As is the case with all the financial products available, annuities have their place. When implemented properly, an annuity could provide an important safety net for one’s retirement. Unfortunately though, they are often misused by individuals who are viewed as an advisor, but are really more of a salesperson. As a result, they have found a place in a lot more portfolio’s than they should have.
The Financial Industry Regulatory Authority (FINRA), defines an annuity as a contract between you and an insurance company in which the company promises to make periodic payments to you, starting immediately or at some future time. Notice the words I have made bold: contract, insurance company, promises, and periodic payments. One thing is very clear, an annuity is not designed to be a growth tool. (I will expand on why it is not a growth tool in a future post.)
An annuity can provide a couple of nice benefits. The first being the promise of a periodic income, while the other is the tax deferred growth potential. “Wait a second,” you might say, “you just said it wasn’t a growth tool!” Not exactly. What I am saying is that an annuity is not designed to be growth tool by definition, however, the expectation is that some growth will occur. And, in the case of an annuity, the growth will be tax deferred.
So when would the purchase of an annuity be something to consider?
- You have maxed out all other tax-advantaged retirement investment options, you won’t have a need to access the funds for several years, and you are in a high income tax bracket.
- When it comes to investing, you would classify yourself as very conservative. You are at least 50 years old (preferably 55, but I’m going to be generous) and you just don’t feel comfortable with any of your money in stock investments. You don’t care if your money does not grow that much, as long as it does not go down.
- You are approaching retirement and the loss of a steady income is something that concerns you the most. At this point, capital growth is not important to you anymore, you just won’t feel comfortable unless you have a set amount of income coming in every month.
These are just a few examples to give you a general idea of when an annuity might be suitable for you. Other circumstances certainly do exist, but so do other options. If an annuity is proposed to you as a solution, don’t assume that it must therefore be the optimal solution. Ask as many questions as it takes for you to feel that you understand it well enough to explain it to someone else. Remember, annuities are a complex financial tool and they are not risk-free.
While it is not common for an insurance company to be unable to meet its obligations, state guaranty associations (GA) provide basic protections for Life, Health and Annuity values. In Virginia, we have the Va Life, Accident & Sickness Insurance Guaranty Association which, as of the time of this writing, will provide you with protection of up to $250,000 (max of $350,000 per individual) in withdrawals and cash value in an annuity.
As a final word, I will reiterate that an annuity may be suitable when you are looking for a tool that can provide you with a steady income stream, or you are in a high income tax bracket and have maxed out all other tax-deferred investment options. An annuity is NOT a good tool for maximizing your wealth. Nor is it ideal to use an annuity as a simple diversification tool just to protect some capital.
Kevin Warman
(last updated 05/19/2015)
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