(Re)Modeling the Perception of Annuities in Retirement

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Annuities: Courtesy of napkinfinance

Annuities get a bad rap. Let’s just address the elephant in the room first and foremost. There are many reasons why they get both good and bad attention, however, that isn’t the point of this piece. Consumers are misinformed. We are here to solve that problem.

To begin, annuities (all forms of them) are powerful financial tools. In the right hands, they can help manage and stabilize your dependable and spendable income in retirement, but it’s also really easy to cut your fingers off if you don’t know what you’re doing.

Think of annuities as contracts in which you give someone (usually an insurance company) money upfront in exchange for an income stream immediately or in the future. You’re buying a stream of reliable income.

Annuities can be broken down into four overarching categories based on whether the contract’s income stream amount is constant or changeable and whether it pays out now or in the future:

Constant (Now) — Single Premium Immediate Annuity & Immediate Variable Annuity / Changeable (In Future) — Deferred Income Annuity & Deferred Variable Annuity

Immediate vs. Deferred Annuities

When you start receiving your income stream is pretty cut and dried. With an immediate annuity, you give the insurance company your money and they start sending you checks right away based on whatever schedule you set with them (usually monthly or annually).

With deferred annuities, your income is paid later, as their name implies. This generally means your payments will be greater (based on annuity crediting rates) than if you paid the same amount for an immediate annuity.

Fixed vs. Variable Annuities

Just like the timing, the basics of fixed and variable annuities are simple, but the finer details can be incredibly complicated. Variable annuity sales have been declining for a multitude of reasons but mainly because they’re a giant can of worms when you peel back their fees and layers. In addition, the Department of Labor fiduciary rule and back and forth tennis match over the past few years have delivered a one-two punch to variable annuity sales.

Fixed annuities provide level and stable income streams over the entirety of the annuity contract. You may adjust them for inflation or have the payments reduced after your spouse passes, but the adjustments are straightforward.

Variable annuities are far less predictable. They’re based on the performance of a set of underlying securities, and that performance will determine what your payouts look like, but it will never drop below the minimum payout spelled out in the contract.

That “based on performance” piece is easier said than done. The performance calculations for variable annuities can get incredibly complex, but they generally limit the upside potential of whatever securities the contract is based on.

This makes sense — the insurance company is taking on the risk of poor performance, so they need to be able to capture (hedge) the upside when the securities do well to balance things out.

The devil is in the finer details here. If you’re considering a variable annuity (I would not), you want to be sure the underlying securities are good investments and the returns aren’t constrained so much that you basically end up with an expensive fixed annuity.

Shopping Annuity vs. Traditional (Lump Sum) Annuities

On the contrary, there are newer tools (courtesy of the advantage of the digital age, technology and referral tracking systems) that leverage the closing down of traditional brick-and-mortar retail stores and capitalize on growing e-commerce trends. This isn’t a financial product yet but I promise you everyone will know about the Shopping Annuity in years to come.

The main difference between the Shopping Annuity and a traditional annuity is that ours does not require a large lump sum of cash to put into an account. You do not need to sit back, watch it grow and then start receiving payments. It is actually the opposite approach.

The Shopping Annuity is based off of the money (your budget) that is already being spent on a daily, weekly, monthly and yearly basis. There isn’t any more or less money that needs to be spent or redirected. You’re actually losing money by not doing this…

Take what you’re already spending at stores like Nike, Walmart, Target, Kohls, Starbucks, Dunkin Donuts, Travelocity, Home Depot, Dell and thousands more. Redirect those dollars, and now in the form of cashback (which is real cash totaling $40,000,000+ paid out to date to individuals), which is complicated but in the form of traditional ad dollars, you’ll be saving money and earning money.

It just makes sense because all of us are already spending money (trust me we’re good at that) and will continue to do so for the rest of our lives. It comes down to converting your spending into earning. If you’re remotely interested I’ll post more information in the educational resources below for you to check out!

So, How Do Annuities Work?

Annuities can be great tools, but just like powerful tools, there are more wrong ways to use them than right ways. But there are right ways. You (the consumer) simply need to be mindful, do your homework and be careful of insurance agents or brokers out there looking to make a quick splash.

Unfortunately, most of the wrong ways make more money for both the salesperson (mentioned above) and insurance company selling the annuities than the right ways — so that’s what they often push.

You may have heard people say that annuities are sold, not bought. Annuity salesmen and women can make a lot of money when you buy an annuity from them (some more than others), so they often steer you toward annuities that might not be in your best interests. It pays to be on your guard and this is why the fiduciary standard is so important today and moving forward. It’s not about what is in your best interest but what is necessary for your clients. It goes the same way in the medical field and law practices around the world.

But annuities can have a little bit of magic to them — especially if you’re looking for lifetime reliable income. One of the biggest risks in retirement planning is longevity risk — the uncertainty of how long you’ll live.

Living longer is a good thing, overall, but longer retirements cost more money. This matter is both binary and certainly an unknown variable. You’re either alive or you’re not. You could pass away next year, or you could live until you’re 100. This makes a huge difference when you’re laying out your own individual income plan.

But insurance companies aren’t planning for individuals. They’re working with really big pools of people, so they use actuaries (statistics) to understand what the pool is likely to look like.

You might blow way past your life expectancy, but someone else in the pool will come up short. It’s not an exact art or science, but it allows the insurance company to effectively diversify against longevity risk.

If you are looking for reliable income in retirement, it’s often a good idea to look into a fixed income annuity. They are usually pretty straightforward, and it’s very easy to understand exactly what you’re getting. There are also new products on the market today called qualified longevity annuity contracts (QLACs) which are essentially deferred income annuities with tax advantages.

The Bottom line: you don’t want any surprises with your reliable income.

Disclaimer

Unfortunately, people need to write one of these even for blogs:

All information and data on this blog are for informational purposes only. Because the information on this blog are based on my personal opinion and experience, it should not be considered professional financial investment advice yet. The ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting an investment advisor.

My thoughts and opinions will also change from time to time as I learn and accumulate more knowledge. With that being said, here are a handful of educational resources to dive further into.

Resources:

Investopedia — Annuity

Shopping Annuity

Evolution of Economics

Investor.gov— U.S. Securities and Exchange Commission

Thanks for reading!

My Very Best,

Donovan Vogel

Written by

Philadelphia based teaching financial literacy | Prospering all other hours | Writer | Lifter | Reader | Traveler | Freedom & Wellness

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