When Annuities Are a Good Fit and When They Aren't
Annuities are probably the most misunderstood investment vehicle on the market. Investors really love them or really hate them. You have to go back and understand the history of annuities to see why they are misunderstood. The bad press started when the insurance industry developed a product called the equity indexed annuity. It was a horrible product.
The only way you could get the money out of the product was through annuitization. Annuitization occurs when an investor decides that they want to take out annuity payments for the rest of their life. The problem is that once you annuitize the contract, you lose access to the cash value of the contract. If you didn't annuitize the annuity, then you were only able to take out a lump sum that was a smaller value than the full contract value. As I said, it is not a good contract.
To make matters worse, they were grossly misrepresented by insurance agents and financial advisors. Investors who invested their money in the equity indexed annuities were thinking that they had one thing when they actually had another. After a series of lawsuits and complaints, the industry removed the product from the market.
There were two key complaints. First, the investor felt that they lost control of their money. Second, the return did not meet expectations. That was the fault of the advisor who set those unrealistic expectations.
Years later, the insurance industry developed another product called a fixed indexed annuity. At the time, I was convinced that these were awful products without doing any homework. Then I went to a conference and learned that they greatly improved the product. They gave the investor back control of their money and no one was going to force you to take a lifetime annuity. If you wanted to transfer your lump sum at the end of the contract, you would get full contract value.
There are two problems with the fixed indexed annuity which continues to dog their reputation. First, advisors are still misrepresenting these products setting up the wrong expectations in regards to return. That might never change. Second, only a small percentage of these products are really good conservative options for an investor's portfolio. To give you an example, if you had 100 insurance companies that had 100 fixed indexed annuities, you could take 90 of them off of the table because they were inferior, leaving only 10 worth considering.
I have done my homework and can identify the ones that are truly a good fit. Once again it is a small percentage.
Here is one of the main points that are rarely discussed in annuity presentations. It is important to invest into the right type of annuity that is a fit for your financial situation. There are 4 big benefits of fixed indexed annuities:
1) Death Benefit - Some are designed to create a larger death benefit over time. If you were leaving that money to someone and had no need for it, then this type of annuity would be a fit.
2) Liquidity - Some are designed to return principle to you at any time or a shorter time period.
3) Income - Some are designed to create an income stream you can't outlive while still retaining control over the cash value.
4) Conservative Growth - Some are designed to just give you the potential for good conservative growth.
Now here is the disclaimer that is often left out of conversations between advisors and their clients. Of the 4 big benefits, in most cases each annuity is only going to be designed to deliver on 1 of 4 of those benefits. For example, if the annuity is designed to produce a good income benefit, then you are not going to be impressed with the growth potential. If the annuity has a good growth formula associated with it, then you are probably not going to have a good income provision.
Bottom line: Since all fixed annuities are guaranteed not to lose money, insurance companies can only give you so many benefits with these products
Currently, there are a few options on the market that excel at two of those benefits. For the most part, you are choosing an annuity that delivers on the one thing that is most important to you.
Other things to know about annuities:
The money in an annuity is shielded from creditors and lawsuits
Money inside of an annuity grows tax deferred. You don't pay taxes until you take the money out
Annuities are beneficiary directed. So the money can pass onto a spouse or kids effortlessly
One last warning when dealing with an annuity salesperson -
There are guaranteed returns and projected returns. ALWAYS be comfortable with the guaranteed returns. Pay very little to the hypothetical returns. Most of the time the stars have to align for those numbers to work out.