Who Should Buy Annuities

Annuities are unique in that they offer a wide range of benefits for investors, however, like any investment; they may not be suitable for everyone. Along with the benefits come certain restrictions or limitations that, if not fully understood, could work against an individual’s circumstances. But, for the right people, and when used in the proper financial context, annuities can be an unparalleled in their ability to help people reach their financial goals.

The features and characteristics that go into making annuities work the way they do are best understood when applying them to the financial needs and objectives of individuals who are better positioned to benefit by them. While not an exhaustive analysis, this can provide prospective annuity owners with a way to classify their positions to determine if annuities might suitable for them:

Suitable Candidates for Annuities

People who are Risk Adverse

Some people prefer to put their money in vehicles that have no exposure to risk. While that really isn’t possible, people associate savings accounts, T-Bills, and bank CDs with safety of principal. There are many different types of risk, which, if not accounted for in your savings or investment strategy, could have a detrimental effect on your long term savings. But, as a long term savings vehicle, annuities provide many layers of protection for preserving principal. In addition to principal guarantees offered in many annuities, they also include minimum rate guarantees to protect against steep declines in interest rates.

People who don’t Like Taxes

Nobody likes to pay taxes, but for those investors in the higher tax brackets, annuities offer benefit of tax deferral on earnings that accumulate inside the contract. For someone in the 50% tax bracket (combined state and federal), that would mean that their earnings could grow 50% faster than an equivalent taxable vehicle. They will, however, have to pay taxes on their earnings when they are withdrawn, but assuming they are in a lower combined tax bracket at retirement, they will end up saving on the amount of taxes that would have otherwise paid.

People who want a Competitive Edge

Even risk adverse people like to get that extra edge of a half a percent or more interest credited to their accounts. The yields on annuities tend to be higher than those available on equivalent savings vehicles. Additionally, many annuity contracts will pay a bonus rate on initial deposits that exceed a certain amount. And, for CD-Type annuities, the rates go up even further when the deposits are committed to a minimum guarantee period (i.e. five to 10 years).

People who are Thinking Long Term

For investors who have done a good job of establishing other savings or investment accounts that are available for meeting short term or emergency needs, they can turn toward annuities for their longer term needs. In return for the guarantees, the tax deferral, the competitive interest rates, and the extra layer of protection that annuities provide, the annuity provider asks that you commit your funds for a minimum period of time.
To do that, they have established surrender periods during which, if any withdrawal of funds is made in excess of 10% of the account value, it will charge a fee. This should be of no concern for investors with a long term time horizon because, eventually (within seven to 12 years), the surrender period ends and the funds can be withdrawn without a fee. Additionally, after age 59 ½, investors don’t have to worry about the 10% IRS penalty assessed on early withdrawals.

People who don’t Like Surprises

Even risk tolerant investors, especially those who experienced the shellacking in the markets of a few years ago, would like to have some stability and predictability built into their retirement portfolios. Annuities, with their minimum rate guarantees and minimum income guarantees can accomplish that. When combined with other investments that fluctuate in value due to market swings, fixed annuities can level out the downside returns with their steady rates and predictable income streams.
Risk tolerant investors might want to also consider variable annuities for their potential to earn market returns. Aside from the tax advantages of deferring taxes, many variable annuities offer options that will protect their value against market declines. Although these options come at an additional cost, savvy investors might look at it as a small insurance premium.

People who worry about Outliving their Income

If you are one of these people, you are not alone. Nearly 80% of Baby Boomers lay awake at night wondering if their assets are sufficient to generate the income they need for their lifetimes. Most of them are victims of the “lost decade” of the stock market from 2001 to 2009. Others just fell into the rut of not saving enough. In either case, people are approaching retirement with greater fear and many of them are turning to annuities to insure their financial security.

Annuities are built as income generators, but, unique to them are the guarantee of a minimum level of income for as long as a person needs it. Life insurers are able to convert a lump sum of capital into an income stream that cannot be outlived. Because the investors have to give up control of their annuity deposit, it is recommended that they have other assets under their control that are available for income investing as well as for short term needs.

Summary

While annuities aren’t for everyone, this list may very well include some attributes that most people share. Still, the key is to thoroughly understand your own needs, objectives, priorities, time horizon and tolerance for risk before you consider any investment. If you find yourself falling within one or more of the classifications outlined here, annuities may be the right choice for you.