(Note: Each client's account is uniquely managed, based on account size and risk tolerance. Your account will only own some, not all, of the investments bought and sold over time.)
An annuity provider sent me an article last week entitled: "Have Indexed Annuities Become Too Complicated?"
I believe this is old news, which is easy for me to say being so entrenched in the financial services industry. So I can see how this might be news. In short, yes they have.
Annuities are a source of income for those who need a specific amount of money for a specific period of time in retirement. It is like creating a pension for yourself, except with your own money. The two main types of annuities are immediate and deferred.
Immediate annuity: You put up a chunk of money today in exchange for a stream of income that starts now. That stream of income could last your entire life, the collective lives of you and your spouse, a set number of years, etc. The longer your timeline, the smaller the annual payments.
Deferred annuity: You put up a chunk of money today, but your income stream does not begin until a point in the future (often 5 years, 7 years or 10 years later). While your money is committed, it ideally grows based on some investment strategy. The growth could be fixed (e.g. guaranteed 4% per-year) or it could vary (e.g. tied to the stock market). This is where it gets complicated, as investors seek for ways to grow their savings in the years just preceding retirement.
Once upon a time, certain annuities had appeal, particularly a hybrid known as "indexed" annuities. These became popular in the wake of the 2008 recession. Indexed annuities provide the ability to earn up to a certain amount, or "capped" return, which is tied to the performance of a particular index (typically the S&P 500). In exchange for having a cap on the potential gain each year, you are guaranteed against loss. The latter having big appeal following the financial crisis.
Indexed annuities were en vogue as investors wanted to invest but could not stomach any risk of loss. Because these annuities are not technically invested in the market - rather, credited interest based on market performance - they have been deemed insurance products. As popularity grew, more and more insurance companies created their own flavor of indexed annuity in an attempt to provide one more feature than the next. And because there are far more insurance reps than there are professional money managers, these annuities have had great distribution.
Today, most indexed annuities I see are over-engineered. Their multi-page brochures are chock-full of confusing terms, a multitude of hypothetical scenarios explaining how the annuity might perform and a ton of fine print that often buries key restrictions. It would take me an hour to fully understand the product and another two hours to properly explain it to you. That may be a bit overstated, but the point is, if I cannot easily understand an investment how could I expect you to?
Annuities, by and large, have a place for certain retirees who want to live off a known, fixed income. But they also face many headwinds. Just a few of them...
- They can carry heavy commissions that are often concealed and go unknown until after you get the annuity, when it is too late
- The market has a natural bias to rise over time. So while indexed annuities might look great coming off 2002 (tech bubble burst) or 2008 (financial crisis), what about all those non-recessionary years?
- A lot of insurance reps (and annuity providers!) do not understand the annuities they sell. This often leads to clients making bad financial decisions, whether the insurance rep was intentionally misleading or just naive/uneducated.
- If you change your mind, you will pay a sizable "surrender charge" to reclaim your money. This makes buyer's remorse costly. (In fairness, the surrender charge on a deferred annuity does typically go down over time.)
- Most annuity owners do not need an annuity, they need proper financial planning that determines how they will generate retirement income and avoid running out of money. Oftentimes annuities provide an adequate solution for this, but not the best solution.
Whether an annuity is immediate, deferred, fixed, variable or indexed, it can have its place for the right type of client. But you must cut through the confusion to fully understand how it functions, the restrictions involved and how it ultimately fits you better than the next-best alternative.
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I will be traveling to Ohio to visit family all of next week. It will be business as usual, working remotely, but my response time may not be as quick while I am away. I return on Monday, July 3rd. I hope your summer is starting out well!
Have a great weekend,