Annuities – Pros and Cons
Annuities Pros and Cons:
As with any investment, you need to consider all aspects when investigating annuities. Pros and Cons lists focus on the product itself, however, and what is most appropriate when considering ‘annuities pros and cons’ is to to first think about your own needs- Focusing on YOU first is what a good advisor should do, and only after your situation is fully understood, should you consider what products, if any, make sense for your needs.
For unbiased advice on annuities we recommend you sign up to the right – receive a free report outlining all you need to know about annuities, and contact the advisor when you are ready to make an informed decision. You won’t be disappointed.
Now, on to the analysis…
Annuities Pros and Cons- First, the Pros…..
Here are some brief introductions of the benefits of annuities.
Tax Deferral: Like an IRA, annuity earnings are tax deferred. This makes them more appealing than CDs, money market funds, or other safe investments. Tax Deferred Annuities offer greater compounding of your investment earnings over regular taxable accounts like CD’s or securities investments.
Safety of Capital: Your money is safe in annuities. Insurance companies are required to keep cash reserves to ensure this. Most states also have a guarantee fund up to $100,000 per annuity for additional security.
Liquidity: Your money is accessible. Most contracts have an annual withdrawal clause that will allow you to take 10-15% of the account value each year without incurring any penalty.
Rate of Return: Annuities offer higher rates of return than other safe investments. Currently, annuities are yielding an average of 4% tax deferred in comparison to only 2% taxable with CDs. As our economic markets stabilize, annuity yields should increase accordingly. Annuity rates of return offer more stability in fluctuating markets.
Income stream: Fixed annuities that provide an income stream have been found to be one of the best retirement income vehicles according to a study done by New York Life and the Wharton Business School. After the first annuity contract year, most annuities can provide monthly income payments for your lifetime. Likewise, immediate annuities provide monthly income payments for your lifetime, but they start immediately.
Annuities Pros and Cons: Now for The Cons
The wrong annuity product can have negative effects. It is important to know these cons so you do not purchase the wrong product for you.
Short Term Money: If there is a chance you need all of your money returned to you in the short-term, say one to two years, an annuity is not right for you. It is best to only invest funds you will not need for at least the next five years.
Surrender Schedule: Because annuity contracts have surrender charges for withdrawing money before the contract matures in lieu of up front sales charges, you will be obligated to the terms of the contract. Some surrender schedules can be as long as ten years.
Sales Commissions: As with any purchase, the sales agent will earn a sales commission. An unethical sales agent may not have your best interests at heart and will not show you the right product for your needs.
Liquidity: You may be referring back to the pros section and find liquidity featured there as well. While liquidity can be a pro, it can also be a negative in so much as you realistically knowing how much money you may need to access and when you will need it. Without knowing these answers, liquidity can easily turn into a negative.
There are always tradeoffs, and often, the benefits of annuities far outweigh the negatives for people of a certain age. Annuities really are a great retirement income planning tool.
So, What Are Annuities?
Now that you understand annuities pros and cons, lets discuss annuities in general. In the broadest sense, an annuity is a contract offered by an insurance company- in exchange for getting your money, they offer you guarantees of income and/or appreciation.
An annuity payment stream is a factor of your age- it’s somewhat like life insurance in that the issuing company is looking at your age and weighing the risks of paying you over the term of the contract. In the case of an immediate annuity with lifetime benefit, the issuing company will pay you some amount of money monthly for the rest of your life. If you live longer than expected, the company may lose a lot on the contract, but that is balanced out by earnings from other buyers who do not live as long as expected. The insurance company absorbs the risk of longevity and extends benefits to you in exchange for your capital.
Insurance companies are big investment houses, and they invest your funds in instruments like bonds, equities, real estate mortgages, and other investments. They manage their risks so that they earn more than they are obligated to pay out in insurance claims or annuity payments, and they hope to make a profit. Well run companies make profits, but remain competitive by paying better rates to their insured parties.
Finding a balance among these forces, understanding the insurance company’s balance sheet, and knowing their track record, is a key component in your research process. Better yet, it’s what your annuity sales person SHOULD be doing for you, to find the best place for your capital.
Annuities are generally sold by insurance agents. Often, your home or auto agent will try and offer annuities also, yet they are not generally well equipped to do so. Variable annuity products and in the near future, equity indexed annuity products, are sold thru registered broker-dealer networks, like stock brokers, these sales people need to have SEC registrations and some more training. Like many financial products, annuities are sold on a commission basis, and commissions vary widely between products and companies.
There are dedicated annuity and retirement income specialists, however, and these specialists can offer you a higher level of service, a better understanding of the playing field, as well as better advice on how an annuity might fit in with your needs. One of the best is available at http://www.AnnuityStraightTalk.com/
Annuities come in a lot of different forms- the major types of annuities are:
- Fixed Annuities
- Immediate Annuities
- Variable Annuities
- Fixed Index annuities
Within variable annuities, some of the major types of contracts you will see are
- Guaranteed lifetime withdrawal benefit annuities (GLWB)
- Guaranteed minimum income benefit annuities (GMIB)
Before you rush out to buy an annuity, it’s imperative that you educate yourself on the different kinds, and fully understand your needs and retirement income goals. There are some incredible ways to use annuities that most advisors will not tell you about, for the simple reason that it takes more work to explain, and might even earn the annuity salesperson less in commission.
The products that pay the most to the salespeople often are not the best products available, and when you are searching for guarantees and security, it’s often the less flashy companies and simpler products that offer the best benefits. In the annuities pros and cons list perhaps we should add, too many variations!
What’s the magic formula for the right annuity?
Safety, Flexibility and Profitability.
We use this simple formula to understand these complex contracts, and filter all the contractual points against this screen.
Safety We want clients to have the best possible security against risk- the last 2 years of financial crisis have underscored the importance of doomsday thinking, and intense scrutiny of the track record, reserves, and financial strength of the underlying insurance company
Flexibility We want clients to maintain the most possible control over their funds and therefore shy away from long term commitments with speculative returns. You simply don’t know when unexpected needs might arise, and for people of a certain age, we feel that products that provide ways out or end dates on contracts are far superior to long term lockups.
Profitability Finally, we want clients to enjoy the highest possible yield on their annuity in light of the factors above- sure, you can find a 7% return on an annuity, but you probably have to buy it from a weaker company and give up control for 10 years or more.
We believe that a little time spent understanding your needs and learning the annuity playing field can help greatly to connect you to the right products, the right companies, and the right income and guarantees that you are seeking. Don’t be pushed by hard sales or urgency, and also, don’t ignore these powerful tools. A good advisor can help put all the pieces together, and you can then understand the pros and cons of annuities and the specific contract you are considering.
If you would like more information on annuities, The Annuity Report is a great free resource to get you started.
Now, for a little humor- this quick video is informative, but the gentleman on screen is a bit overly enthusiastic! On the annuities pros and cons scale of arm waving, he’s at a 9!