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Annuities Are Like Puppy Dogs
A friend of mine was once asked if he sold annuities, to which he answered yes. The person asking was in disbelief because, in his opinion, annuities were so bad – in fact awful. So, my friend responded with the following anecdote. Annuities are like puppy dogs: there are dogs that will jump in your lap and lick your face and other dogs that will try to bite your hand off when you put it anywhere near their face. He’s correct. When financial writers talk about how bad annuities are, they are writing about the ones that are like a dog that wants to bite your hand off.
Annuities are often perceived to be more complicated than other financial products. While it’s true that there is some complexity to annuities, they do offer significant benefits. Some annuities are more complex than others, but the primary benefit is generally easy to grasp. The good dog equivalent annuity can provide guaranteed income payments for life. There is no other product that can provide this kind of protection.
Much of the perception of complexity comes from the fact that annuities are already something of a hybrid product by necessity – combining the guarantees that make them unique with features found in other products. In recent years, providers have designed multiple variations in annuity products as client needs have evolved and competition in the category has increased, leading to a proliferation of new features that can be hard to keep pace with.
Another contributor to the perception of complexity, for both advisors and clients, is the amount of information in the annuity contract itself. The product’s terms, features, charges and benefits as detailed in the contract, and the value these contracts can provide must be explained so you can determine if it will “lick or bite.” The range of annuities may be easier to understand if it is broken down into the most common types.
Immediate and deferred annuities:
- An immediate annuity enables clients to begin receiving their guaranteed income payment very quickly, usually within the first 12 months of purchase.
- An immediate annuity generally requires one lump sum payment that can’t be withdrawn. In the event of a client passing away prematurely, annuity payments would end unless the product provided for a refund or a guaranteed payment term.
- A deferred annuity enables clients’ assets to accumulate assets tax-deferred for a period and then for the client to receive payments or make withdrawals at a time of their choosing.
The two distinct phases of a deferred annuity are:
- The saving or accumulation phase, during which the client invests money in an account that has the potential for growth.
- The payout phase, which begins when the client chooses to receive annuity payments or make withdrawals.
Generally, withdrawals and payments can be taken before retirement, but there may be tax penalties for withdrawals before the age of 59½. Withdrawals may also be made during the accumulation phase, but withdrawal charges may apply.
Within immediate and deferred annuities, there are three sub-types. These are fixed, variable and indexed.
- A fixed annuity enables clients to receive a fixed rate of interest on their principal for a set period. In addition, their principal and any interest it accrues are guaranteed.
- A variable annuity enables clients to potentially generate higher rates of return than with a fixed annuity by investing a portion of the principal in sub-accounts that have the potential for growth. With this type of annuity, the invested portion could be affected by volatility and the annuity may have mortality and expenses charges. Also, the principal may be subject to loss in the event of a downturn.
- An indexed annuity combines features of both fixed and variable annuities, enabling clients to benefit from yields based on market performance. Losses are limited in the event of a downturn and yields are limited by an agreed cap.
An annuity can be used to address a range of needs. Different annuities have different degrees of complexity and the ability to solve for specific needs. At its simplest, an annuity can generate a guaranteed income in retirement that can provide an element of security in knowing your essential expenses are covered.
Despite any complexity and misconceived notions, annuities should still play an important role in retirement planning discussions. It is key to understand the values for the costs you are paying, and the level of certainty that the annuity can provide in terms of guaranteed income. Knowing the full picture can help you determine if annuities are right for you. Do not let the complexity keep you from learning if an annuity can benefit you. My firm can help you take control of that decision.