“Annuities are among the most misunderstood retirement and income products on the market. Even some agents who sell annuities don’t truly understand them or their power to transform your retirement.” Brad Rhodes
Contrary to what some television financial “advisors” say, an annuity, when properly understood and sold correctly, is an excellent retirement and income planning tool. For the average retiree or pre-retiree, the purchase of annuity is specifically to create a stream of cash during retirement. Annuities function best as hedges against the possibility of outliving your savings. For this reason, many economists and financial researchers respect annuities and praise their ability to create a source of contractually guaranteed income. That’s because, as much as we may desire to do so, few of us will be able to predict our lifespans accurately. Thus, transferring the risk of a longer-than-expected lifespan (“longevity risk”) via an annuity contract makes sense.
Annuities can provide some measure of growth, along with longevity risk protection, although you should not place them into the wealth accumulation sector of your retirement portfolio. An annuity’s purpose is to protect and preserve wealth. So any growth that results from owning one is merely icing on the cake. If you desire to protect your investment, gain income for life, provide money for long-term care, or create a legacy, you may want an annuity. However, if none of these goals are important to you, then an annuity probably doesn’t make sense. Either way, a sensible approach to annuities involves understanding them better. When you discover more, you will avoid some of the most common mistakes and misconceptions people make when adding annuities to their retirement plans.
Here are some of the most common mistakes people make when thinking about an annuity:
Many people believe that all annuities come with high fees.
Many traditional financial advisors dissuade their clients from purchasing an annuity because they mistakenly believe that all of them have high fees. However, most of the burdensome costs your advisor may warn you about exist only in variable annuities. Many fixed-index products contain no or very few fees at all. Figuring out what, if any, costs your selected product has can be challenging. That’s why savvy annuity purchasers get a second set of eyes, preferably those of an annuity expert, to review their selections before purchase.
Some seniors put too much of their money into the annuity basket.
Annuity products, when explained the right way, sound too good to be true. They can provide you with a predictable, protected source of income to supplement Social Security and other accounts. Certain annuities are designed to give you cash if you need long-term care or additional medical assistance not covered by Medicare. An annuity can also assist you in leaving a legacy for your loved ones. For all these reasons, it’s tempting to want to put every penny of your savings into purchasing an annuity. However, you should keep in mind that annuity contracts are often somewhat illiquid and inflexible. Even deferred annuities, products that allow you to withdraw a portion of the guaranteed annual value (5-10%) without penalty, could have provisions that may cause you to lose your income guarantees if you take out too much money.
You, your advisor, and your annuity expert must discuss how much, if any, you should invest in this product. Adding up your expected retirement expenses and subtracting pension and Social Security funds and other income may give you a rough idea of that amount.
You might select the wrong payout option.
When purchasing an annuity, you must decide the payout option that works best for you. For example, a single-life version of an immediate annuity (one that stops paying when you die) gets you a high payout. However, if you are married, a single-life immediate annuity stops paying when you die and leaves your spouse with no income. A lower payout annuity that continues to pay after your death might be a better option.
The bottom line: Annuities come in a broad spectrum of “flavors,” each with its own set of pros and cons. Anyone looking into these often complex financial tools must partner with an expert in annuities and their many nuances to avoid potentially costly mistakes. A qualified safe money and retirement advisor will assist you in discovering the right annuity, if any, and help you avoid making costly mistakes.