Advanced Annuity – Excuses and Reasons to Buy
In my last post, I discussed that you need to understand the purpose of your money before you buy an annuity.
Now, I want to expand on that a bit and go over some advanced annuity issues. I do not sell annuities. I don’t often even suggest them. But I strongly believe you need to buy one, not have one sold to you. Thus you need to understand them in order to know when you might consider buying one.
This blog is a bit wonky, but I have had an interest in understanding annuities for a few years now, and this is my best attempt at coming up with the top 18 reasons to buy an annuity.
Reasons to Buy an Annuity
Let’s look at the top reasons to have an annuity:
Fees are worth the cost
Not all annuities are chock full of fees. Advisor-sold Variable Annuities tend almost never to be worth the cost. But Investment-Only Variable Annuities can be used to 1035 exchange prior bad decision annuities or life insurance into lower cost alternatives to make up your basis before finally selling them.
In addition, no-load variable annuities with income riders might be considered if you want to use them as a sequence of return risk hedge. The strategy here: aggressively invest a low-cost VA for retirement. If the market does great, you do fine. If the market doesn’t do well, you still have the guaranteed return you get from the income rider. Win-Win. Some suggest putting up to 30% of your nest egg in the VA Sequence Risk strategy. I don’t think I’d ever bite on this, but it is in fact a use case for a VA. Blame Moshe Milvesky for the idea, not me!
Some annuities are “Free”
You will often hear that Fixed Indexed Annuities have no fees. While that is strictly true (100% of your money is put into the account—sometimes with a bonus!), the advisor is being paid from the spread on your illiquid money. That is, the insurance company earns more than they pay out, and there is a surrender penalty to get out of the annuity before the lock up period. They use that spread to pay the salesman if you leave early. Let’s be honest, though, nothing in life is free.
As a Bond-Alternative
Indexed Annuities pay more than bonds. That’s right, there is a use case for annuities as a bond-alternative. If you take some money out of your bonds and put it in an annuity, you might earn 1-2% more than if you leave it in bonds. Remember, bonds have a purpose in your portfolio, and make sure you understand what that is. I’ll just say it now—bonds are no longer for income. Total return trumps income anyway, as I explained in the last blog.
Index Annuities are deferred annuities and protect against loss of principle. If you want return of your money more than return on your money, a MYGA or Fixed Indexed Annuity might be worth considering.
Enough said. If you are a high-income earner and you are maxing out your other tax-deferred space, this is at least worth considering. Tax-deferral is an indication for Life Insurance as well. Careful as there is a 10% penalty if you take out income before 59 and a half.
Income You Cannot Outlive
People who have annuity income are happier than people who don’t. Spend your account down to zero and magically more money appears next month. That is a nice feeling! Of course, maximize social security before you consider this use of an annuity. Social Security is the best annuity around. Here, a SPIA or DIA/QLAC might be the ticket.
You Cannot Tolerate Market Volatility
If you understand that volatility is not risk and you don’t lose out unless you sell, then this is not a problem. But people sell low all the time. They would be better off if they didn’t invest in the first place! For these troubled people, an annuity might help. If you cannot help yourself and you are going to sell low, don’t invest in the stock market, look to a VA or FIA.
I’m going to say that again: Mortality Credits. Understand these if you are going to buy an annuity.
If you are worried about outliving your savings, then an annuity is right for you. Your bond portfolio will not provide you as good of an income floor as an annuity because of mortality credits. Mortality credits mean that the annuity company can pay your more from day one because they know some people will die and stop being a liability on their balance sheet. This “risk pooling” allows them to pay you more. Many complex features of annuities (such as period certain and return of premium) destroy mortality credits and much of the reason behind getting an annuity in the first place. Understand, please, what makes a good annuity “good.”
You cannot beat the fixed-income returns of an insurance company. They are big and get better prices on bonds, and hold them for the duration. If you want income, think no further than a SPIA
Insurance Companies—They Play Both Sides of Life
If you die early- they win because they stop paying out your annuity. And if you die late- they win because they can wait to pay out on your life insurance. If an insurance company has too much liability from life insurance, they can sell annuities, and visa-versa. Die early or die late, they are covered. Insurance companies, for the most part, are highly rated and secure companies that will not go out of business. If they do, there are funds in your State to cover some of your losses.
You Blow All Your Money Every Month
If you cannot save, you might want to think about an annuity. After all, once you turn on the income stream, you can spend everything you get and next month there will be more. But then again, if you blow all your money, how did you save up enough for an annuity in the first place?
This might be oversold, but not infrequently annuities have better creditor protection than your brokerage account. This is state specific, so see here.
You have under-saved for retirement
Honestly, if you take your cash out and buy a SPIA, you will be better off if you plan to live a normal or prolonged life span. Mortality credits will pay you better than your bonds do.
You think you need an income producing portfolio so you are taking too much risk
Risk can sneak up on you all sorts of ways if you are reaching for yield. If you are reaching for yield, annuitize some of your reach and you will reduce risk significantly. Total return investing beats the pants off of income production for this generation. If you think you need income producing assets to retire on, think again, and think about a SPIA instead.
You have longevity
You are already old but desperately need to do Roth conversions
Yes you can still do Roth conversions when you are older than 72. A QLAC or two might help out in this situation. If you take longevity out of the equation by using a QLAC or two, you might be able to save your heirs a ton of money, especially if they are in a high-income tax bracket or you must put your legacy assets in a trust. This is a new idea I just had. I’m not sure how well it would work out, but it is a consideration if you want longevity insurance and the ability to aggressively Roth convert after RMD age.
You desperately want Long-Term Care Insurance but cannot get it with traditional or hybrid policies
Annuities with Long-Term Care riders tend to be based on your mortality risk rather than your morbidity risk, whereas the opposite is true with hybrid Life Insurance/LTCI policies. We are getting far into the weeds here, but if you have a pot of money laying around and you desperately want LTCI and cannot get it through other means, talk to a salesman about an annuity with an LTC rider.
You must have guaranteed income for life
The safety-first vs investment-only spectrum is just that—a spectrum. I suppose there are some people who cannot take any risk at all and cannot have any stock market risk.
Reasons NOT to have an annuity
- Because you got sold one.
- You don’t know the purpose of the money.
- You don’t understand every feature and bell and whistle attached to the product
- The money is already tax-deferred. Don’t get snookered into investing your pre-tax money into an annuity. This is called a qualified annuity. One of the nice features of annuities are tax-deferral. If you are investing in an already tax-deferred account, please be careful!
- You know how to invest your money and are comfortable with volatility. If so, a total return approach will beat out an annuity. Only if you use an annuity as a bond-replacement might you win. If you are thinking about an old-fashioned bond ladder just stop it—and get an SPIA instead
- Your Gut Tells You No. Just Walk Away if your gut tells you no. There is almost no reason why you cannot buy an annuity tomorrow instead of today. If considering a deferred product, the longer you wait the less you might make. Eventually, you will lose out to inflation, but not in just one day. Remember, you buy annuities, you are not sold them.
Summary: Top 18 Reasons to Buy an Annuity
Honestly, if you can think of any bad possible feature of an annuity, the industry can come up with a comeback for you. A lot of the complexity baked into annuities are “answers” to the problem people had. Here are some of the problems:
They are Illiquid—so, FIAs and VAs have withdrawal features which allow you to take out 10% or so a year
Loss of Legacy—they make return of premium riders and death benefit riders for these. I’m not sure these will ever make sense because if you plan to die early, an annuity is almost never right for you. If you plan on living a long time, then you will be happy if you die early and the kids can have whatever is left over.
Loss of Money—there are period certain annuities that pay you or your heir for a certain period of time. These mostly don’t make sense unless you are using them to cover expenses until some other income source kicks in. Again, this takes away mortality credits which is what makes simple annuities so special
I like to keep it simple. If you want income, if you understand mortality credits, and if you want a safety-first retirement, then consider an annuity.
Remember, in times of low interest rates, mortality credits actually pay out proportionally more than during times of high interest rates. So, bonds won’t do what annuities can do when rates are low.
Here are 18 reasons to buy an annuity. I hope you find one that suits your needs, then buy it. Don’t get sold something you don’t need.