In a recent article for The Wall Street Journal, the American Association of Individual Investors’ Charles Rotblut offered “A Guide to Avoiding the Biggest Annuity Mistakes.” Annuities confuse many people, so it is the responsibility of advisors and insurance companies to make sure that these products are well understood. Confusion often drives people away from products that could have offered them lifelong financial benefits. The author says that annuities are a good product if they are used in the correct way for individual investors. He believes that they are best used for their lifetime stream of income, particularly later on in retirement. Annuities account for longevity risk in your retirement portfolio. Since you really have no way of knowing how long you will live, you can transfer your longevity risk to an insurance company through the purchase of an annuity product. After a lump sum payment to the insurer, you will receive lifetime income payments starting immediately or at some point in the future.
Mr. Rotblut recommends annuities that are simple and used for an income stream, rather than for the creation of wealth. He believes that fixed indexed annuities are more complex than many investors need and recommends investing in a diversified index fund instead because of the lower cost. He doesn’t point out in the article, however, that direct investments don’t offer the guarantees that you can get with fixed indexed annuities. While neither product is better or worse in all situations, it’s worthwhile to do a legitimate comparison of the costs versus the benefits before deciding whether indexed annuities might work for you. The article says that variable annuities can be beneficial to investors if they are no load and have low surrender fees. They would work for people who have already maximized their retirement plan contributions. It’s important to know all of the fees associated with indexed and variable annuity products, especially how much it would cost to immediately access your money.
The longer you wait before receiving your annuity payments, the higher your payout will be. This is one of the reasons that longevity annuities and QLAC’s are being used more now than ever before. You can purchase one of these annuity products for a relatively low cost and receive significant income when your payments start later in retirement. If you need your payments to start right away, an immediate annuity product can do that. The author says that because of historically low interest rates, you might want to consider laddering your annuity purchases over time to take advantage of the potential for higher interest rates in the future. Spreading out your purchases over time is called dollar-cost averaging and makes sense when rates are low. This is especially true since we’ve just seen the first interest rate increase in years and are likely to see more increases this year.
Perhaps one of the most important things to do before buying an annuity is to ask questions. Make sure that you know all of the different costs that come with your annuity, including any commissions and surrender charges. If there is any part of the annuity product that you don’t understand, your advisor should be able to explain it to you. If they cannot and they don’t find the answers to your questions, then it’s probably not a good idea to purchase that product. Annuities are useful products for retirement planning, but you have to ask questions and know the details before making such a significant purchase.
Written by Rachel Summit