Don’t Just Jump to Indexed Annuities

The burden of educating nearly everyone on this website wears me down sometimes.  Too many advisors have a one-track mind and fail to explain all options for either income or asset protection.  At worst this puts a fair number of people into contracts that are inappropriate and on average it’s ok but not nearly as good as it could be.  Yes, most people could do a lot better if they truly understand all options related to guaranteed income or asset protection.  And there aren’t a lot of advisors who take people through the correct progression of all options.

Using an annuity in retirement means making a structural change to a portfolio.  Whether you are reducing risk or trying to improve a safe allocation, it represents a change in objective and departure from all of you have done while saving for retirement.  It’s different from what any of you have done to this point and in a lot of cases you only get one shot at it.  Because it is often the largest financial commitment a person can make, it deserves some real attention.  I don’t mean to say there are no advisors doing it the right way but judging what I see on a daily basis it’s definitely the exception rather than the rule.

Here’s about how it goes: someone goes looking for a way to generate income or just protect some assets and the salesperson jumps right into selling them a fixed indexed annuity.  The customer may or may not have heard about them and most often doesn’t know much about annuities in general.  They go home and do some searching and find me, make an appointment and I have to figure out why the indexed annuity was recommended in the first place.  More often than not it was the only option given.  For everyone who makes it through the proposal meeting without buying there’s at least one other who accepts it and signs the papers.

We have to make some assumptions in order for me to give you an example of what I’m talking about.  Let’s assume a person has 100% of assets in the stock market, which was the case with the guy I was talking to when this idea hit me.  He was retired and didn’t need any of the money in his portfolio so he left it alone and let it grow for the past few years.  Now he’s getting closer to 70 years old and decided he wants to reduce risk and preserve some capital.  His current broker is just a stock market guy and only gave him the typical line, “just let it ride and it will go up over time.”  The broker is probably correct but the customer wanted to reduce risk and take an easier path through retirement.

He met with two other salespeople before me and during our first call jumped right into asking what I thought of the two indexed annuities that had been recommended.  I knew nothing about him so we had to take a few steps back.  I wasn’t a big fan of either contract but that was beside the point.  I had to first figure out if he knew there were other options for safe accumulation and it didn’t take long to learn that he didn’t.  Fixed indexed annuities are the most complex safe money option and are not hard to understand but it’s a lot easier if you have the building blocks first.  It’s harder for a child to learn to read without first knowing the ABCs.

If you are using an annuity to reduce risk then you have to go through a progression of options with fixed indexed annuities being the last option to consider, not the first or only.  This may seem like I’m patronizing people but there really are a lot of people who don’t understand one or more of these options, as simple as it may seem.

1. Go to cash- The easiest thing to do is liquidate a portion of assets and stick it inside a money market fund in your IRA or brokerage account.  Regardless of what many say, all brokerage accounts, IRAs and variable annuities have a fixed interest account.  This is easy because it’s fully liquid and can be a great place to park money while other options are being evaluated. Rates are variable at all times.
2. CDs – If you want some FDIC insurance and desire to lock a fixed interest rate for a longer period of time then this is an option.  It’s likely the most popular place to park money but CDs have no liquidity and are taxable annually if you don’t own them inside an IRA.
3. Bonds – The investment management crowd likes this one and it’s the traditional safe allocation for portfolio management.  You’ll get consistent interest payments but there’s interest rate risk if you need more cash flow and being the primary owner of a bond is usually better than owning a bond fund.  Interest is also annually taxable unless the money is inside an IRA.
4. Fixed Annuities (MYGAs) – This is essentially a bond with an additional layer of security.  Yes, bonds back annuities so you get similar if not better rates and insurance company reserves give you additional protection.  Taxes are deferred until withdrawals are made whether an IRA or not and there is no interest rate risk for withdrawals up to 10% annually.
5. Fixed Indexed Annuities – An alternative to fixed annuities (MYGAs), fixed indexed annuities have the same structure and protection from interest rate risk but offer potentially more yield based on growth in an external market index.

This is the progression of options when evaluating safe money.  Too many advisors have a favorite and never offer anything else.  I like to go through this because three of the five options are assets that I don’t offer.  To save time for both of us I need to first make sure that the best option for you isn’t something that you already have access to.  With the insurance products, there are too many agents that skip the fixed annuities (MYGAs) and go straight to fixed indexed annuities.  At the very least it needs to be explained that the fixed annuity (MYGA) is the building block for the fixed indexed annuity.  Without that you aren’t given the basics that will help you truly understand how fixed indexed annuities work.

Each of the above has advantages in terms of time, liquidity and overall benefits.  It’s up to you to figure out which works best and someone who can effectively explain all options is going to be more beneficial than someone who does not.  It also saves you from talking to several people and getting a whole bunch of different proposals.  If you want to make decisions based on confidence, knowing that you did indeed get the best option then this is the way to do it.

Podcast Episode: Don’t Just Jump Into An Indexed Annuity

Last Updated on January 19, 2024 by Bryan Anderson