Annuities are unique in that they offer a wide range of benefits for those thinking about how to fund their retirement as well as protect their assets while leaving a legacy for their loved ones. However, annuities are not an investment; they may not be suitable for everyone.
Along with the benefits come certain restrictions or limitations that, if not fully understood, could work against an individual’s circumstances. But, for the right people, and when used in the proper financial context, annuities can be an unparalleled in their ability to help people reach their financial goals.
The features and characteristics that go into making annuities work the way they do are best understood when applying them to the financial needs and objectives of individuals who are better positioned to benefit by them. The following can provide you with a way to classify your client’s unique circumstances to determine if annuities might be suitable for them.
Suitable Candidates for Annuities
People who are risk averse
Some people prefer to put their money in vehicles that have little to no exposure to risk. People associate savings accounts, T-Bills and bank CDs with safety of principal. There are many different types of risk, which, if not accounted for in your clients’ savings or investment strategy, could have a detrimental effect on their long-term savings. However, as a long-term savings vehicle, annuities may provide many layers of protection for preserving your clients’ principal. In addition to principal guarantees offered in many annuities, they also include minimum rate guarantees to protect against steep declines in interest rates.
People who don’t like taxes
While nobody wants to pay taxes, for those individuals in the higher tax brackets, annuities offer the benefit of tax deferral on earnings that accumulate inside the contract. For someone in the 50-percent tax bracket (combined state and federal), that would mean that their earnings could grow 50 percent faster than in an equivalent taxable vehicle. They will, however, have to pay taxes on their earnings when they are withdrawn, but assuming they are in a lower combined tax bracket at retirement they will end up saving on the amount of taxes that would have otherwise been paid.
People who want a competitive edge
Even risk averse people like to get that extra edge of a half a percent or more interest credited to their accounts. The earnings on annuities tend to be higher than those available on equivalent savings vehicles. Additionally, many annuity contracts will pay a bonus rate on initial deposits that exceed a certain amount. And, for CD-type annuities, the rates go up even further when the deposits are committed to a minimum guarantee period (i.e., five to 10 years).
People who are thinking long term
For individuals who have done a good job of establishing other savings or investment accounts that are available for meeting short-term or emergency needs, they can turn toward annuities for their longer-term requirements. In return for the guarantees, the tax deferral, the competitive interest rates and the extra layer of protection that annuities provide, the annuity carrier asks that your client to commit their funds for a minimum period of time.
To do that, they’ve established surrender periods during which, if any withdrawal of funds is made in excess of 10 percent of the account value, they will charge a fee. This should be of no concern for individuals with a long-term time horizon because, eventually (within seven to 12 years), the surrender period ends and the funds can be withdrawn without a fee. Additionally, after age 59-and-a-half, investors don’t have to worry about the 10 percent IRS penalty assessed on early withdrawals.
Even risk tolerant individuals, especially those who experienced the downside in the markets of recent years, would like to have some stability and predictability built into their retirement portfolios. Annuities, with their minimum rate guarantees and minimum income guarantees, can accomplish that. When combined with other investments that fluctuate in value due to market swings, fixed annuities can level out the downside returns with their steady rates and predictable income streams.
People who worry about outliving their income
If your clients are like these people, they are not alone. Nearly 80 percent of baby boomers lay awake at night wondering if their assets are sufficient to generate the income they need for their lifetimes. Most of them are victims of the “failed decade” of the stock market from 2001 to 2009. Others just fell into the habit of not saving enough. In either case, people are approaching retirement with greater reservation and many of them are looking into annuities as a way to ensure their financial security.
Annuities are built as income generators, but unique to them are the guarantee of a minimum level of income for as long as a person needs it. Carriers are able to convert a lump sum of capital into an income stream that cannot be outlived. Because the individual trades control of their annuity deposit for guarantees and/or safety, it is recommended that they have other assets under their control that are available for income investing as well as for short-term needs.
While annuities aren’t for everyone, this list may very well include some attributes that are common concerns to many of your clients. The key is to thoroughly understand your clients’ needs, objectives, priorities, time horizon and tolerance for risk before they consider any transfer of funds or purchase. If you find your clients falling within one or more of the classifications outlined here, annuities may be the right choice for them.