Professional Insurance Blog

Vegetables are good for you. However, too much of one thing is good for nothing. Heard those clichés before? It’s funny how one statement modifies the other. Indeed, every statement has its own context. We may not immediately recognize the grey areas that exist, but they are there. That annuities are good for people is a general statement. In specific contexts, a different truth could exist. It would, therefore, be reasonable to ask if annuities are the solution to the problem of planning for retirement. One would have to properly weigh the pros and cons of annuities to find a defensible response.

Provision of a guaranteed lifetime income is the major advantage of an annuity. This feature is unique to annuities. It removes some of the risk and uncertainty for the retirement phase of your life. The uncertainty cannot be totally eliminated, since the actual pension amount may not be known long in advance. The amount that is determined specifically at maturity is guaranteed for a lifetime to the annuitant. This amount typically remains the same throughout retirement. The downside to that would be purchasing power risk. That’s why it’s very important that the initial pension amount is at least eighty percent of your pre-retirement income. The real value of your pension is guaranteed to decrease. If an annuity cannot provide a figure close to that target, then other high-yield options should be seriously considered.

There is limited risk when investing in annuities. The annuities I am familiar with have guaranteed accumulation rates even. One can have greater confidence in planning using an annuity because of this. This doesn’t suggest that more volatile investments shouldn’t be considered. However, a significant portion of your retirement savings should be held in a low risk vehicle. The annuity provides this option. The fixed annuity can provide even more stability. However, there’s greater inflation risk with fixed annuities. Headline inflation should be used as a guide in determining whether a particular plan could work for you. Annuities with accumulation rates that are continually above headline inflation are the only ones that should be considered. The more powerful annuities come in hybrid forms. These comprise components of fixed and variable annuities.

Tax breaks are a useful benefit of the annuity. These should be taken advantage of. However, sales representatives use this benefit as a reason for clients to invest in the annuity. The tax break is merely an incentive to help support oneself during retirement. If someone is saving ten percent of their salary in an annuity already, it may be self-serving to encourage the person to save more just to get the tax break. If it fits your adjusted retirement target, that’s fine. The fact that registered annuities are tax deferred and that the company would retain a significant portion of the cash value to purchase the annuity would mitigate the tax-break benefit in any event.

Liquidity risk is also a factor with annuities. Since the future is uncertain we may not know if or when we need a lump sum for emergencies. People who do not have relevant forms of insurance and an inadequate emergency fund face a higher liquidity risk when investing in annuities or any long-term plan. They would be the ones who may need it and face prohibitive administrative or surrender charges on premature withdrawal. This is yet another reason why it’s important to have adequate coverage through the protection products that you need.

The investment period is critical to an annuity’s success. Suppose you have less than ten years until retirement and don’t have any plans in place. Using the annuity as a pension is a less desirable option. This is because the pension may not be more than you would have obtained using a money market fund and then living on the interest at retirement age. The interest would usually be bit less, but you’d still have full ownership of the fund. This wouldn’t have been such a great option if planning started earlier. However, with less than 15 years to go, using the annuity for a pension may be unfeasible. In some cases, the retirement target would not be met. If you’re low on financial discipline and prudence, then you should probably consider the annuity regardless.

Darrell Victor is a financial services sales professional who specializes in retirement planning.