Cost, Complexity, and their Irrevocable Nature (once you annuitize)
For a long time, annuities have been considered a tool by many that can help with retirement planning by providing a stable, consistent income for a lifetime. They are built to fill the gaps in late retirement and old age that traditional savings plans do not always cover, and that makes them a bargain, right?
The fact is, annuities provide you with some security and consistency that other investments lack, but they do so at a cost that most small investors saving for their retirement cannot afford over the long-term. To fully understand how they fit into the investment landscape and the reasons why they are not usually the soundest choice vary, you need to understand what types exist and what they are used for.
What Are the Types of Annuities?
Different kinds of annuities all have one thing in common: they can provide a stream of income to the recipient in exchange for irrevocably giving your money to an insurance company. The ways they work are varied, though, and they depend on the annuity type.
- Single-Premium Immediate Annuity (SPIA): These annuities are the most common type that people think of because they are the simple, “original” version. In these situations, you make a lump sum premium payment up front in exchange for annual income for life or an agreed-upon number of years or for life. These are most similar to a pension.
- Variable Annuity: A variable annuity includes an separate investment account where you can pick from a number of typically expensive options. Eventually you can take withdrawals from the investment account or annuitze similar to a SPIA.
- Deferred Annuity: These work just like an SPIA with one exception. Instead of beginning immediately, these annuities are delayed until the recipient reaches age 85, at which point they begin delivering larger returns every year than an SPIA would.
- Variable With Guarantees: Last but not least, there are some options that combine variable and fixed annuity strategies by basing the benefit partially on the performance of the original funds in the market and partly on a guarantee of a minimum annuity amount.These get complicated and expensive quick. Buyer beware!
Common Annuity Issues
On the surface, it sounds like they provide great benefits but there are some cautionary tales floating around about annuity investments and some mathematical reasons why you are probably not getting as much out of your investment as you could through other vehicles.
- Annuity salespeople are not necessarily speaking objectively when they pitch the benefits of deferred or variable annuities. In fact, according to Forbes, the people who sell variable annuities often work on commission and have incentive to exaggerate their performances. Owing to hundreds of pages of disclosures, some, simply don’t understand the products they peddle.
- Complex variable annuities, which often bring into play a web of interacting factors that help determine the final annuity value, are incredibly difficult to understand. Most people who purchase them are not fully aware of their implications.
- Fees tend to be very high. Fees in the 3.5 to 4% range isn’t uncommon, where a typical all in cost for a financial advisor is around 1%.
- Annuities convert capital gains into ordinary income, making them more costly investments from a tax perspective.
- Costly inflation adjustments.
Non-Annuity Options for Bond Investments
Most of the time, people who “invest” in annuities are concerned about a sudden market decline or they wish to establish a floor of income in retirement. We think most* clients are better served over their retirement lifetimes–especially married couples–by delaying Social Security, and/or maintaining enough stock exposure for their retirement accounts to grow and enough bonds and cash to weather the inevitable short-term market fluctuations.
For more information about annuities and the other options you have for generating retirement income, get in touch with a Certified Financial Planner in Birmingham, AL, to discuss your options.
*Every once in a while, someone’s circumstances are such that a SPIA looks like a reasonable alternative.