Annuity is complex, but good retirement hedge

The Bakersfield Californian
June 7, 2012

With defined-benefit pensions disappearing and stock market volatility giving people nightmares, an increasing number of my boomer retirement planning clients are asking me about investing in annuities.

An annuity is an “investment,” most commonly with a life insurance company, that can pay out retirement income, often through the lifetime of the investor and/or his or her spouse. They come in many forms, paying out in a variety of ranges. Internal Revenue Service rules are being formulated to give annuities greater use in retirement planning.

Annuities often generate a great deal of controversy, with some financial advisors promoting the arrangements for their security and others claiming they are not economical because of their fees and “hidden” costs.

But each person’s circumstance is unique. Most often I will advise people that annuities most likely should be included in an investment portfolio that is balanced between establishing a secure retirement income and growing it.

Annuities should not be used by people who need to have a high degree of financial “liquidity.” Most people claim they need liquidity, but it’s only because they lack a structured income plan. Annuities should not be used for people who change their amount of income frequently, or who need a high rate of withdrawal on their investments.

The prime demographic for people who benefit from investing in an annuity is those age 50 to 70, who need the certainty of income. With people now living many more years beyond their retirement dates, this is the certainty that a retiree will not outlive his or her savings.

Depending how an annuity is structured, the concept is for a person to “invest” a certain amount of money into an “instrument” that will at some future date pay out a regular monthly “retirement” income.

In some arrangements, the “investment” will revert to the company issuing the annuity upon the death of the investor; in others, it will be passed along to a spouse, or to heirs. In each arrangement, the costs will adjust to pay for the benefits.

When I discuss investments with clients, I include annuities, but seldom label them as such. Stunningly, nearly 90 percent of my clients respond by asking to have annuities included in their portfolios.

I have had many people who have said that they would never buy an annuity, and then they have actually bought one. I have one client who didn’t like annuities and now has all his money in them. Often by putting some of their money in an annuity, people have sufficient “peace of mind” to be free to invest in other long-term strategies.

But annuities can be complex and confusing. Ways to protect yourself include:

  • Work with a trusted financial advisor.
  • Identify all fees, including “hidden” fees. Do not be afraid to ask questions.
  • Understand the terms before investing.
  • Ask how inflation will be accommodated.
  • Determine what will happen with your money. Are your heirs accommodated?
  • Take your time.