When you see a headline involving annuity products, the words “bad,” “scary,” and “avoid” often are included. Obviously, the use of such words has created a bit of an image problem, driving many investors to steer clear of all annuities. Lumping all such products together and determining them all to be “bad” is quite a disservice, as there are vast differences between the many available products. According to a recent Kiplinger article, there are two main product types in the annuity industry: “savings annuities,” which are designed to accumulate savings, and “income annuities,” which are designed to pay out income for life. Try to decide for yourself if these financial products are good, bad or simply misunderstood as we discuss the differences between them.
The annuity products criticized most often are variable annuities. The variable annuity’s main objective is to allow investors to build after-tax savings on a tax-deferred basis through a choice of underlying mutual or ETFs. Because it is an “annuity,” the investor has the opportunity (and in some cases is required) to convert to an income annuity. Index annuities are another product that are often attacked. An investor’s savings grows by an interest rate that can reflect the performance of a particular stock index. Just like a variable annuity, it can be converted to a lifetime payout.
Right off the bat, there doesn’t seem to be anything too negative about these products, so where does all the criticism come from? There are a number of reasons.
- Complexity. Annuity companies often add bells and whistles to differentiate their annuities from their competition. These can often be confusing.
- High annual fees and/or back-end surrender charges. Investors need to decide if the fees are worth the value of the benefits for the intended use of the product.
- High commissions. Brokers and agents usually receive commissions that are higher than the commissions they get for income annuities or for load mutual funds and bonds.
- Too good to be true? The downside protection provided by most annuities requires the companies to adopt complex hedging strategies. That may concern some investors about the risks assumed by annuity companies.
Are there often better options, especially for some Baby Boomers, than a variable annuity? Yes. Does that mean that these annuities are bad for everyone? Absolutely not. The problem is that many investors do not fully understand these products and therefore can’t safely decide if they are right for them.
Income annuities, on the other hand, have existed in some form for over 100 years. They are offered by insurance companies that survived not only the Great Recession in the 2000s, but also the infamous Great Depression of the 1930s. They are designed to pay out a guaranteed lifetime income, providing the unique protection from outliving retirement savings. With these products, you don’t pay management fees or hidden charges. You simply pay a bulk am0unt in return for a monthly payment, made to you by the insurance company, for the rest of your life. These payments are guaranteed, and if you live long enough, you can definitely receive more than you initially paid.
Income annuities are customizable so that consumers can tailor them to their personal situations. Options include spousal payments if you pass away first, payments adjusted for inflation, or an arrangement to leave a lump sum to heirs. Another feature that facilitates advanced retirement income planning is the ability to select the date income payments start. A QLAC is a type of deferred income annuity purchased out of a rollover IRA, also provides unique tax benefits. Income annuities that are purchased out of non-rollover IRA accounts also offer special tax benefits.
Shopping around for the best annuity product for you is always recommended, but you’ll likely find that the highest-rated companies often offer the best rates. If you choose an annuity from a company rated “A” or higher, your guaranteed payments are backed by financially strong companies. But as with any large financial decision, it is imperative that you understand exactly what you’re getting yourself into before signing on the dotted line. Discuss how an annuity product might benefit your retirement savings plan with a trusted financial advisor, and remember that you can’t always believe what you read.
Written by Rachel Summit