In my latest book, Fortify Your Financial Kingdom, I go into great detail about why I think correctly designed life insurance is the most powerful tool available for strengthening and protecting your accumulated wealth.
However, life insurance isn't the only underutilized product for fortifying one's financial kingdom. Annuities are an amazingly potent vehicle that can provide you with safety, flexibility, and a stream of guaranteed income.
Before you tell me how much bad press you've read about annuities, let me say, "I get it." I know that because of how these tools are marketed and some bad actors in the insurance space, annuities have a somewhat negative reputation. You or someone you know has probably gone to one of those chicken dinner seminars featuring a nervous guy in a cheap suit with a slideshow. Before you ate, Mr. Cheapsuit treated you to a rambling pitch about how the "XYZ Plus Annuity" could solve all your financial worries and give you the most excellent retirement ever.
Many of these agents, like Mr. Cheapsuit, only sell one thing: annuities. And, you know that old saying, "If the only tool available to you is a hammer, you tend to see every problem (and solution) as a nail."
But, I encourage you to put past experiences and negative information aside for a moment and ask yourself if an annuity may have a place in your retirement matrix. For most people, the answer will be "Of course."
I will add, though, that you must choose the right annuity for you, which may not be the one that makes the most commission for the salesperson.
Annuities, far from being novel products, have been around since the days of the Roman empire, perhaps even longer.
Rulers used annuities for good and bad purposes, from rebuilding crumbling infrastructure to waging wars. Roman emperors often rewarded their soldiers' years of loyal service by offering pensions as an annuity. When combined with insurance and other investment options, annuities are powerful fortification instruments.
Still, not everyone should do as the Romans and purchase an annuity.
As I said, you must select only those annuity products that best fit your financial objectives. It would help if you asked yourself some basic questions before considering an annuity contract.
- Do I truly understand this product? Warren Buffett is famous for claiming he never buys anything he doesn't understand. Choosing the right annuity may feel overwhelming. Even sophisticated, seasoned investors may find annuity company marketing confusing and full of unfamiliar terminology. You can address this challenge by partnering with a retirement planner who thoroughly understands annuities and their various customization options and can explain all the nuances clearly and precisely. For most products, you should think like Warren and avoid purchasing anything until you know the essentials.
- 2. Do I want or need the protection of my principal? Certain annuities offer guarantees, such as a guarantee that no matter what the market does, you won't lose your initial investment.
Fixed index annuities, for example, allow you some potential for market gains while protecting your principal against downside risk.
- 3. Am I concerned about outliving the cash I've saved? The fear of running out of money in retirement and living on Social Security alone prompts many seniors to purchase annuities.
Income riders added to specific annuity contracts create a guaranteed lifetime income stream. Many seniors feel they must have at least one guaranteed income source to augment Social Security payments.
- Is leaving a legacy for loved ones one of my priorities? Other than Social Security or a private pension (for those lucky enough to still have one), annuities are the only commonly available product that will provide guaranteed income you can't outlive. But what if you don't live as long as you believed you would? Does the insurance company keep all the leftover funds if you die too soon? With certain annuities, that's certainly a possibility. However, there are many ways to structure your annuity so that you can leave money to loved ones while providing the income you need while still alive.
- Do I have a long-term or short-time mindset? Most annuities have "surrender charges" if you cancel the contract before a specific time has passed, typically seven to ten years. This feature makes an annuity a longer-term investment.
Answering these questions and discussing those answers with a qualified annuity specialist will greatly assist you in deciding which of the many types of annuities is necessary to accomplish your retirement goals. Again, making an informed choice is crucial if you want optimal wealth protection and tax advantages.
Some annuity types include variable, fixed, multi-year guaranteed (MYGA), or fixed-index, to name a few. Each product has different design options, features, benefits, and costs.
Fixed index annuities (FIAs). FIAs are fixed products but add an interest component tied to an index, such as the S&P 500. FIAs may offer riders that give you a guaranteed income stream and the possibility of some principal upside since they're associated with an index.
When researching FIAs, be sure to ask your advisor exactly how that particular product could potentially throttle your returns with participation caps. For example, if we experience another bull market, caps could limit your gains, so they are not on par with other investments. Nevertheless, caps may not matter to you if you're close to retiring because you may not want any more risk in your portfolio. If you'd like to possibly take advantage of potential market appreciation without having to play in the market, a FIA might work well for you.
As the name implies, fixed annuities pay guaranteed interest rates. These are annuities initially intended to replace traditionally conservative savings tools, such as bank CDs. Fixed annuities remain popular with more fiscally conservative retirees. If you are someone wanting predictable, less costly, guaranteed solutions, you might look into fixed annuities.
Generally, traditional fixed annuities are easier to understand, more flexible, and may provide some tax-deferred growth during the accumulation phase. You are also not limited on much you can invest into a fixed annuity annually.
Because a fixed annuity isn't correlated to the stock market, your account is not affected by marketplace volatility. One potential downside of a fixed annuity is that many have early-withdrawal penalties. They may also be weaker hedges against inflation.
Immediate annuities. You could purchase an immediate annuity if you have a lump sum of money you'd like to grow and protect. You take your lump sum and give it to the annuity company in exchange for consistent, immediate payments. These payments last either until you die or for a predetermined period. Immediate annuities are also tax-advantaged. Many times, immediate annuity payouts are significantly higher than those of other types of annuities. If you believe you're likely to need a more significant lifetime income and are willing to sacrifice your initial investment, you may choose an immediate annuity.
Variable annuities. Variable annuities are perhaps the most exotic annuity option. With a variable annuity, your value is incumbent on the performance of your chosen "subaccounts." For an additional cost, some variable products offer riders that give you a guaranteed income stream, even if your subaccounts underperform. Variable annuities are considered riskier products than other annuities. Although they might give you a potentially higher income than fixed products, their market ties mean they also have a risk.
Variable annuities are a somewhat controversial selection for pre-retirees and retirees because you could lose money, which is never a good thing in retirement. Still, variable annuities remain popular with those who want the chance to create more significant income streams.
You might run across a few of these annuity designs as you build the "safe money" part of your portfolio. You'll also see multiple ways to customize your annuity and different payout options. I can't stress enough how critical it is to seek guidance from a trusted retirement income specialist. Your advisor can help you clarify precisely what you want and need your money to do.
Bottom line. Annuities are products that can help you secure your financial fortress, remove uncertainty, and provide greater peace of mind.
You can supplement your Social Security, private pension, or other accounts using an annuity and build a predictable, guaranteed lifetime income stream. You can also use annuities to provide for long-term care needs, create a legacy for your loved ones, or give you greater peace of mind. However, annuities are not for everyone. If you don't need or want the protection of your principal, long-term care insurance, safeguards against longevity risk, legacy creation, or tax-advantaged growth, they may not be the ideal choice.