How to Choose the Right Annuity Type
The Annuity Man
It’s important to lay the foundation before answering this question by reminding you that annuities (regardless of type) are transfer of risk contracts. In my opinion, and after three decades in the financial services business….annuities should not be classified as investments. They are contracts, and should be purchased solely for their contractual guarantees and by shopping all carriers for the highest guarantee for your specific situation.
PILL + 2
So how does a person choose the right annuity type? It’s very simple using a method I have developed using 2 basic questions and one easy to remember acronym.
First, you need to understand that annuities primarily solve for 4 different contractual goals. The acronym I’ve created and easy to remember is P.I.L.L.
P = Principal Protection
I = Income For Life
L = Legacy
L = Long Term Care/Confinement Care
If you don’t need to contractually solve for one or more of the items listed in P.I.L.L., you do not need an annuity. Period! It's really that simple.
Secondly, you need to ask yourself 2 simple questions to find out if you need an annuity…and if so…what type.
- What do I want my money to CONTRACTUALLY do?
- When do I want those CONTRACTUAL guarantees to start?
From those 2 answers, you can then match yourself with the correct annuity type…and then quote all carriers to find the best/highest contractual guarantee for your specific situation and goals.
Where's the "G"?
G stands for growth, but is not part of the P.I.L.L. acronym to determine if you need an annuity. Market growth is the gorilla in the annuity room because the majority of annuities sold today are Variable Annuities (VAs) and Fixed Index Annuities (FIAs). Both promise but don't guarantee market growth.
In my opinion, annuities should never be purchased for pure market growth. The annuity industry and most agents/advisors disagree with me on this, so let me factually make my case with each product type.
Fixed Index Annuities (FIAs) were introduced in 1995 to compete with CD returns, and that is exactly what they have done. Unfortunately, that's not how they are typically sold. "Market upside with no downside" is a common sales pitch, but factually not true. FIAs are life insurance products, not securities, and there are contractual limitations on any upside attached to an internal call option on the accumulation value part of the policy.
In my contractual guarantees only world, FIAs can be an efficient delivery system for attached Income Rider benefits for lifetime income needs in the future.
Variable Annuities (VAs) were introduced in the 1950s for tax-deferred growth using mutual funds (i.e. separate accounts). VAs have a stronger "market growth" argument than FIAs, but you are still limited by your mutual fund choices depending on the specific product and issuing carrier.
In my opinion, when it comes to pure market growth, there should be no limitations on the upside...which obviously eliminates all annuity types.
Shoulder the risk...or transfer it?
As I pointed out in the opening paragraph, annuities are contractually guaranteed transfer of risk products. You either want to continue shouldering the risk, or you want to transfer that risk to the annuity carrier. For example, you can transfer the risk for lifetime income payments, or you can transfer the risk for principal protection against market loss.
Once you determine that you actually need an annuity and the type that best fits your situation, then you should shop all carriers for the highest contractual guarantee because annuities are commodity products. Don't let an agent or advisor only show you one product. Demand to see quotes for the highest contractual guarantees from at least 5 carriers.
Remember the 2 questions, use the P.I.L.L. acronym, and make your decision on your terms and on your time frame. Choosing the right annuity type is that easy.