Do annuities have a place in your financial plan?

What is an annuity?
An annuity is a term that means a series of regular payments over a period of time. Typically, when the topic arises during some sort of financial planning, reference is often being made to independent insurance products offered by insurance companies and sold by their agents. However, annuity contracts can also derive from other sources such as retirement plans, pension plans, and even lottery winnings.

Annuity contracts sold by insurance companies can be (and most often are) very complex financial tools with aspects spanning financial, tax, risk management, and legal disciplines. Many times the products are sold rather quickly by overzealous insurance sales agents – often under the guise of acting as a trusted adviser – who focus their clients’ attention on the fear of running out of money within retirement (i.e., mortality risk), and/or optimizing or reducing income tax liabilities. Of course, these same advisors often quickly gloss over very important factors such as surrender charges, and hefty overall commission charges they are entitled to as part of the contract. Many well-intentioned investors find themselves in a hairy situation a year or two down the road when they decide they shouldn’t have locked in a great deal of their nest egg in such a product.

While an insurance annuity product may have a rightful place within a properly organized financial plan, it’s important to know that even the sales agents themselves often do not fully understand the contracts they push for sale to their clients. Thus, it’s important to ensure your own understanding and comfort level and do not make a purchase decision unless you are totally comfortable with, not only the specifics of the product, but also its function within your financial plan.  

Is an annuity right for me?
Many people wind up having this question at some point in life but especially when nearing or within retirement. As already mentioned, the decision can become quite complex rather quickly. Following are some items to consider and think about when faced with the decision of whether or not to purchase an annuity.

1) Do you really need what an annuity provides? Remember, one of the major functions of an annuity is to transfer your (and perhaps your spouse’s) mortality risk to an insurance company. This is not a cost-free exchange. While it may result in stable income payments for life, you must decide whether the costs make sense. That is, do you already have other forms of lifetime income from sources such as military pensions, or other retirement pensions? Are those other pensions sufficient to meet your long-term income needs?

2) Do you desire to maintain flexibility in how your retirement funds are utilized? An annuity obligates funds that you later might decide to use for other purposes (e.g., legacy, gifting, purchases, etc). Once an annuity is purchased, it may be difficult and/or costly to reverse the decision. Also, your choices may be limited if purchasing through your retirement plan (401k, TSP, etc).

3) What is the financial record and long-term viability of the insurance company?  Simply put, will the insurer be able to hold up their end of the deal over the long-term?

4) Are you making the decision based upon objective planning or fear? Decisions driven by fear do not have a place within your financial plan. Make certain that you have carefully thought out all areas, set realistic goals, and are operating under a specific plan to help you achieve them.

5) What happens to the annuity at death? Of course, the answer depends on the specifics of the contract. There are certainly options to ensure an annuity can pass on to your spouse in the event of your death (e.g., joint life). However, a single life annuity will cease payments at your death. Again, it’s important to fully understand these factors, costs, etc, when making your decision.

These are just a few of the topics you should think about when making a decision regarding purchasing an annuity. It’s important to note that purchasing an annuity, discussed here, is not the same as being provided a pension annuity (i.e., lifetime income) from, say, a military or other employer-sponsored pension plan.

In summary, there are plenty of nuances to the annuity puzzle – decisions which often make novice investors’ heads spin. The key, like many aspects within personal financial planning, is to fully understand your options and subsequent decisions – before making them. Be sure to employ the services of a competent and objective financial planner who can assist you in sorting out all the details – without the biases potentially involved with selling financial products.