Before you add an annuity to your income strategy, it’s prudent to understand what an annuity does and what it doesn’t do.
Essentially, annuities are insurance contracts. They are built to pay lifelong streams of fixed income, protect money from market losses, or offer tax-deferred money growth.
Indeed, billions of dollars sit in these contracts. A large part of that is due to their popularity for lifetime income, or for higher growth potential than with other low-risk interest-earning vehicles.
Nonetheless, there are still a number of myths and misconceptions about annuities. That might be attributable to a few factors, from annuities being fairly complex to misleading annuity marketing and sales tactics being touted.
This isn’t to say that annuities don’t have a place in a retirement portfolio.
Just like with any other financial vehicle, though, they must have a specified role. That can include solving for particular retirement risks, working in tandem with other parts of a portfolio to reach certain goals, or even simply providing peace of mind with predictable retirement income streams.
Let’s break down some annuity myths and misunderstandings, one-by-one, and learn more about them.
Breaking Down Common Annuity Myths
Annuity Myth #1:
You can easily get lifetime income from “better” financial vehicles than annuities.
Annuities are the only financial vehicle that can offer guaranteed lifetime income.
What sets annuities apart from other retirement income strategies, such as bond laddering, is that owners of certain annuities can benefit from what is known as a mortality credit or mortality yield.
With these participating annuities, the premiums paid by those who pass away earlier-than-expected add to the gains of other participating annuity owners. This provides a larger credit to survivors than they could potentially achieve outside of this pool using other individual investments.
Based on their actuarial math, annuities are oftentimes better than bonds for increasing lifetime payments.
Annuity Myth #2:
Annuities cost too much.
Annuity costs vary depending on which one you choose and the solution you want it to provide.
To begin with, there are simplified, lower-cost annuity options. When you are choosing an annuity because you want it to solve for a specific financial risk, you may elect to receive additional benefits from your annuity for an added cost.
These additional benefits come in the form of “riders” that are attached to your annuity contract. These riders are designed to enhance your annuity's income, legacy, or long-term care benefits.
There are two types of riders, living riders and death benefit riders. Just as you would expect, living riders are designed to provide benefits to you while you are living.
Death benefit riders are designed to protect benefits that will go to your beneficiaries. Should someone die before the annuity has returned all of their premium payments, that person's estate or their beneficiary receives the difference from the insurance company.
Annuity Myth #3:
Don’t buy an annuity before retirement.
An annuity can help you preserve hard-earned retirement dollars for future income before you retire.
When you buy a fixed-type annuity while working, you put a protective ‘shield’ over your nest egg. How?
Because, with the strict reserve requirements and other safeguards that fixed annuities have, you can avoid stock market fluctuations, or even a costly market drop, prior to your workplace departure.
This can be especially helpful when you are in the retirement red zone, which is 10 years before you retire. Why?
Because some annuities reward you for delaying taking a payout from the contract. The longer you wait to take income, the higher the income you will receive from the contract.
By preserving your retirement money, annuities can also help you save valuable time.
No one can predict how quickly the market might recover from a correction or a more significant drop. But that being said, the protection of your money also means you sidestep the time it would take for your money to climb back to its original value.
This can be crucial to keeping your planned retirement date and financial goals on track.
Annuity Myth #4:
When you pass away the insurance company takes your remaining cash balance.
This is only the case when someone chooses "life-only" among the choices for annuity payouts. In several other cases your beneficiaries will continue to receive income payments or the remaining cash balance within the contract.
Consider your retirement financial plan before choosing an annuity. For example, you may want to select an annuity that ensures your spouse will have enough income after you pass away.
Annuity Myth #5:
You can compare fixed index annuities to the stock market.
Despite the temptation, comparing these two investments is not an apples-to-apples exercise. It’s more like apples-to-oranges.
Fixed index annuities (FIAs) don’t actually participate in the stock market as, say, a mutual fund would. By definition, a fixed index annuity provides principal protection in a down market and some opportunity for growth, something the stock market isn’t designed to provide.
The interest an FIA earns doesn’t come directly from the stock market. Instead, fixed index annuities credit interest based on the movements of a key stock market index, such as the S&P 500, excluding stock market dividends.
Yes, a fixed index annuity doesn’t include dividends that you might otherwise earn from equity market investments. But this also means that your money inside a fixed index annuity will never be exposed to stock market risk.
The trade-off of less growth potential, in exchange for principal protection, is one of the hallmark features of a fixed index annuity.
Better Manage Your Retirement Risk
Recently, Wade D. Pfau, Ph.D., CFA®, a respected authority on investing and retirement planning, published a whitepaper titled “Managing Risk with Fixed-Indexed Annuities in the Pre-Retirement Years.” He reports that FIAs are “another option for pre-retirees to consider that provides structured returns to better manage downside risks.”
According to Pfau:
Fixed index annuities can also “function as an asset class within an accumulation portfolio to better manage downside risks, while still allowing for participation in the market upside. The ability to better manage downside risks can lay a foundation to either reduce the asset level necessary to successfully retire, or to enhance the returns produced by a given asset base.”
Does an Annuity Make Sense for You?
To judge for yourself how an annuity may fit into your retirement income needs, consult with a financial professional who can help you evaluate your unique situation. With their guidance, you can explore if a carefully selected annuity can help you meet your needs for a safe, secure retirement.
When you are ready for personal assistance in exploring your retirement and income options, JenniferLangFinancialServices.com can assist you.
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