I spoke with several financial advisers about the role annuities play in their clients' portfolios, and the answers literally ranged from "Love 'em" to "Hate 'em." The common ground among the advisers was to look for the best product match with their clients' needs and to use an annuity if it provided that match.
The best way to determine whether an annuity product is suitable for you is to first define exactly what you want to invest, the type of return you want, your appetite for risk, the stability of your financial situation, how you're positioned for surprise expense needs, and your family and legacy considerations.
Once you have this knowledge, you should then work with a financial adviser to determine if there's an annuity product that works for you. (If you need a brush-up on the basics of annuities, we've got one here.)
1) "Annuities are tools used for long-term planning purposes," says Keith Ferris, a financial planner in Branford, Conn. "Therefore, today's economic and financial environment is not that relevant because it quickly becomes a new environment tomorrow. What is important is the individual's economic and financial environment. However, any given economic environment is used to market and sell different types of annuities. When times are good and the market is generally rising, variable annuities are touted. When times are bad, out come the fixed annuities as the answer. For the cautious who want to be greedy, indexed annuities come to the fore."
2) "I favor annuities that solve a problem that other financial products are not designed to address," says Ferris, who is affiliated with the Commonwealth Financial Network. As an example, he cites a newly retired woman in her early 70s who has no pension other than Social Security, is not financially sophisticated, and has modest savings. She doesn't have much debt and lives frugally, but she is still taking care of her mother. Ferris says he would recommend she put a portion of her savings into a variable annuity with a guaranteed payout for life. "This arrangement still allows for access to the account value in an emergency (which would lower the payout, of course) and the potential for long-term growth to address the inflation risk," he says
3) Keith Singer, an adviser in Boca Raton, Fla., says, "All annuities that guarantee principal or create a minimum level of income are more attractive than ever under today's market conditions. People are finally beginning to appreciate the risk of their investments."
Singer, a strong advocate of annuities, provides these client profiles and recommendations:
- Immediate annuities for clients over 70 who are concerned about maximum guaranteed income.
- A combination of immediate annuities and life insurance for clients over 70 who are concerned about maximum guaranteed income but are equally concerned about leaving money to their heirs. In addition to annual returns, 100 percent of the annuity principal is conveyed tax-free to heirs.
- Variable annuities with a guaranteed minimum retirement income benefit for people who want to invest in the stock market but want some safety.
- Deferred index annuity for people who want growth with safety of principal. Singer uses a deferred index annuity that is credited with interest each year based on the S&P 500 index. All profits are locked in each year, and the client's money is guaranteed to grow at 3 percent per year regardless of how the index performs.
4) Mark La Spisa, a financial planner in South Barrington, Ill., near Chicago, finds annuities lacking for many reasons, and he usually seeks other solutions that he feels are more appropriate. However, for clients seeking a low risk and willing to accept modest returns, fixed annuities might be appropriate.
"Index annuities are very expensive [and] most professionals and clients have no idea how they are priced or packaged and therefore cannot even tell how much the client is paying for them," he says. "Variable annuities have two levels of fees—for the insurance wrapper and mutual fund. Fixed annuities are good as an alternative to CDs, but they generally have high surrender fees for long time periods following their purchase. . . . Death benefits in annuities are rarely used by clients and are very costly."
La Spisa also dislikes the fact that annuity payments are taxed as ordinary income, whereas it's easy to find attractive mutual funds that receive capital gains tax treatment on much, if not all, of their income. A 15 percent percent tax rate versus a 33 percent or even higher rate can disadvantage an annuity, he says, particularly when insurance company fees are added.
"The person I think I would recommend an annuity to is a client with no heirs who is looking for a guaranteed return and not a grand slam or even above-market returns," he says. "I think a fixed annuity can be a great product here, but the problem with a fixed annuity is that it can carry a back-end surrender charge. You end up being locked into the product for a long period, and your investment guarantee may only be valid for a year."
- Click here for 15 Things You Need to Know Now About Annuities.