Annuities are for Protection
One of the more regular comments in my career comes when people contact me and say that they know nothing about annuities. Most claim to have not done any homework before retiring and now feel at a loss because someone pitched them an annuity product and they don’t know if they should trust the advice. For me, it is hard to step back to the basics because I have spent so much time writing and documenting information about annuities. So, for anyone who says, “I don’t know anything about annuities”, this is for you.
It is hard for me to start without sounding patronizing but I do understand why many people need the basics first before jumping into more technical planning strategies. I have tried for years to develop an order of introductory emails that would walk everyone through the process but each person moves at an individual pace and not everyone opens, reads and understands every single email.
From this point forward, this will be my go-to newsletter and podcast for anyone who has the same concern. It’s very simple if you take it one step at a time.
First and foremost, annuities are for protection! Decide what you are trying to protect and there is likely an annuity that will get you at least part of the way there. When I say this is simple I also want to mention why the remaining scope of financial options is not as complicated as many people think. Annuities are meant to protect in a way that no other financial product can.
Income annuities offer guaranteed lifetime income and protect you from running out of money.
Variable annuities were created to protect growth from taxes.
Fixed and fixed indexed annuities protect you from market volatility.
Income, taxes and asset preservation all sound like core retirement concerns to me and nearly everything that might concern you in retirement is closely related to one of those. But annuities are hardly that simple. Within the entire scope of this retirement product is an abundance of options and uses. That’s what loses people.
Let’s start with the two different types of annuities, immediate and deferred.
Immediate annuities are an exchange of premium for lifetime income payments. You give the insurance company money and the company sends you monthly, quarterly or annual income payments for life.
Deferred annuities allow you to wait a while until the insurance company starts sending you income payments. During the deferral period, your expected income payments will grow bigger the longer you wait.
Immediate annuities are simple and straightforward with a few internal options that make them more palatable for anyone who doesn’t just want to hand money over to an insurance company. But deferred annuities bring about the most complexity. This is where you will find all the options that make it sound confusing. The most important thing to understand is that deferred annuities are very open-ended and offer many options. Yes, they all have provisions for guaranteed lifetime income but they also offer a number of other living benefits.
You will find three types of deferred annuities…
Variable Annuities – originally created to shield market investments from taxes
Fixed Annuities– offer a fixed deferred interest rate just like a CD
Fixed Indexed Annuities– leverage interest from a fixed annuity to purchase market options for potentially higher growth
Your individual preferences will direct you toward the product that is best for you. Unfortunately you may be limited to certain options simply because of who you ask. Insurance guys sell fixed and fixed indexed annuities while investment managers sell variable annuities, generally speaking. This website is dedicated to helping people see all the options regardless of what that means for me.
I mentioned before that deferred annuities in basic form are meant to defer income for a period of time. That’s what makes them annuities. But you have the choice of whether to exercise that option and many never take it. For this reason you’ll find much more flexibility with deferred annuity contracts.
The confusion comes from all the additional riders, or additional benefits that can be used with deferred annuities. Fixed annuities simply offer a guaranteed interest rate for a number of years and don’t typically have additional bells and whistles. But fixed indexed and variable annuities have several riders that can be added for additional benefit. Let’s do it one product at a time.
Variable annuities all come with mortality and expense fees that guarantee the initial investment against market losses as a death benefit. If the market drops and you die, your beneficiaries will still get back all the money you put into it. Below are the additional riders you can attach.
Guaranteed Lifetime Income- Allows you to take guaranteed income payments for life, regardless of market performance. As you withdraw money, the market investments need to outperform the withdrawals and fees. With poor performance you may well drain the account to zero at some point but with this rider you will still get your income payments.
Enhanced Death Benefits- Income payments and withdrawals will reduce the original death benefit guarantee that comes with every contract. An additional rider for an enhanced death benefit
Long-Term Care Benefits- This is closely tied to the guaranteed lifetime income rider and offers an enhanced income payment for a set period of time if the annuitant needs long term care. This is covered extensively in podcast episode 5 “Annuities and Long Term Care.”
This is all covered in the “Simple Guide to Variable Annuities” that is a medium-sized report available in the newsletter from May 7, 2021. I’m not going to recreate the whole thing here but if you want more detail that’s a great source.
Fixed indexed annuities have the same options as variable annuities so it’s not worth repeating. It is nothing more than an additional guarantee you can place on the contract if it comes with a benefit you really want. The main difference between fixed indexed and variable annuities is how the account performs. Otherwise it’s the same thing.
There is one remaining point of confusion regarding deferred annuities that relate to both FIAs and VAs. There is a big difference between contractual provisions for guaranteed income and an additional guaranteed income rider. The contractual provision essentially commutes the cash value to an immediate annuity while the guaranteed income rider allows you to maintain the residual cash balance. One comes for free and the other costs money, probably because it’s a more enticing benefit.
There are several newsletter and podcasts where I dive into more detail about income and deferred annuities. One of the most recent podcasts is something I sent out on July 29th of this year, titled “Guaranteed Income: Yes or No?”
Annuities are not that complicated if you start with the basics first. I suggest checking out some of these resources on this website and asking me if you don’t know where to look. If you come up with a request for a topic that hasn’t been covered then you’ll have the benefit of knowing that you inspired a podcast that will help a lot of other people.
Enjoy your weekend!