• Annuities: The Good, the Bad, and the Ugly

    Written by Thomas A. Lane, Jr., ChFC®, CFP®

    I HATE annuities, and you should too” is a popular marketing campaign utilized by a national investment advisory firm to create uncertainty and fear among annuity owners with the hope they will seek out their firm who will then “rescue” them from these “horrific” products.

    Is there any basis or truth to such a comment? I can only assume that the owner of that firm probably does hate annuities. That said, he is making a very broad statement inferring that ALL annuities are bad, which, of course, is not the case. Annuities receive a lot of press, some good, some bad, some ugly, and deservedly so. Annuities are pushed very hard by insurance salesmen and brokers who are paid, often times, excessive commissions, by the insurance companies to peddle their products, without consideration to the needs of the individual or couple to whom they are selling the annuity. The truth of the matter is that not all annuities are bad and not all annuities are great. In my many years of practice as a CFP® professional, I have seen all types of annuities. Some of which have been a nightmare for clients in terms of fees, expenses, and poor performance; and some that have worked extremely well.

    The problem with annuities is that they are often painted with a broad brush by the uninformed media as being “bad”. It is this overwhelming belief by consumers that prevents them from enjoying the benefits the right annuity can offer. As a result, when an annuity is recommended to a client by an experienced advisor who clearly has his client’s best interest at heart, the client will often react defensively and may miss out on a perfectly reasonable solution to their specific financial need. As with any solution to a specific planning need, annuities are not an elixir, and there is no “one size fits all”.

    Types of Annuities:

    Fixed, Variable, Indexed, Deferred, Immediate, Longevity.  What to do these terms have in common? They all describe different types of annuities that are as different as their names imply. Unfortunately for the consumer, it is very difficult to understand the differences between the several types of annuities and, more specifically, how they work before making a determination as to whether or not they have a need for an annuity.

    It is beyond the scope of this article to provide an in-depth description of each product, so I will provide a brief overview of each and will keep the description of each as generic and simple as possible so as to provide the reader with a basic understanding of various types of annuities. 

    Fixed Annuity: The simplest way to describe a fixed annuity is to imagine a tax-deferred CD. This is not to imply that a fixed annuity is a bank product that offers the guarantees associated with FDIC insured products. For example, if you purchase a five-year fixed annuity, a pre-determined fixed rate of interest is credited annually for five years. Interest is not taxable during the deferral period unless withdrawn from the contract.  After five years, the annuity can be 1) “cashed in”, at which time tax would be due on the accrued interest, 2) left with the insurance company for an additional five years, or 3) exchanged (without tax¹) for a new annuity at a different insurance company if more competitive rates are available. Barring cashing in the annuity during the “penalty” period, you can’t “lose” money in this type of annuity².

    Indexed Annuity: Indexed annuities are similar to a fixed-rate annuity, with the exception of how the insurance company credits interest. Rather than a “declared” or fixed rate, the interest credited to the annuity is linked to an index, i.e., the S&P 500, subject to a cap. For example, if the annual cap is set at 5%, and the index earned 9%, the interest credit would be 5% for that contract year. However, if the index is negative for the year, regardless of how steep the decline, there is simply no interest credit. The annuity does not lose value. Indexed annuities also offer additional benefits, for a fee, including enhanced income and death benefits that are beyond the scope of this article.

    Variable Annuity: A variable annuity (VA) is considered a “security” and can only be sold by a registered representative. A VA might be viewed as a tax-deferred mutual fund account, however, with much greater fees.  VAs historically have very high fees, which eat into the returns offered by these contracts. Some VAs offer “enhanced” income or death benefits that can justify paying high fees if real value is created by protecting the annuity owner and/or beneficiaries against market risk. VAs are very complex products and should be considered only when enhanced benefits are offered that are desired by the consumer. It is important to note that money can be lost in a VA, as the funds are invested in sub-accounts/mutual funds that are directly invested in the equity and bond markets.

    Immediate Annuity: A single premium immediate annuity (SPIA) is a contract between an insurance company and the annuitant where, in exchange for a lump-sum of capital, the annuitant receives a guaranteed stream of income, often times payable for life, or joint lives. A SPIA can maximize the amount of income the annuitant can receive from a lump-sum of capital since the payments consist of both principal and interest. A SPIA is appropriate for someone who is concerned about spending down assets during their lifetime. A good financial planner can help a client determine when an immediate annuity is appropriate, and if so, which type of payout structure is optimal to meet their needs.  

    Longevity Annuities: These products are similar to the above-referenced SPIA and were brought to market by the insurance industry as a solution for the client who fears “living too long” and running out of money.  These products, while much more complex in how payments are calculated, provide guaranteed income starting at a pre-determined age, typically as late as ages 80 or 85. The amount of income that can be generated at a pre-determined point in time can be substantial when compared to more traditional options; not due to unreasonably high rates of returns, but for the simple concept of “surviving” to the specific age when the payments commence. Mortality credits are applied to the annuitant who attains a certain age, at which time the payments commence and greatly enhance the amount of income paid. 

    As with any of the aforementioned annuity products, careful thought and consideration must be given before purchasing any type of annuity contract, as they are very complex and there are “the Good, the Bad, and the Ugly” in terms of product choices for every type of annuity. I suggest that you consult with a qualified advisor who understands how annuities work and will act in your best interest when recommending an annuity product to meet your specific needs.

    An excellent resource for information about all types of annuities can be found at http://www.annuityfyi.com. I have often used this site during my career when researching various annuity products for our clients.

    ¹ via a 1035 Exchange, which if done properly allows an annuity owner to “exchange” on annuity for another company’s annuity without paying tax on the accrued interest.

    ² Principal is guaranteed by the issuing life insurance company. Losses may be suffered if the annuity contract is surrendered during the first five years.

  • Bridging The Retirement Income Gap With FIAs

    Authored By: Heather L. Schreiber, RICP® NSSA®

    What do retirees fear most?

    According to a GoBankingRates survey, 66% of Americans worry that they will run out of money during retirement. That’s ahead of the 50% who were concerned about a steep healthcare outlay¹.

    How can seniors and their financial advocates address this worry? Many are choosing to do so with a fixed index annuity (FIA). LIMRA reports that FIA sales were $79.4 billion in 2022, up 25% from 2021, and 8% higher than the record set in 2019²’³. What’s so appealing about FIAs? Before the big reveal, let’s set the stage.

    Shaky Stool

    During the 20th century, a so-called 3-legged stool provided an underpinning for retirees’ finances. That is, cash flow could come from 3 sources: Social Security, pensions from former employers, and personal savings. However, employer pensions have become the exception rather than the rule for many retirees. Pensions are still common for long-term government workers but are relatively rare in the private sector.

    Instead of pensions, private sector employers offer employees the opportunity to put wages into defined contribution plans such as 401(k)s. Generally, those dollars go into funds holding stocks and bonds. Recently, though, market
    volatility has been in the headlines.

    Down Year

    The Morningstar U.S. Market Index lost 19.4% in 2022, the biggest annual loss since 2008…when it lost a 38.4%. Bonds are supposed to offer stability when stocks sag, but the Morningstar U.S. Core Bond Index lost 12.9% in 2022, its biggest annual loss since inception of the index in 1993³.

    To demonstrate the potential effect of such results on an approaching retirement, suppose a hypothetical Holly Smith retired in early 2022. At the start of that year, Holly had managed to accumulate $600,000 in retirement savings, evenly divided between stock funds and bond funds.

    Assume Holly’s investments matched the broad equity and fixed-income markets. At the start of 2023, her holdings would have been down to $241,800 in stocks and $261,300 in bonds—from $600,000 for retirement to just over $500,000. After such a loss, Holly would need almost a 20% gain just to get back to where she had been. Moreover, our Holly had retired in 2022, taking 4% of her savings ($24,000) to supplement Social Security last year. Now, Holly bears sequence-of-return risk, which impacts people whose retirement coincides with a bear market.

    Holly’s choices might be taking that same $24,000 this year, from the $479,100 left in her portfolio. That’s a 5% withdrawal rate, which could lead to depletion while Holly is still alive. Or, Holly might stick to her 4% strategy, withdrawing only $19,164 (4% of $479,100) in 2023, which could mean cutting back on her lifestyle in retirement.

    Financial markets have bounced back in the past, and that could be the case again, helping Holly’s portfolio last longer. Even with a rebound, retirees such as Holly face risks such as longevity that could eventually drain her portfolio, inflation that could strain her budget, and a need for costly long-term care. Threats to cut back on Social Security benefits add to Holly’s dilemma.

    Mitigating Retirement Risks

    Savvy planning can help take these key retirement risks off the table, or at least reduce them to the point where retirees are comfortable. Fixed Index Annuities (FIAs) can help mitigate these concerns to the extent that exceeds what other sources of retirement income can provide for retirees.

    An FIA is funded either through a single lumpsum payment or a series of periodic contributions from a consumer to an insurance company. In exchange, the consumer receives a contract that may deliver tax-deferred buildup, principal protection in a down market, and growth potential. Increases to the annuity value, termed interest, are credited to the contract annually, tied to a market index such as the S&P 500. FIA dollars are not directly invested in the index components but are pegged to the results.

    Generally, FIAs offer protection against market losses. In return, they usually provide lower upside potential than being invested directly in the market. With a crediting rate of 70% of the S&P 500, for example, a hypothetical 12-month index gain of 10% would generate a 7% crediting rate to the annuity value of an FIA with that provision. The tax-deferred nature of an FIA allows money to compound over time without having to pay ordinary income taxes on the growth until funds are withdrawn. Consumer have the choice of turning on a reliable income stream from an FIA for a period of time or for a lifetime to supplement other sources of income in retirement.

    Related Article: Passing an Inheritance to Your Children: 8 Important Considerations

    Bountiful Benefits

    On the plus side, considering a fixed index annuity when building a retirement income strategy has several advantages which include:

    Tax deferral. Any gains inside an FIA avoids immediate income tax, allowing the annuity owner to take advantage of pre-tax compound growth during the accumulation phase. FIA owners also benefit from flexibility in creating retirement income drawdown strategies by controlling when and how to take income from the annuity.

    Asset allocation alternative. Conventional wisdom holds that a 60-40 split, stocks to bonds, combines the growth potential of equities with the stability of fixed income. However, both stocks and bonds suffered double-digit losses in 2022, as previously mentioned. Concerns of ongoing inflation may lead to hesitation regarding investing in bonds.

    An income stream that retirees can’t outlive. Americans are living longer than ever. That generally equates to more time spent in retirement and pressure on retirement assets to last longer. Even with Social Security and perhaps other sources of dependable cash flow, there still may be a gap between actual income and desired annual outflow. An FIA can fill that gap, generating income that will last as long as the retiree (and perhaps a spouse) may live.

    Principal protection against possible market losses. As explained above, sequence-of-returns risk occurs when financial markets drop early in retirement while a retiree is tapping his or her investment portfolio. That can cause lifelong savings to deplete more rapidly than would have been the case if those market corrections occur later in retirement. An FIA can protect retirement assets by offering a source of cash flow that is not exposed to this risk during a market downturn.

    Income to allow deferral of Social Security benefits. Waiting to claim Social Security benefits, perhaps to as late as age 70, can increase lifelong payouts substantially and often increase payments to a surviving spouse. In order to finance such a delay while avoiding additional stress on other assets, an FIA can play a key role. A retiree might start tapping into an FIA at, say, age 62 to bridge income so that Social Security claiming occurs later. Seniors can make their accumulated retirement assets work smarter, not harder.

    Support for a surviving spouse. When one spouse dies, the Social Security income benefit of the lower-earning spouse goes away, and the higher benefit is payable to the survivor. Loss of a spouse generally means a decline in income—going from two Social Security benefits to one survivor benefit—so depending on an FIA to replace lost income may be a strategy that can help the survivor maintain the same standard of living.

    A hedge against unanticipated long-term care expenses in retirement. Standalone LTC insurance policies can be costly. Data from the American Association for Long-Term Care Insurance put the average premium for a 55-year-old couple on a $165,000 initial policy with a 3% annual growth in maximum coverage at approximately $5,025 per year³. That can be an unnecessary expense if the policy benefits are never used.

    Nevertheless, LTC coverage may be necessary, because Medicare does not cover custodial LTC and the average cost nationwide for a private room in a nursing home is about $9,000 a month, according to Seniorliving.org⁴. Adding a long-term care rider to an FIA can provide an additional layer of protection, offsetting the potential expense of a need for LTC.

    Spousal benefits. FIAs, when jointly owned, can create income streams over the course of two lives for a married couple. This can be extremely important because widow(er)s typically become single taxpayers, owing increased income tax. What’s more, a surviving spouse may not have much experience handling the couple’s finances. An FIA offering continued contract ownership to the survivor may provide tax deferral and market risk-free cash flow to an aging widow(er) in need of stable income.

    Legacy planning: Non-qualified annuities, with properly named beneficiaries, may be utilized as an estate planning opportunity to permit non-spousal beneficiaries, such as the owner’s children, to stretch post-death withdrawals over decades, based upon their life expectancy. That’s because non-qualified annuities are not covered by SECURE Act’s 10-year rule.

    Due Diligence

    No financial product is perfect for every consumer in every situation, and that’s true for FIAs, too. These annuities may deliver exceptional results, but there are risks as well. For starters, any guarantees are backed by the issuer, so it’s necessary to evaluate the insurer’s financial strength; therefore, due diligence is vital. A knowledgeable financial professional can provide real value here.

    In addition, FIAs may have costs, just as is the case with any financial product, such as an additional fee for an income rider. Again, a financial professional can help by determining the actual cost of buying a specific FIA to ensure that the product and associated costs meets the specific needs of the investor. The more that is known before buying an FIA, the greater the chance of enjoying the multiple benefits listed above.

    Retirement Action Plan:

    • Prepare early. Determine a realistic retirement timeline that considers income needs in retirement, source of retirement income, family history, and current investor health.
    • &nbsp
    • Develop a plan that includes guaranteed income sources for predicable and necessary expenses. This plan should aim to fill any projected gaps.
    • &nbsp
    • Recognize the various risks that come with any financial plan, including market risk, healthcare risk, inflation, loss of employment, or death of a loved one. Adjust the approach to minimize such concerns.
    • &nbsp
    • Schedule a plan review at least annually with a knowledgeable financial professional and make needed changes.
    • &nbsp
    • Consider including a fixed index annuity as part of a retirement income plan, to provide needed lifelong income without exposure to possible market weakness.


    ¹ https://www.nasdaq.com/articles/66-of-americans-are-worried-theyll-run-out-of-money-in-retirement-here-are-7-tips-to-make

    ² www.morningstar.com/articles/1131213/just-how-bad-was-2022s-stock-and-bond-market-performance

    ³ www.aaltci.org/long-term-care-insurance/learning-center/ltcfacts-2022.php#2022costs


    Not affiliated with the Social Security Administration or any other government agency. This information is being provided only as a general source of information and is not intended to be the primary basis for financial decisions. It should not be construed as advice designed to meet the needs of an individual situation. Please seek the guidance of a professional regarding your specific financial needs. Consult with your tax advisor or attorney regarding specific tax or legal advice. ©2023 BILLC. All rights reserved. #23-0432-053024