When it comes to financial planning, there are some people who want to invest before doing anything else with their money, whether that’s the market or a certain financial product. Unfortunately, that way of thinking can be potentially misguided.
There’s no get-rich-quick investment that is going to make you instantly wealthy or a single product that is going to save your retirement. Even though some firms and advisors claim that products like an annuity can “guarantee” success.
Whether you’re 25 or 85 years old, there’s a segment of the financial industry that is recommending annuities. If someone recommends putting a significant amount of your portfolio inside an annuity without significant discussion, that’s a major red flag.
While an annuity can be a good option for some, it may not be right for others. At Zephyrus, we plan first and invest second. That means we work with our clients to create a customized financial roadmap before we even talk about any investments. We believe it’s important to educate and inform our clients about whatever investments they’re interested in.
There’s no one-size-fits-all approach to financial planning. In this blog, we’ll go over what annuities are, what considerations need to be made and how to determine if it’s right for you.
What is an annuity?
An annuity is an investment product containing a contract between you and an insurance company in which the insurer promises to pay you a certain amount of money over the life of the contract in exchange for your premiums. It is designed to provide a stream of income, typically for those in retirement. It differs from a traditional life insurance policy in that it does not just pay out benefits only when the insured dies.
What are the different types of annuities?
There are several different types of annuities, with the most common being fixed and variable.
A fixed annuity guarantees a fixed (hence the name) rate of return on your money for a set time period. Earnings are tax-deferred, meaning the owner doesn’t pay taxes until they withdraw the money, either through monthly payments or as regular income.
Variable annuities fluctuate in value, rising or falling based on the performance of the investments chosen to fund the income. Similar to fixed annuities, variable annuities are tax-deferred. What makes them variable is the opportunity to create higher rates of return by investing in equity or bond sub-accounts, similar to mutual funds.
What are the pros and cons of annuities?
Annuities can be a beneficial piece of the retirement planning puzzle; however, they’re complex, and you must understand all the risks associated with them.
There are many benefits to an annuity, starting with the guaranteed steady stream of income that it can provide. However, it is not always guaranteed in every situation. For example, if someone has an annuity with a guaranteed 5% annual withdrawal rate, but the account loses value or the person needs to take a large distribution for an unexpected expense, that 5% could potentially be worth less dollar-wise from year to year.
In addition to tax-deferred growth, some annuities include a level of protection from market volatility, as well as various death benefit options.
Some of the downsides to annuities lie with their high fees and costs associated with surrender charges for early withdrawal, management fees and rider charges. Aside from the base contract price of an annuity, almost all additional riders for income, death benefit, etc., come at a cost. These are complicated products. That’s why it’s so important to work with a trusted advisor who will disclose all of that information up front before agreeing to any contract.
Additionally, annuities offer limited liquidity, meaning that your money can be tied up for years with no access, and getting it out would require additional fees.
How do I know if an annuity is right for me?
Annuities are intended for income, but again, it’s not a one-size-fits-all product. Insurance companies have large marketing budgets, and just because you hear or see commercials on daytime television promoting them or read sponsored articles on financial websites, it doesn’t mean it’s a good investment for everyone. Annuities, and all financial products for that matter, should be treated on a case-by-case basis.
First and foremost, it’s important to have a goal in mind before considering any type of investment. Having an idea of where you want to go can and does drive what type of investments are best suited for each person. Things like your retirement timeline, risk tolerance and taxes are just a few of the things that need to be taken into consideration before choosing what to invest in.
Each person has different goals they are working towards and different lifestyles. $1 million saved for retirement may be enough for one person to retire comfortably, while it may not be for another person. If you want to buy a second home, a fancy sports car and become an international traveler, that $1 million could dry up pretty fast.
Why it’s important to work with a trusted advisor
There’s a lot of misinformation around annuities, mostly driven by how complex these products can be. Not only does the client need to be able to understand them, but so do the advisors selling them. If they fail to disclose pertinent information, it could make a huge difference for a client.
So, how does someone sift through the noise and make good financial decisions? Make sure you are working with someone you trust, get a second opinion and ask questions if you are confused or unsure. Ask your advisor how they are compensated through the sale of the contract.
Make sure you know your advisor’s credentials and how they are being compensated. Not only does working with someone who puts your interests ahead of their own financial gain establish trust, but this can make a huge difference in your financial security and ability to retire comfortably.
If you're not currently working with a financial advisor, it may be worth finding one you feel you can trust. While it’s not required to be a fiduciary to discuss or sell annuities, we believe that can be an important consideration when choosing an advisor to work with. When acting as an investment advisor representative, the advisor is required to act in the client’s best interest and to prioritize their needs above their own. While not everyone who calls themselves a 'financial advisor' is held to that same fiduciary standard, we think it’s a meaningful distinction
More than anything, it’s critical to have a financial roadmap in place to guide you before agreeing to any type of product. Inside of our customized financial roadmaps, we can test inside of our client’s plan and see if an annuity works for them or if some other mix of investments would serve them better. Planning drives the decisions, not the product.
Finally, the old adage rings true for annuities and other financial products: If it seems too good to be true, it just might be. There is no magic wand in investing. No one product, investment or stock will make you rich instantly. If there were, everyone would be invested in it!
It can’t be overstated just how much relationships matter when it comes to financial planning and making investment decisions. We understand our clients' wants and needs. The deeper the relationship and the more we know about our clients’ entire lives, not just their financials, the more we can help them work towards and achieve their financial goals. It would be hard for us to make meaningful recommendations if we knew only a small part of what the client wants to do with their money. It’s not just finding the advisor who says they can grow you the largest pile of money, but rather the one who helps you understand what it is you want the money to do for you.
An investment in a variable annuity involves investment risk, including possible loss of principal. There is a surrender charge imposed generally during the first 5 to 7 years that you own the contract. Withdrawals prior to age 59 ½ may result in a 10% IRS tax penalty, in addition to any ordinary income tax. The guarantee of the annuity is backed by the financial strength of the underlying insurance company. Investment sub-account values will fluctuate with changes in market conditions. Variable annuities are designed for long-term investing. The contract, when redeemed, may be worth more or less than the total amount invested. Variable annuities are subject to insurance related charges including mortality and expense charges, administrative fees, and the expenses associated with the underlying sub-accounts. Investors should consider the investment objectives, risks and charges and expenses of the variable annuity carefully before investing. The prospectus contains this and other information about the variable annuity. Contact Amanda Schueler at 96 4th Ave NW, Hutchinson, MN 55350 or 320-234-2501 to obtain a prospectus, which should be read carefully before investing or sending money.
If you are purchasing an annuity to fund any tax-qualified retirement plan (IRA), you should be aware that this tax-deferral feature is available with any investment vehicle and is not unique to an annuity. Carefully consider the features and benefits of the annuity before making the decision to purchase.