Let’s say you’re 65 years old and a relatively successful, long-term stock and bond market investor. Should you – or you and your spouse – consider buying an annuity to supplement your cash flow in retirement and hedge against a reawakening of volatile financial markets?
As is the case for almost everything in the investment and investment-related arena, the answer is maybe. Among other things, it depends upon your risk tolerance, your investment prowess and how much you personally want to pilot your investments. It also depends upon whether you have a problem with paying relatively high fees, regardless of whether they are worth the price of admission to an annuity.
That said, the right annuity makes a lot of sense for our aforementioned 65-year-old and at minimum warrants a serious look. Annuities are essentially the private sector equivalent of Social Security. In the end, what’s not to like about an additional guaranteed stream of income for the rest of your life and your spouse’s life?
You can quibble about the expense, but annuities are insurance products and insurance products are not inexpensive. But not many people complain about insurance if they have it and it turns out they need it.
Many investors try to accumulate as much money as possible to sidestep the worry of running out in their golden years. They figure the more assets they have, the less they have to worry about financially. The fact is, however, most retirees, including millionaires, periodically worry about the possibility of running out of money. And if those people had retired in 1999 or 2007 – just before two of the biggest bear markets ever – they indeed would have had plenty to worry about.
The degree of financial worry comes and goes with the times. Today, we’re in the midst of a strong bull market and, in fact, have been in one for a decade. This means retirees have been able to withdraw 4% or 5% annually from their non-guaranteed accounts for years without worry.
Will it last? Who knows? But what is virtually certain is that another bear market will arrive at some point, generally hitting retirees harder than non-retirees. Younger investors can look at a market opportunity as a buying opportunity. Retirees can, too, but for them it’s much riskier because they have less income and far weaker earnings prospects. No question, most seniors want to avoid this scenario.
Without an annuity, seniors also have to cope with year after year of unusually low bond interest rates. Relatively low-risk bonds have always supplemented stock investments and there is no good reason to think things will change. For seniors, at least, such low rates are a negative.
In today’s environment, popular fixed indexed annuities (FIAs) may be the best annuity option for most retirees and near-retirees. They offer relatively generous guaranteed income riders, stock market participation and the uplifting feature that investors lose no money in down markets. It is true that market returns are also less – most FIAs pay no more than 50% of an annual gain in the stock market. For many folks, however, this is a reasonable trade-off in exchange for no market losses.
Again, however, annuities are not for everyone who can afford them. Because many offer lifetime income and all offer death benefits, their fees are higher than those of standard investments. These can commonly be up to 3% annually. For those who midjudge their ability to stay the course in an annuity, there are also steep surrender charges up to about 10 years. Some retirees have a big problem with this.
Annuities also are not suitable for seniors who take pride in investing all of their money on their own. Personal control can backfire, but there is definitely something to be said for this. In addition, some people are better than others at managing their money and some are also conservative spenders highly unlikely to burn through their retirement savings. For them, an annuity might be restrictive and unnecessary.
Lastly, it’s important to note that annuities are not growth products. Even the best variable annuities, which pay full boat on increases in the stock market, have limited investment choices and restrictions on moving money between separate accounts (mutual funds). And plain vanilla fixed annuities, as well as fixed income annuities, were designed to compete with conservative certificates of deposit. Historically, these have not rivaled the returns of more robust investments.
The bottom line has not changed: The right annuity makes a lot of sense for many seniors. Just remember that an annuity should not be perceived as an investment product. It is an insurance product – and one that should be purchased only for the guarantees outlined in its contract. While an annuity may turn out to be a good investment, this is not the fundamental reason to buy one.
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