The most critical time in most of our financial lives comes when we retire and face years of living on Social Security, our pension (if any) from our employer(s) and the assets we have put aside for this purpose. The two most critical issues are;
• Will it be enough?
• Will it last as long as we do?
The creation and maintenance of a financial portfolio is totally different for someone who must live off of those assets versus someone who is still in the process of accumulating them. For the accumulator, time is his friend. For the spender, time can be the enemy; the unknown quantity that must be considered in each investment and withdrawal decision. The greatest asset to address the longevity issue for most Americans is Social Security, the ultimate pension plan, guaranteed by the federal government to pay monthly income for as long as you live.
While certainly not the desired total source of retirement income, the Social Security annuity provides a significant lifetime income base on which can be added additional income from personal assets.
While most investment advisors offer investment strategies designed to provide income from your assets that will last your lifetime, the best they can do on their own is assure you they will do their best to be successful with your money to meet your objectives.
Ask them if they can guarantee results and of course they must step back and offer only assurances of best effort. The success or failure unfortunately will be totally on you because only institutions like insurance companies and governments can provide guaranteed results.
All pension plans that are fully guaranteed must emanate from an institution and in the world of personal finance, only an insurance company has the investment resources and the unlimited time horizon combined with the actuarial resources to provide guaranteed income for your lifetime.
We are hearing more and more each day from people who sell annuities and from observers and professionals who try to minimize their value in comparison to properly invested and managed portfolio.
The annuity salesmen promote high rates of return that are tax advantaged and tell us that this is the way to go. While the investment community tells us annuities are overpriced, over rated and over sold.
We believe they are both wrong. There are many annuities that are fairly priced and provide results that cannot be achieved any other way. The key is to first understand the retiree’s needs and concerns then determine what financial strategies and products to employ to achieve them. If an annuity can help, then the proper one or two can be selected for the client to consider as a portion of their investment portfolio.
Options available for receiving income are:
• Immediate annuity income for life based on client’s current age and amount to deposit.
• Deferred Income in 5 to 10 years or more with guaranteed increases each year.
• “Longevity insurance”, is an annuity with income guaranteed to begin at a specified point in the future at an amount guaranteed today.
• Lifetime Guaranteed Income Rider that guarantees a specific monthly income for the life of the annuitant with “annuitizing” the contract. The monthly income is less than annuity income but any remaining principal (if any) is returned to the heirs.
Options for crediting interest are:
• Fixed Interest is declared by the carrier at the outset and reaffirmed each year with adjustments as needed and as specified in the contract.
• Equity Indexed Annuity that credits interest each year based on the increase in one or more stock market indices with protection from loss of value in down markets.
• Variable Annuity that allows the owner to choose an investment portfolio typically of stocks and bonds to grow the annuity value for future withdrawal or to “annuitize” for more retirement income. Value can rise or fall as with any investment outside of an annuity. Most are typically purchased with a death benefit guarantee of principle and sometimes with a guaranteed principal guarantee if used for income and not liquidated.
The Annuity Controversy
Annuities may be one of the most controversial financial instruments proposed to clients who are retiring. People who sell investment advice for a living often advise their clients that the guarantees provided by annuities come at too high a cost and point to the commissions earned when an annuity is purchased. On one level this is understandable as the criticism is coming from one who is competing with the insurance company for control of the client’s asset. What is not discussed are the commissions or fees (or both) paid to manage a portfolio of financial assets and even more confusing is the role that the advisor fees play in such a discussion.
The fixed annuity typically does not charge any specific fees that are associated with advisor compensation to the principal of the account. Instead, it requires a commitment on the part of the owner to maintain the account in place for a specified period of time, generally 3 to 10 years. If liquidated prior to that period of commitment, a “surrender charge” is imposed that is initially 5%-10% of the account balance and reduces over the “surrender charge period” by 1% per year to 0% at the end of the period. So if the annuity remains in place for the full period of the commitment the compensation to the advisor is totally paid by the carrier.
Fee-based planners on the other hand take an annual fee (usually 1% to 2%) of invested assets they manage. As long as you keep your account with them they are charging this fee. So you can liquidate an annuity after the surrender charge period and never pay for the agent’s commission. You pay the advisor for investing your money every year until you take it away from him/her.
The person who does not do complete financial planning or portfolio management but only sells annuities is biased to point out the advantages of this product to the exclusion of other financial alternatives. This advice should be considered carefully. There is seldom only one correct alternative when it comes to managing a portfolio or creating a retirement plan. The important thing is to have as much information as possible and be able to ask the important questions that matter to you. Then you are better equipped to judge what portion of your retirement income (if any) should be derived from annuities and how your other investments should be arranged.