When considering purchasing an annuity you should be looking to do so for one (or more) of 3 reasons. Annuities are primarily used for; guaranteed income, accumulation with some form of protection and tax-deferred growth. Think of these as three legs to a stool. While I do not believe that an annuity is right for everyone they can certainly play a vital role in the financial planning process.
Do You Want Guaranteed Income?
To begin, lets look at the guaranteed income leg. Guaranteed income in retirement sounds like utopia, doesn't it?? Well it certainly can be! However, you do have to pay for those guarantees. It's these costs that tend to give all annuities a bad rap. What is every investors number one fear in retirement? RUNNING OUT OF MONEY! This type of annuity can ensure that never happens.
Fortunately for you, not all annuity products come with egregious fees. In fact, in recent years I've seen more annuity companies come out with solutions that are quite competitively priced compared to other traditional investment options.
Don't let a television commercial or something you overheard at a party ruin your outlook on annuities. Annuities, like investments, are not created equal - there are some great ones and there are some not-so-great ones. As a financial planner, we must look at all the options available and decide which ones are the most suitable for you and the goals you're trying to accomplish.
If you're someone who is worried about the markets and you prefer less volatility in your investment portfolio this may be a solution for you. Not to mention, many annuities allow you to see exactly how much guaranteed income you will receive based on what age you begin your withdrawals. No surprises!
Would You Like Some Accumulation With The Potential For Downside Protection?
Potential for downside protection, not to be confused with total protection from loss! Another reason someone may consider an annuity is to still have the ability to participate in the market while knowing some of their losses may be covered by the insurance company. What do you need to give up to receive this? You must give up some of your potential upside.
For example, let's say there's a solution that says, you can select a market index (S&P 500, Dow Jones, NASDAQ) and receive all of the annual returns up to 10% from when you invested. Now, any of the returns over 10% for that year the insurance company keeps. However, for that they agree to cover the first 10% of your losses if the market is negative for your contract year.
Once again, this an example of the insurance company willing to accept some risk, however, they must be compensated accordingly for doing so. You may be beginning to see that these solutions are not as awful as the mainstream media and financial pundits makes them out to be. There are many cases when an annuity makes a great deal of sense.
Would You Like Tax Deferred Growth?
Last but not least I'd like to cover annuities that are used for their tax deferred growth benefits. If someone is using an annuity for this benefit they are assuming that they will be in a lower tax bracket when it comes time to take distributions.
Now, if you're investing with retirement money (think IRA, Roth IRA, 401K) then you would not need to use an annuity for tax-deferred growth because IRA and 401K assets already grow tax-deferred and Roth IRA assets grow tax-free. So, this is only an advantage for what we call "non-qualified money" - think money that has already been taxed (i.e. money in the bank).
Once again, if you're an individual in a relatively high tax bracket and presume it will be much lower in your retirement years then this strategy would make perfect sense for you. One thing to watch though, like IRA's and 401K's if you invest your after-tax dollars into an annuity you will still receive a 10% penalty for withdrawing it before age 59 1/2.
If you are in a situation where you are facing a steep tax bill, using an annuity for some of your investment portfolio could be a great way to help reduce this tax burden. Every case is unique so what works for one person may not work for another but that's why we believe no investment tool should be completely ruled out solely because there are a few bad apples in the bunch.
Annuities are long-term investments suitable for retirement funding and are subject to market fluctuations and investment risk, including the possibility of loss of principal. Annuities generally contain fees and charges which include, but are not limited to, mortality and expense risk charges, sales and surrender charges, administrative fees, charges for optional benefits and riders, and annual contract fees. Annuity guarantees, including guarantees associated with benefit riders are subject to the claims-paying ability of the insurance company. Surrender charges may apply if money is withdrawn before the end of the contract. Additionally, if purchased within a qualified plan, an annuity will provide no further tax deferral features. The contract, when redeemed, may be worth more or less than the total amount invested.