When You Should Buy an Annuity: 5 Real Life Scenarios

Joseph Meyer
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When to buy an annuity

By this stage, most people start thinking about putting their money somewhere safe, as average savings rates of 0% do little to build up wealth in today’s harsh financial climate. In short, they’re looking for somewhere to park their money and forget about it.

The problem is that annuities are still a relatively opaque product, and consumers aren’t sure if it’s the right thing for them. Based on what we’ve seen, there’s a more effective way to communicate with consumers about annuities. And this revolves around the term ”income for a lifetime”.

To explain, here’s an example scenario.

A 48-year-old woman is currently working as a business director in a small business. She has a final salary pension under auto enrolment and earns 27,000 a year before tax.

The stock market freaks you out

And you want to make sure that you have a steady stream of income for retirement.

2. You want to know to the penny how much interest you’re going to make

If you don’t mind having your money in a fixed account, you won’t mind the relatively small interest rates that annuities currently pay. But if you want to know to the penny how much you’re going to make, then annuity might not be for you.

You want guaranteed and predictable income

Since you receive a fixed income from an annuity each year, it’s a good choice when there is uncertainty in your future income. For example, if you’re trying to recover from a career or health setback, you might lean toward an annuity. Guaranteed income can help you stay out of debt and rebuild your life while you’re recuperating.

4. You can’t get life insurance (and want to leave more to your heirs)

You want long term care protection, but don’t want to pay out of pocket

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Annuities are one of the biggest retirement financial planning tools and they are the main alternative to investment portfolios and funds. There are two main types of annuities: fixed and variable.

Fixed Annuities:

Fixed annuities are popular investments because they carry some of the highest guaranteed lifetime income rates in the retirement market. They are very similar to a pension that’s paid for by an insurance company and can be invested in several ways. Fixed annuities are known as secured investments because they are guaranteed by a third party and are backed by the company’s assets, such as property, stocks and bonds.

Variable Annuities:

Variable annuities also carry lifetime income and can also be invested in different ways, but the income is not guaranteed. Think of variable annuities as mutual funds that carry guaranteed lifetime income. Variable income annuities are investment options that are income-driven … meaning they have target annual withdrawal amounts that are withdrawn every year. Most income-driven options are in the equity class, which use indexes, such as the S&P 500, to match what is lost in capital value to the income paid out every year. Since these annuities are invested in investments that change daily, the savings rate can also change.

When not to buy an annuity

Annuities may not be suitable in the following circumstances:

If you are still young and planning on living another 30 years or more, an annuity may not be a good option for you. Your money would be tied up in the annuity for a very long time, and you could lose a substantial amount of money by simply tying it up for so long.

If you have many dependants, an annuity is not a good idea as it means that they will have to struggle with less income while you enjoy the lump sum you receive from your annuity.

If you are already financially independent, you should not consider an annuity… there is not much point in going for an annuity when you do not need any benefits in terms of insurance or pensions.

If you are willing and able to take significant investment risks, you could invest the money that you would use to buy the annuity in other assets that have the potential to give you a higher return than an annuity.

If you simply want to take money from your pension fund and spend it in whatever way you please, you shouldn’t pay an early withdrawal or surrender fee to take your money out early.

You can invest your own money

Or your annuity money in stocks, bonds, real estate, and much more.

When you buy an annuity, you transfer your retirement funds to an insurance company and in exchange, they pay you a fixed stream of monthly income payments for a period of time. If you meet certain criteria and are in good health, you can qualify for a monthly guaranteed income for decades to come.

An annuity is a useful tool that may meet your financial needs at retirement. But no one knows your situation better than you do and you may be wondering whether you actually need an annuity, or when you might not need it at all.

Annuities are different from all other financial products. You might find it hard to choose between the many annuity products that are offered by insurance companies. The different types of annuities are based on their withdrawals. Annuities are generally classified into three categories: annuity with a guaranteed income, joint life, and some form of variable income with a shared guarantee.

You’re conservative with spending

Annuities offer a guaranteed stream of income and higher payouts than most bank products. If you’re a conservative investor, you’ll typically have shorter time horizons in retirement, and you’ll spend less than your peers. Annuities can also last for your lifetime, provided that you can qualify for a lifetime payout stream from different insurance companies. In return for getting locked into a lower payout percentage and a longer time horizon, you’ll have the security of knowing that you’re going to get a fixed income.

You aren’t comfortable paying a lot of fees

You want pure investment returns

You’re blessed with a very long life – somewhere between 100 and 120 years old. Perhaps you could even live beyond that, so you’d like your money to continue to grow while you’re still around. An annuity could help. It guarantees a guaranteed lifetime income that your heirs will inherit.

This maximum payout is common with Level Payments, which are typically index-linked or inflation-adjusted, so that you’re income increases as inflation goes up. But you’ll pay dearly for that insurance — the longer that your income lasts, the higher your rate of return will have to be to make up the difference. And because annuities limit how long you can receive income, they are not ideal if you are likely to move to another state where you’ll be taxed on withdrawals.

You want control of how your money is invested

Contrary to what you might think, annuities are not guaranteed. You may be told that your principal is guaranteed, but the interest you earn may be variable. You don’t have a choice or input into this. Variable rates can change to lower amounts. If this is important to you, an annuity is not a good choice.

You don’t like strings attached to your investments

You want to do your own thing, with your own money. Generally, I agree with you on that point. But not so with annuities.

Annuities are simple, safe, hands-off and worry free investment vehicles.

You deposit a certain amount of money, a fund manager does nothing and lets time take its course. The whole fund is invested in a basket of stocks and bonds and the returns come back to you.

There is no sales person breathing down your neck to sell you a product, and no artificial asset management fees. For that, you pay an annuity commission to the bank selling you the annuity.

That commission, although not hidden, is very small. It is usually around 0.5-1.5% of the investment amount. But don’t let that small fee deceive you – that small commission covers an extraordinary large risk.

An annuity is very simple to use, but very complex to evaluate. There are lots of gray areas. Let’s talk about those gray areas and see when annuities can be a safe and helpful vehicle.

You have no need for additional tax-deferral

In retirement.

The Internal Revenue Service considers non-qualified deferred annuities to be pension plans, so any withdrawals you make will be subject to income taxes. If you are already in a low tax bracket or you have no desire to further shelter your retirement savings from taxes, this is a great annuity for you. You can choose a fixed or variable payout option or a combination of both.

You don’t believe the one-size-fits-all hype for one minute

You want to make sure annuities are the right choice for you, and so you ask your CPA for help

Here’s the problem: Annuities are inadequately explained to the average consumer because most salespeople are even less well-informed. If you’ve only got a few minutes, below are the highlights for you in a nutshell.

You’re only being offered one product from one company

What do you do?

If you’re not offered the opportunity to invest in the investment vehicles of your choice, you should be asked to complete a product questionnaire. What is that? It’s simply a standardized contract that show’s the features, benefits and terms of the investment product you’ll be asked to consider.

In this type of situation, you should be given a period of time to consider the product and think about any questions you may have before you make your final decision. After that, you’ll be asked to complete a product questionnaire and sign a form that obligates you to purchase the product unless you can meet certain exceptions.

Optionally, you can request a Purchase Order form, which gives you a few additional days to consider the terms and conditions of the investment, but it’s not typically required. When you’re provided a Purchase Order form, you must have a specific number of days to sign and return the agreement. There’s no running out the door in the middle of the night to sign.

There are many reasons why employers offer a specific product. They may have a strong relationship with a provider, have been pressured by a provider or employee stock ownership plan, or they only want employees to have access to employer-sponsored investments.

You came in to buy life insurance but you’re being sold an annuity

Instead. What’s going on?

Sales agents who sell insurance heavily cross-sell, meaning they try to sell you as many products as possible. For the consumer who naively thinks, “I can buy a policy, pay the commission, and be done with the transaction,” this cross-selling can be a problem.

Here are some of the most common cross-selling situations agents try to put on unsuspecting consumers. If you’re feeling pressured into buying, here’s what to say to fight back.

Agent: You should buy an annuity.

You: Um, do you have anything more affordable?

Agent: An annuity will give you guaranteed income for life.

You: I totally understand; I just want to make sure my family has enough to live on. Is there anything more affordable that will guarantee me that?

Agent: A single premium immediate annuity would guarantee your family’s income for the rest of your life.

You: I really appreciate that, but can you show me some other options that won’t break the bank?

Agent: You’ll owe taxes on your Social Security benefits if you wait until your full retirement age. Plus, you risk outliving your money.

You’re not entirely sure of the terms of the annuity

Annuities can have very rigid terms that can make them much more of a hindrance than a help. A few of the most common annuity red flags include cost of living provisions that never fully adjust and a minimum guaranteed interest rate that lags the returns of the stock market.

If you’re considering an annuity, be sure to fully understand the terms of the contract. Be sure that you have a reasonable estimate of what your money would earn in the market. Think about, for example, if you had to take a permanent step back and significant dip in your standard of living, how would the terms of the annuity stand up?

And then be sure to compare this with the amount you could make in the market. Use an annuity calculator to figure out where it’s most efficient to invest your money instead of choosing an annuity.

You’re not concerned about outliving your money

If you’re 70 or older and your retirement investments consist of low-yield cash, CDs, stocks, and bonds, it may be a good time to consider buying an annuity.

When used carefully, annuities can be a good way to get a guaranteed monthly income for life. However, you need to be careful, as they can also cause you to run out of money over time. This is why annuities are usually sold as a deferred income annuity or life income product rather than as a lifetime annuity. This is important because a deferred income annuity allows you to withdraw the contract’s value, and a life annuity provides you with a guaranteed income stream for your life.

You don’t want an investment that will lock you in

Committing yourself to one type of investment just before you retire could be a huge mistake. Sometimes the one bit of advice you need the most is to stay flexible and adapt to what’s happening in the industry. Annuities are great investments for specific type of people. Read this guide, and you may find that you fit the bill more than you think.

The insurance agent is pushing too hard

Mention annuities and many people immediately run for the hills, what? Why does that person want to make me continue paying a premium forever? Annuities are complicated and often misunderstood but they can be a good tool to use to reach your financial goals.

Annuities are versatile investments that have great potential to make your money work harder for you. They do have rigid parameters when it comes to withdrawal so you’ll need to be sure that you are doing them for the right reasons to be wise about your decision.

Just make sure that your financial advisor isn’t pushing you to buy one because their commissions are higher. The higher commissions are often the reason they will try to push you into an annuity sales cycle. However, the commissions on an annuity less than the commissions on something else your advisor is trying to sell you.

Your gut is telling you that this isn’t the right investment for you

But you play it safe and buy one anyway. Over time, you begin questioning that decision. “Should I have bought something else, like a traditional mutual fund or annuity?”

The annuity and mutual fund examples are admittedly sensationalized and, as you know, flawed in terms of accuracy. But the fact is, you cannot time the market, and you don’t know a single thing that’s going to happen next.

Bottom Line

There may be a time when buying an annuity makes sense, but mainly for the wealthy. Even then, do your homework. Annuities aren’t for everyone.