Retirement Planning
June 6, 2022

Annuities Explained

The benefits, drawbacks and opportunities
Stewart Willis
Co-Founder & Co-Owner Asset Preservation Tax & Retirement

Not many understand how annuities work, but if set up right, an annuity can be a powerful tool to provide you with a reliable income in retirement. However, you need a strategic plan, or an annuity can drain your finances with high fees and other losses. Having a guaranteed income in retirement sounds great, but it’s critical to understand the pros and cons of annuities and decide which type is the best fit for your situation

Annuity Basics

Mainly used as an investment tool for those in or near retirement, an annuity is an insurance contract that provides the purchaser with a fixed income stream. The payouts typically last the lifetime of the buyer, and the payout amount is agreed upon when the annuity is purchased. Some people like to view annuities as a pension-replacement to receive guaranteed income in retirement.

Annuities come with plenty of benefits. Depending on which type you choose, it can be a relatively safe investment option since the insurance company must pay the income promised to the buyer. The terms of an annuity are customizable, so you can truly create an agreement that fits your unique needs. Not to mention, a stream of guaranteed income brings incredible peace of mind in retirement. Some people have an aversion to annuities, but after a bear market hits, our clients are happy to have annuities as a safety net.

No investment tool is perfect, though, so it’s important to realize the downsides of annuities. One reason many people hesitate to use annuities is because of their potentially high fees. Riders are the terms added to customize an annuity contract, and riders add cost, quickly eating up any potential gain for buyers. If you cash out your annuity early, you’ll be fined, and some investors aren’t comfortable with that level of illiquidity. For certain types of annuities, the guaranteed income stream may not keep up with inflation. Although the market risk for an annuity is absorbed by the insurance company, the control is also surrendered to the insurance company, and you may prefer to stay in charge of your own investments

When deciding between types of annuities, it’s important to keep in mind the difference between interest and income. Oftentimes, annuities promising lifetime income conflate those terms. Interest is what you make, but income is what you take. If you aren’t careful, your “guaranteed income” promised by TV and radio ads can be eaten up by fees. To prevent this, it’s important to pick the right type of annuity.

Immediate - Buyers of immediate annuities exchange a dollar amount for an income stream by giving a lump sum of money to the insurance company. Payments begin immediately after purchase.

Deferred- Just like an immediate annuity, a deferred annuity provides payouts in exchange for a lump sum of money, only these payouts begin at a future date. The dollars grow tax-deferred until the buyer takes out their money.

Fixed - This type of annuity provides a fixed rate of return on the principal. With a set rate of return, inflation protection isn’t available for fixed rate annuities.

Variable - Although this type of annuity is risky and can be expensive with lots of rider fees, variable annuities offer the largest potential for gain. A variable annuity uses various investment options like stocks and bonds to grow the principal and determine payouts.

Equity Indexed

Annuities can be many combinations of deferred, immediate, fixed or variable to create a unique contract to fit your risk tolerance and income needs. The type of annuity we recommend most for clients is an equity indexed annuity. They give you part of the upside of the market without any of the risk. As a buyer, you’ll receive a guaranteed minimum income from the interest earned, while the other portion of the investment is linked to a specific equities index, such as the S&P 500. Although the participation of the annuity buyer is limited to a certain portion for the market gains, the potential risk is mitigated by having a portion of guaranteed income. Equity indexed annuities keep a good balance between risk and return, and we avoid using equity indexed annuities with any rider fees to make sure our clients can maximize their income.

With so many variables built into their contracts, annuities should be discussed with a professional advisor. When we work with clients at Asset Preservation Tax & Retirement Services, we make sure to understand their complete financial situation and take their unique retirement goals into consideration before selecting the right option for them. We passionately believe education is the key to empowering our clients to make confident financial decisions.

Stewart Willis is the founder and president of Asset Preservation Wealth & Tax, a financial planning firm in Phoenix, Arizona. Investment advisory services offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.

The commentary on this blog reflects the personal opinions, viewpoints and analyses of the author, Stewart Willis, providing such comments, and should not be regarded as a description of advisory services provided by Foundations Investment Advisors, LLC (“Foundations”), an SEC registered investment adviser or performance returns of any Foundations client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this website constitutes investment, legal or tax advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Personal investment advice can only be rendered after the engagement of Foundations for services, execution of required documentation, including receipt of required disclosures. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Foundations manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Any statistical data or information obtained from or prepared by third party sources that Foundations deems reliable but in no way does Foundations guarantee the accuracy or completeness. Rates and Guarantees provided by insurance products and annuities are subject to the financial strength of the issuing insurance company; not guaranteed by any bank or the FDIC. Investments in securities involve the risk of loss. Any past performance is no guarantee of future results. Advisory services are only offered to clients or prospective clients where Foundations and its advisors are properly licensed or exempted. For more information, please go to https://adviserinfo.sec.gov and search by our firm name or by our CRD # 175083.

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