National Annuity Awareness Month is upon us! Let’s go over how annuities can be an important part of a retirement plan.
June is National Annuity Awareness Month, giving us the perfect reason to discuss how they can positively impact your retirement. Annuities have always played a role in retirement planning, but with growing uncertainty and market volatility, their importance has boomed. They offer the chance for growth along with the protection of principal during market downturns which is guaranteed by the claims-paying ability of the issuing insurance carrier.
While they can be a vital part of the retirement-planning process, annuities can sometimes be overlooked by advisors who focus strictly on accumulation and stock market investments. For people getting close to retirement and those without the appetite or flexibility for stock market risk, annuities can be an attractive option to guarantee income for life.
In fact, annuities were created for retirement; they were first invented during ancient Roman times to compensate retired soldiers. They’re meant to help you generate income once you stop collecting wages. There are many different types of annuities, but fixed and fixed indexed annuities are different than retirement accounts like 401(k)s and IRAs in that they are not subject to market risk, and they offer guarantees.
In other words, fixed and fixed indexed annuities can offer a guaranteed income stream to eliminate some of the uncertainty that comes with retiring. It’s important to understand fixed and fixed indexed annuities are not investments, they are contracts. Even though they may credit interest based on market gains, they are not actually invested in the market at all. Fixed and fixed indexed annuities are contracts between you and the issuing insurance company, who again, based on their claims-paying ability, guarantee your principal and sometimes offer participation in stock market upside.
One of the main concerns of Americans on their way into their golden years is funding a secure retirement. In fact, a recent study showed that 56% were worried about running out of money in the next stage of their lives [1]. That worry seems to be well-founded, as a 2019 study projected that over 40% of U.S. households will run out of money in retirement [2].
One of the biggest reasons retirees run out of money is sequence of returns risk. This can happen when clients withdraw money from accounts early in retirement in a down market. The withdrawals can then out-pace the growth of the account, making it more likely that a person completely drains their funds while still living.
A fixed indexed annuity can counter sequence of returns risk by providing a guaranteed lifetime income option. Under a properly-structured fixed indexed annuity, the principal and the lifetime income benefit are both protected, which can be beneficial in a market crash. They also offer flexibility in diversifying your portfolio, as retirees with a guaranteed lifetime income benefit can keep other assets invested in the market, conceivably giving them a chance to wait out valleys and plateaus.
Some annuities are even designed to help combat inflation by offering a COLA, or cost of living adjustment. Considering the 2021 inflation rate was the highest America has seen since 1981[3], it’s no wonder experts are expecting an increase in inflation-protected annuities [4].
While annuities are popular among those looking for protection as well as growth potential, purchasing one can be treacherous without proper help and education. It’s important to know that annuities can also have drawbacks, such as early withdrawal fees and high commission fees [5]. As previously mentioned, annuities are contracts with insurance carriers. Those contracts may contain clauses subjecting the owner to surrender fees if they need to take money from the annuity before the end of the contract’s term. Similar to IRAs and 401(k)s, owners can also face a 10% early withdrawal penalty for taking money from the annuity before reaching age 59 and a half.
Additionally, advisors usually receive a commission from the sale of an annuity contract, just like brokers receive commission on the sale of mutual funds and securities that they trade. Unlike brokers, most fee-based advisors charge fees based on a percentage of the assets they manage. If they also make commission on the sale of an annuity, that fact is required to be disclosed. Annuity commissions can sometimes be higher than the fees charged for asset management, especially if they are spread out over the length of the contract. It’s paramount to be extremely familiar with your annuity prior to making the purchase, and the right financial advisor can help you examine the pros and cons—including the risk of principal loss, fees, commissions and costs—for various options, including having your money invested in the stock market.
There are many different types of annuities, and they don’t all offer identical benefits or protections. For example, variable annuities are directly invested in the market and carry the same risk that any market investment would. There are pros and cons to each type, and innovative insurance companies are working to design new annuity products with enhanced benefits every single day.
If you have any questions about annuities or how to implement them into your retirement plan, please give us a call! You can reach Barrett Financial Services in California at 619.473.8727.
Sources:
1. https://www.nirsonline.org/wp-content/uploads/2021/02/FINAL-Retirement-Insecurity-2021-.pdf
3. https://www.thebalance.com/u-s-inflation-rate-history-by-year-and-forecast-3306093
5. https://www.investopedia.com/articles/retirement/08/annuity-mutualfund.asp#toc-the-cons-of-annuities
Investment advisory services offered through Horter Investment Management, LLC, a SEC-Registered Investment Advisor. Horter Investment Management does not provide legal or tax advice. Investment Advisor Representatives of Horter Investment Management may only conduct business with residents of the states and jurisdictions in which they are properly registered or exempt from registration requirements. Insurance and annuity products are sold separately through Barrett Financial Services, Inc. Securities transactions for Horter Investment Management clients are placed through AXOS Advisor Services, TD Ameritrade and Nationwide Advisory Solutions.
Insurance and annuity products are not sold through Horter Investment Management, LLC (“Horter”). Horter does not endorse any annuity or insurance products nor does it guarantee their performance. Owners of these products are subject to the terms and conditions of the policies and contracts of the issuing companies. All product guarantees depend on the insurance company’s financial strength and claims-paying ability.
Fixed annuities guarantee that your money will earn at least a minimum interest rate. Fixed annuities may earn interest at a rate higher than the minimum but only the minimum rate is guaranteed. The issuer of the annuity sets the rates.
Fixed index annuities are a type of fixed annuity that earns interest based on changes in a market index, which measures how the market or part of the market performs. The interest rate is guaranteed to never be less than zero, even if the market goes down. Although account balances in fixed index annuities are connected to the performance of a particular index, the owner’s money is not actually invested in the index itself. Instead, it is held in an account that is administered by the insurance company. These products are subject to various charges and expenses, such as sales charges, administrative charges, mortality and expense charges and surrender charges. All product guarantees depend on the insurance company’s financial strength and claims-paying ability.
Variable annuities earn investment returns based on the performance of the investment portfolios, known as “subaccounts,” where you choose to put your money. Your investment choices likely will include subaccounts with different types and levels of risk. Your choices will affect the return that you earn on your annuity. Subaccounts generally have no guaranteed return; however, you may have the option of placing some of your money in a fixed rate account, with a rate that won’t change for a set period. There is no guarantee that the values of the subaccounts will increase. If the subaccount values go down, you may end up with less money in your annuity than you paid into it. These products are subject to various charges and expenses, such as sales charges, administrative charges, mortality and expense charges and surrender charges.
