The Benefits of Annuities

Are all Annuities Scams? Certainly not if properly positions and structured for a conservative or risk adverse investor.

Annuities are investment contracts sold by insurance companies. Annuities may be ideal for conservative investors who are seeking an alternative to low interest bank rate products like CDs. Fixed and indexed annuities may be ideal for that portion of your investments that you do not want exposed to the risks of the stock and bond markets. Many annuities have guaranteed income features which is why many people like them. Conservative lifetime guaranteed income is the big appeal for many annuity buyers.

The number one fear of retirees is outliving their supply of money. Annuities can solve that issue by providing life-long financial serenity.

Many advisors believe that the first step in planning for retirement is establishing a guaranteed inexhaustible income stream before investing your remaining assets in riskier, possibly higher performance investments. In short, part of your retirement nest egg should be protected from the volatility of the stock and bond markets.

An indexed annuity enables individuals to create their own private pension account with the security of a large insurance company guaranteeing the income for life features.

Let’s start the annuity discussion by addressing the negative and misleading spins that are often promoted in the media. These misconceptions get in the way of understanding the great benefits of an annuity and must be disproven.

  1. Annuities have high commissions. In contrast, you pay no commissions! There are no commissions deducted from your investment in an annuity. All of your money goes to work for you immediately. Your annuity advisor is paid a finder’s fee directly from the insurance company that does NOT directly affect your investment.
  2. Annuities have high fees. Yes, some variable annuities have higher fees. However, most fixed and indexed annuities have no fees unless you elect certain optional features that may have fees.
  3. Annuities have high surrender fees. Therefore, your money is not liquid. Annuities are intended to be longer term investments, and so most annuities have a declining surrender fee if you withdraw too much money too early. These fees are typically limited to 10% and occur only in the first 5 to 10 years of the annuity. These fees also decline to zero over the first 5 to 10 years. Furthermore, most surrender fees can be avoided if you limit your withdrawals to only 10% per year. Even with a full 10% surrender fee, 90% of your money remains liquid from the first day. But for comparison purposes, if you invested in a stock early in the morning you could lose 10% by that same afternoon. The surrender fee is inconsequential when compared to the volatility in other less conservative investments.

Guaranteed life-long income is the most attractive feature for most annuity contract buyers.

Industry reports show that over 70% of indexed annuities are sold with an income guarantee. However, many annuity buyers misunderstand this guaranteed income and mistakenly believe they are guaranteed interest payments which they are not!

The income guarantee feature is a planned fixed periodic withdrawal from the annuity’s cash value. If the annuitant lives beyond when the cash is exhausted, then the insurance company must continue to make payments. This means you can’t outlive your investment. A huge advantage you can only get from annuities.

Fixed and indexed annuities provide only positive growth that cannot be reduced by declines in either the stock or bond markets. You will never experience a market related decline in a fixed or indexed annuity. They are as safe as the insurance company that guarantees them. And that is very safe compared to other investments. These growth rates compare highly favorably to many bank-rate products such as CDs.

The cash value of some annuity contracts can continue to grow even after an income-for-life feature has started paying income. This increases the possibility of remaining cash value being available to your heirs after you are gone.

Some annuity companies charge a fee for the income guarantee while others offer this income guarantee for free.

If an annuity buyer understands that the income guarantee is not interest, but instead limiting the cash value withdrawal rate in exchange for the insurance company’s promise to continue providing cash if the annuitant outlives the cash value, then the income guarantee may be a significantly valuable feature. This is particularly true if the annuitant is in great health and has a family history of long life. In fact, a family history of long life can make an income-for-life guarantee more valuable.

Some annuities feature a withdrawal account or income guarantee account (or some other clever account name) balance as growing at a guaranteed rate per year until you start taking income-for-life withdrawals. However, one must understand this account is not real money that you can withdraw in a lump sum or spend. It is only an accounting number (an imaginary account) that determines what your guaranteed income stream will be once you turn on that “income-for[1]life.” Don’t be confused into believing your investment is growing at this rate.

Sometimes, annuities guarantee this imaginary account is growing at 5 to 7% until you turn on “income-for-life.” How can they guarantee this imaginary account growth? First, there is no real account or money growing. Second, this accounting number can grow higher because it merely reflects the size of your annual payments (withdrawals). Each year you wait to start making withdrawals from the annuity, you are perhaps 3 to 6% closer to your death. This means the insurance company has less risk of paying you for a longer period of time. Since they will be paying you for a shorter period of time (because you are closer to death) the payout rate can be higher. Remember, this imaginary account is growing because it is not real or available in a lump sum. It does not count as anything more than fluff, that misleads the annuity buyer into thinking they are buying guaranteed growth of their money. Annuities cash value certainly do grow but usually not at this high guaranteed rate.

Newer and more honest annuity contracts simply state that your income for life increases each year as you delay your income-for-life starting date. So, by delaying your start of income-for-life payments these payment amounts can increase each year.

Indexed annuity buyers (and salespersons) are so focused on income guarantees that they may ignore the real growth potential of the cash value. Many indexed annuities are indexed to the S&P 500® with annual caps in the 3 to 5% range. But as interest rates are rapidly climbing, I now see caps as high as 8.25% in June of 2022. If interest rates continue to climb, indexed annuities may become more attractive.   

Note your money is not invested in the index, but you may receive an interest credit that is partly determined by the change in the index. With the up-year caps and the down years avoided, the cash values of many indexed annuities can expect an average performance in the 2 to 7% range, a modest but safe investment. Note that in 2022 this rate is increasing. You are protected from stock market declines. If one was to subtract the annual cost of the income rider, typically 0.95%, the cash value grows more slowly. However, some indexed annuities may offer an index crediting method that is competitive with and often better than other low volatility investments. Sometimes you can find an indexed annuity that has a crediting method with a proven history of 4 to 7% average returns per year to the cash value of the account.

An indexed “growth” annuity offers tax-deferral and protection from the stock market declines while providing the possibility of enhanced interest credits. They typically offer much better returns than most bank rate products (CDs).

If an annuity buyer focuses on the cash value growth, some indexed annuity policies offer enticing index crediting methods that provide for substantial real cash value growth. This growth can be in the 4 to 7% range which is very respectable for safer investments and risk adverse people.

You can ask the insurance agent to run an illustration of the cash value growth. If this cash value growth is in excess of 5% average annually for the last 10, 15 and 20 years, you are viewing an annuity worthy of consideration. This real cash growth can be drawn upon when an income stream is needed or used to purchase a much higher paying bond when interest rates have returned to a more desirable level.

Some of the better annuity contracts focus on the cash value account growth and offer income guarantees that are free. These are the annuities that are most worthy of your consideration. The income guarantee can be a nice feature if it does not reduce your cash value account growth due to an attached rider fee.

Are variable annuities better than indexed annuities? Variable annuities are directly invested in the stock market and carry that higher risk. However, the high expense of variable annuities typically removes about 2 to 3% of what you would have earned by directly investing in the stock market, making them an expensive way to invest in the stock market. It would be better to stay with indexed annuities that don’t have this extra expense and are not affected by stock market declines.

Go to the calendar link to schedule and appointment with and expert, Curtis Hill. Discover how an annuity, structured properly could be right for you. Learn how “Not the Same Old Advice” can benefit you