Some investors have bought into a fantasy that they can achieve all their financial goals with just one “magic” product: an annuity. Many investors were sold on the idea that one product could successfully accomplish the dual objectives of guaranteed income with market-oriented growth. Most often this is not the case. However, when annuities are used for a single purpose, they can be more effective, regardless of whether the need is for guaranteed income or the “safe” growth of money.
Annuities have been around for a long time. Many investors use annuities as a way to manage the risk of outliving their assets. An annuity is a contract between you and, usually, an insurance company. The basic principle is that you pay a premium in exchange for future periodic payments. The payments may begin immediately, or at a future date, and can continue for a period that can be as long as your lifetime. Depending on the terms of the annuity, the insurance company may provide you with contractual guarantees, which are based on the claims-paying ability of the issuing insurance company and prevailing market conditions. Annuities provide tax advantages as well as an insurance element. The insurer assumes the investment risk that the earnings in the annuity will not be enough to provide for the predetermined payout, and the risk that the annuitant will live longer than expected, so that payments continue even when the money in the account has been depleted.
Annuities are not a financial plan, but products that can used inside a structured plan to minimize an identified risk. Annuities are still investments, and as with all investments, there are inherent risks. Annuities should be measured for their “risk transfer.” If an investor can transfer an identified risk for a fair return, it is, generally, considered to be a good trade.
If you identify income as your primary goal, your financial adviser’s next step is to determine the amount of your portfolio that should be invested in fixed-income or “safe” investments to help you achieve the desired income. Immediate annuities can allow for a much smaller amount of your portfolio to be subjected to the historically low interests rates by transferring the risk of outliving the income stream and risk of volatile rate swings to a high-quality insurance company. Alternatively, if your prefer growth, your adviser should consider your risk tolerance to determine if deferred annuities that provide guaranteed principle with guaranteed growth are viable options.
A financial adviser can help you assess whether the unique risk transfer features of an annuity could work in your favor. Again, there is no magic investment. Annuities are not right for everyone as they must work in concert with your overall plan.