How To Determine If You Need An Annuity
The Annuity Man
There are 2 guarantees that will happen from this Coronavirus crisis. First, people wearing face masks in public will become commonplace and won’t even draw a second glance. The second guarantee is that if you are an adult with a brokerage or bank account, some advisor or agent is going to pitch you an annuity as a one size fits all solution to your investment problems...so get ready. Spoiler alert...no product like that exists.
Even though I’m known as Stan The Annuity Man and “America’s Annuity Agent,” I’m the first person to say that annuities are definitely not for everyone, even though every U.S. citizen with a Social Security number already owns one. In fact, they own the best inflation annuity on the planet. You guessed it, your Social Security payments are an annuity structure.
Annuities were first introduced in the Roman Times as a lifetime pension gift for the dutiful Roman Soldiers and their families. To this day, the annuity category has a monopoly on lifetime income, and is the primary reason that people consider adding an annuity to their portfolio. But lifetime income isn’t the only contractual goal that annuities solve for, and the annuity company doesn’t have to keep any unused money when you die. I thought I would kill two “misinformation birds” using one factual stone with that sentence.
Principal protection, legacy, and long term care are additional goals that annuities contractually solve for. In addition, if the annuity company keeps a penny of the initial premium when you die, that was a decision YOU made when structuring the policy during the application process.
Do You Even Need An Annuity?
So how do you determine if you need an annuity? One definite answer is to never ask an agent or advisor that question! Too many of them will say yes without knowing any fiduciary type specifics, and then steer you to their favorite annuity product.
There are only 2 questions that you need to ask and answer to determine if you need an annuity.
- What do you want the money to CONTRACTUALLY do?
- When do you want those CONTRACTUAL guarantees to start?
In a perfect annuity world, these 2 questions would be on every annuity application and the answers would be part of the policy approval process. Unfortunately, we do not live in that annuity utopia yet...but I'm working on it!
Annuities, regardless of type, are contracts issued by life insurance companies. The claims paying ability of that issuing life insurance company is what’s backing up the guarantee. There are State Guaranty Funds that cover policies to a specific dollar amount, but this coverage can’t be used within the sales presentation. That little tidbit should tell you right there that State Guaranty Fund coverage isn’t the warm fuzzy blanket you love with FDIC type backing.
Specific Answers = Specific Solutions
Answering the 2 questions listed above will either point you toward the exact type of annuity that will provide the highest contractual guarantee, or it will confirm that you don’t need to buy an annuity. If guaranteed income is the first answer, then the second answer of when that income starts will determine the best type of annuity that will provide the highest income for life payment. Below are some examples of how answering the 2 questions for lifetime income can pair you up with the correct annuity type.
Income starting as soon as 30 days = Single Premium Immediate Annuity (SPIA)
Income starting as soon as 13 months = Deferred Income Annuity (DIA)
Income starting as soon as 5 years = Income Rider
Income using Traditional IRA assets = Qualified Longevity Annuity Contract (QLAC)
With SPIAs, DIAs, QLACs, and Income Riders...there can be variations of the start date and all carrier types should be quoted for the highest contractual guarantee for your specific situation. But you get the basic picture on how this works.
If you answered the question that you wanted no income but full principal protection, then you have 2 tax deferred annuities to choose from...Fixed Index Annuities (FIAs) and Multi-Year Guarantee Annuities (MYGAs). Both are CD products, have no annual fees, and fully protect the principal. Even though FIAs are typically over-hyped as market return products, they are not. FIAs are life insurance products, approved at the state level, and are not securities.
If you answer the first question that you wanted a “reasonable rate of return” or “market type growth,” then you should not buy an annuity of any type. A Variable Annuity (VAs) has the best argument for "potential growth," but load VAs have annual fees that typically range from 2% up to 4% annually for the life of the policy. No load VAs at least strip out those fees, but you are still limited with your mutual fund (i.e. separate account) choices. In full disclosure, I don’t sell VAs because I believe that annuities should only be owned for their contractual guarantees.
In addition to being contracts issued by life insurance companies, annuities are transfer of risk strategies. Another easy way to determine if you need an annuity or not is if you need to transfer risk. Transferring risk has nothing to do with age, gender, or your net worth. Transferring risk is all about not wanting to shoulder all of the risk yourself.
The best example of this is longevity risk, which is the fear of outliving your money. Annuities are the only financial product that contractually solves for longevity risk, so the fact that we are all living longer is driving people to find those lifetime payment solutions. Retirement income and creating a guaranteed income floor is where annuities seem to fit with the over 10,000 baby boomers that reach retirement age every single day. Most are already receiving payments from a pension or their Social Security, and some realize that those income streams don’t provide enough guaranteed income. This is where guaranteed annuity payments can fill in that needed income floor gap, and can be a crucial piece to the retirement planning process.
Using your retirement accounts and retirement savings to buy an annuity only makes sense if you are solving for a contractual goal. The key with any annuity purchase is to use a little money as possible to contractually hit that transfer of risk goal. It’s really that basic, in my opinion.
Regardless of what you are told, what the email message reads, or what the TV ad says, there is NEVER an urgency to buy an annuity. Let me put it another way, there is never an urgency to sign a contract until you fully understand what’s in that specific contract. Remember that annuities are contracts.
The only urgency is to fully understand what you are buying and the annuity paperwork that you are getting ready to sign. Always own an annuity for what it “Will Do,” not what it might do. “Will Do” are the contractual guarantees. The “might do” is the sales sizzle, not the contractual steak. Never purchase an annuity for the hypothetical, theoretical, back-tested, projected, hopeful agent return scenarios. If you buy that dream, you will always end up owning the contractual realities.
So do you need an annuity? Maybe. Maybe not. It all comes down to what you want the money to contractually do and when you want those contractual guarantees to start. Then always shop all carriers for the best deal.
Buying an annuity is like buying a plane ticket. You have to know where you want to go first before you can find the best price.