A reputable financial professional will take the time to make sure you understand and are comfortable with the product they are recommending, and they won’t have any issues answering your questions.
Annuities can offer a lot of flexibility and provide a source of guaranteed income. Given that many of us are genuinely concerned about outliving our assets, consider having a conversation with a trusted financial professional about whether an annuity would make a good addition in your portfolio.
Securities and Advisory Services offered through LPL Financial, member FINRA/SIPC, a Registered Investment Advisor. LPL Financial and Croxall Capital Planning do not provide tax or legal advice. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Fixed annuities are long-term investment vehicles designed for retirement purposes. Gains from tax deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply.
Variable annuities are long-term, tax-deferred investment vehicles designed for retirement purposes and contain both an investment and insurance component. They have fees and charges, including mortality and expense risk charges, administrative fees, and contract fees. They are sold only by prospectus. Guarantees are based on the claims paying ability of the issuer. Withdrawals made prior to age 59 ½ are subject to 10% IRS penalty tax and surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns and principal value of the available subaccount portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than their original value.