Who Should Consider An Annuity? - Replay

My name is Brian Scribonia and on this episode of the Common Sense Financial Podcast the truth is that we don't know for sure what the future holds, but when people discuss historical performance, I find that their references are often too short sighted to understand the reality over time. This is where sequence of return risk to a portfolio over a reasonable time frame can help provide some perspective.

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Opportunities are still there. The attempt at passing down wealth from generation to generation. Consider the outcome, not just popular opinion and the whole teaching there is about preparedness and being ready. There's a difference between what's real and what's true. You're listening to the Common Sense Financial Podcast. I'm your host Brian Scribonia. Thanks for tuning in and let's get into today's topic. While annuities can be complicated, the decision about whether one is right for you doesn't have to be. Some folks are clearly better candidates than others. You can make your best effort for planning your retirement, but how much of what you are thinking or planning can you actually control? You can't control the market, how long you're going to live, inflation, health care costs, your health care needs, tax law changes, pension or Social Security solvency, economic shifts, government intervention, the list just goes on. There is so much uncertainty in life, and besides a weather forecast, we really don't know what tomorrow brings for any of us. The reality of what could happen can hit you like a freight train when you begin to think about what you can and can't control. All this uncertainty surrounding retirement is why annuities are so popular. They are a way to transfer risk over to an insurance company and provide some sense of safety for the future. This concept is nothing new. We transfer risk to insurance companies for all sorts of things and rely on them to cover losses when things outside of our control occurs. Retirement's no different in fact, retirement income can be a much greater risk than any of these other things that we deem worthy to insure. When you think about the amount of money that's at stake, the risk of running out of money is a real concern for many retirees, with an estimated $2.53 trillion of retirement assets held inside of annuities, according to Statista. So what is an annuity? Annuities are issued by insurance companies as a form of insurance, allowing retirees to transfer the risk of running out of money for retirement income or losing money in the stock market away from themselves and onto the insurance company. There are essentially three types of annuities. There's variable annuities, fixed indexed annuities, and then there's fixed rate annuities. The variable allows for stock market investing, the fixed rate has a set rate of interest, and the index has a proprietary crediting method that is tied to an index. The fixed rate and index have guarantees against loss of principal, while the variable has a degree of downside risk similar to any other investment. The index and variable have benefits that can be added for a fee that provide the annuity holder a guarantee for income in their retirement. The income benefits vary from contract to contract and are typically associated with your age. The older you are, the higher the payout percentage tends to be and are determined by the proprietary calculations of the insurance company. One of the misconceptions about income benefits is that the use of this feature is an exchange of the principal for income. That is not true. The income benefits are separate from the account value. However, the income taken through the benefits and any fees applied to the account are deducted from the account value and can deplete the account over time. This is where the insurance kicks in and continues the income beyond the assets in the account. Of course, guarantees of an annuity are based on the financial strength and claims paying ability of the insurer. Comparatively speaking, if you use the 4% rule as a distribution strategy from your investments, that assumption assumes that based on past performance that your money should last for about 30 years. So even while using an investment, you're still facing the risk of depleting your assets, but without the insurance for income. I explained this more in one of my articles titled My Five Minute Retirement Plan. Now, often there is some confusion between what was just described and the fixed annuity version of this income benefit called an annuitization. When an immediate fixed annuity is purchased, the amount deposited is essentially a purchase of a pension like payment for a specified period. However, these two income benefits are not the same and they shouldn't be confused. As you can see, annuities are complex. It would take an entire book to outline and compare all of the annuity types. So while I believe that an annuity should be considered for certain situations, you want to make sure you know what you're getting into and avoid being sold a program that you just don't understand. This shouldn't be a problem if you work with a fiduciary financial advisor who doesn't just sell annuities. I'm a strong believer that whether or not you should use an annuity depends on your situation. That is not necessarily a popular stance to have, since those who sell annuities suggest that everyone should own one. And while those who sell investments tend to badmouth annuities, these are the fringe of the options and opinions and they're rooted more in a business model than what is necessarily best for the client. My take on this is a little different and more geared towards what someone needs or wants. Here's how I see it. When it comes to who may be a candidate for annuities, you may want to consider yes to an annuity. If you're someone approaching retirement who wants to grow and protect your retirement income, or simply wants to keep some of your money out of the market and protect it from downside risk, then an annuity probably makes some sense to at least look at. You should consider saying no to an annuity. If you don't fall into one of these two camps, then it is likely that an annuity isn't the best option for you. There are a few other special use cases, but that is for another discussion. So an annuity versus an investment? What's the difference? I believe the best way to accumulate wealth is through capital appreciation. Over time, the market has more upside potential than most other possibilities outside of owning a business or real estate, which makes it the best option for long term growth as a diversification tool. Using income oriented investments specifically within private markets is a way to not only diversify asset asset classes, but also investment types, which further spreads out your risk and also lessens correlation. Another addition would be the use of a specially designed life insurance contract. Not only do these designs substitute and replace the need for bonds, they also build tax free assets without the restrictions of a retirement account. I dig more into this and explain in more detail about how that works in one of my articles titled what to do with Cash in a Low Interest Rate Environment. With all that said, I feel insurance agents and investment advisors don't always clearly communicate These facts and oftentimes have confused people about whether buying an annuity is appropriate for them. The fact is that annuities are not in competition with investments at all. I mean, they're totally different products with different purposes. They both have a place at different times in someone's life depending on their needs. It is never a one size fits all situation and there's no absolutes one way or the other. The four most common myths I hear about from my audience about annuities are one, Annuities have lower growth potential. Well, the truth is that some annuities can grow just as competitively as a regular managed portfolio. Number two is an income annuity will run out of money. The truth is that while yes, an annuity can run out of money, an investment portfolio carries the same risk of running out of money, only without the insurance. Number three, annuities are too expensive. The truth is that some annuities can be pretty expensive when you add together all the rider options and contract fees. But it's often not mentioned is that there are actually some annuities that don't have any fees at all. The fourth point is that the stock market has historically performed well enough that there's no need for the guarantee of an annuity. The truth is that we don't know for sure what the future holds. But when people discuss historical performance, I find that their references are often too short sighted to understand the reality over time. This is where sequence of return risk to a portfolio over a reasonable time frame can help provide some perspective. For example, if you were to retire in 1989 and enjoyed the Bull Run of the 1990s, then experience the reversal of good fortune in the 2000s, you would have seen the best and the worst of the market. It illustrates that markets will move with earnings and headlines. But economic and political cycles are the real drivers of the market. And the long tailed effects are what can propel you or sink you. Sequence of returns is one of the biggest risk factors for determining the viability of a portfolio when taking income. If you have too many down years in the onset of your retirement, coupled with inflation factors, your recovery could be a very steep hill to climb. You see, it's not the returns that matter as much as the sequence of the returns. So the retirement dilemma is the uncertainty of what you'll experience one year to the next. Relying too much on things outside of your control and basing that decision on bad information is a problem. Whether you use an annuity or not is less important than you understanding why you're making the decision. I'll conclude by saying that just like anything you insure, no one loves insurance unless they find themselves using it to replace something valuable that they lost. At that point, they're thankful they have it. If you would like to evaluate the use of an annuity for your retirement planning, you can request a consultation with one of my team members here on my website@Brian Scribonia.com or you can click the link in the Show Notes that concludes today's show. I'm Brian Scribonia. Thanks for listening to the Common Sense Financial Podcast. Thanks for listening to today's show. If you liked what you heard, be sure to subscribe on YouTube and Spotify so that you can receive notifications when we release new episodes. I'm Brian Scribonia and this is the Common Sense Financial Podcast.

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