If you want to cause an argument between two financial advisers, just get them talking about annuities. Some love these insurance products. Others avoid them like the plague. Each viewpoint has good reasons.
As a provider of guaranteed income, an annuity can help you avoid retirement failure. Even if the stock market crashes and much of your savings are wiped out, you’ll still get an annuity payment. In certain situations, that can mean the difference between being able to stay retired and having to rejoin the workforce.
On the other hand, that annuity payment could net you less money than a well-structured retirement plan without one. After all, the insurance company you buy an annuity from needs to hedge its bets if the market doesn’t perform well enough for the insurance company to give you your guaranteed payment while still making a profit.
There are other drawbacks to annuities as well. For example, in most circumstances, that guaranteed income is going to come in whether you need it or not. Sometimes you want to avoid income for tax purposes, but an annuity’s lifetime benefit rider often forces you to take the income regardless.
One significant drawback is that with a traditional annuity, a number of entities are taking a cut from the annuity’s value. The insurance company obviously extracts some value for itself in exchange for guaranteeing that income. But others have their hands in the pie as well. The insurance agent who sells you the annuity gets a commission, and there’s often another company, called an insurance marketing organization, which promotes the annuity to the insurance agent for the insurance company. All of those services are taking a portion of your annuity’s value — up to 12%; that’s value that could be yours if they weren’t involved.
Advisory annuities: Not your father’s insurance products
An advisory annuity is a relatively new product that hasn’t gotten very much attention. Essentially the same as a traditional annuity, the advisory annuity is sold through financial advisers rather than insurance agents. Especially if your financial adviser is a fee-only fiduciary, this route can eliminate much of the overhead you encounter with regular annuities.
The compensation structure is fee-based rather than commission-based, so the value extraction tends to be more favorable to you; it’s less lucrative to the person selling it to you, but that person is your financial adviser, who is required to act in your best interest and therefore will not begrudge you the loss of commission!
Should you get an advisory annuity?
Any decision on whether to get an advisory annuity will depend on your unique circumstances. However, there are some common considerations when exploring the option.
One compelling reason to consider an advisory annuity is if you already have a regular annuity. Could you end up with more value to you if you converted that regular, commissionable annuity into a fee-only annuity? Frequently, you can. When I get a new client who has an annuity, I calculate the result of converting to an advisory annuity. It is not unusual to discover I can save them a significant amount of money by doing so.
There’s a particularly important factor in that calculation you should be aware of, however: the surrender period. A traditional annuity usually carries with it surrender charges. If you decide you want to get rid of your annuity within a certain time period after you purchase it, the insurance company will charge you what is essentially an exit fee in order to recoup its investment.
The surrender period can be as many as 12 years after you buy the annuity. If you want to convert it to an advisory annuity, you will have to pay any surrender charges; this can reduce or entirely eliminate the value of rolling a traditional annuity into a fee-based one.
An annuity might include a spread or a cap
If you don’t already have an annuity, the math gets a bit murkier. Regardless of the type, annuities are set up to extract value from good performance in order to pay the insurance company. By guaranteeing the result promised by the annuity, the insurance company is taking on risk and will identify the cost for them to hedge that risk. They might use a spread, in which the insurance company takes a certain percentage of any growth as their payment for guaranteeing income. Or they might use a cap, in which any growth over a given percentage is theirs to keep.
Either way, you will not get as much value from gains with an annuity as you would if you had the same investment outside of the annuity. The upside is, should that investment lose value, you won’t suffer with the annuity as you would outside of it.
All this is to say that if you don’t already have an annuity with fees that are draining your returns, the case for getting an advisory annuity may not be as strong.
If you’re willing to accept that you won’t gain as much from market increases, annuities can be good investments to take some risk out of your retirement portfolio. There are many considerations to take into account when contemplating an annuity, fee-based or otherwise. This is not a question you should take on yourself; consult with your financial adviser before you decide.
As Principal and Director of Financial Planning, Sam Gaeta helps clients identify financial goals and make plan recommendations using the five domains of financial planning -- Cash Flow, Investments, Insurance, Taxes and Estate Planning. He is responsible for prioritizing clients' financial objectives and effectively implementing their investment plans and actively monitors the ever-changing nature of clients' financial and investment plans.
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