“Choosing “safe money products” for your retirement involves gaining more clarity about what you need your money to do for you.”


by Chano Arellano

Annuities have existed since the days of the Roman Empire, yet some still view them as a product to avoid. If you listen to today’s self-anointed retirement “experts,” purchasing an annuity is one of the worst things a senior can do. But is that true?

People with annuities in their portfolios probably smile when they read some negative press or watch a talking head disparaging the product on television. As their friends, family members, and work colleagues fret about how much they’ve lost in their qualified plans or brokerage accounts, annuity owners rest a little easier at night. They know they have at least one guaranteed income stream to help them avoid running out of money when they retire.

However, one famous annuity expert I know is fond of saying that you don’t buy an annuity for what it might do but rather for what it will do.

So, if you’re not looking for protection of your initial investment, guaranteed income, possible solutions for long-term care needs, or want to leave a legacy for loved ones, you might not want or need an annuity. However, if even one of these features is essential, you should understand at least the basic features of this powerful wealth protection tool.

Annuity companies love to customize and brand their products, sometimes giving them names that don’t tell you much about what they will do for you. For this reason, I say to my clients they should first understand the four basic annuity contracts they are likely to encounter as they design their “decumulation” plan.

Fixed annuities.

As the name implies, fixed annuities pay guaranteed interest rates and are intended to replace bank CDs by offering typically higher interest and the ability to access income immediately. These annuities continue to be popular with moderate to conservative investors. Pre-retirees and retirees looking for more predictable, less costly guaranteed solutions may find fixed annuities a wise choice.

Financial pundit Suze Orman reluctantly admits that given the ups and downs of the stock market these days, having an annuity might not be a bad idea after all.

Fixed annuities tend to be easier to understand, have flexibility in payment timing, and will give you some tax-deferred growth during the annuity’s accumulation phase. There are also no limits on how much you can put into your annuity in any given year, and because it doesn’t correlate to the stock market, your annuity isn’t affected by downturns. However, a potential downside of these vehicles is that they can come with early-withdrawal penalties and may not be very effective at protecting against inflation.

Fixed index annuities (FIAs).

FIAs are fixed annuities with an interest component tied to an underlying index, such as the S&P 500. FIAs often offer a guaranteed income stream and the possibility of some principal upside since they’re pegged to an index. When looking at a FIA, one thing to consider is how a particular product may limit your returns through so-called participation caps or a spread.

In a bull market, caps may mean your gains will not be on par with other investments. This is a moot point because most people purchasing FIAs are within 5-10 years of retirement. Many pre-retirees and retirees are tired of risking their nest eggs and attempting to time the market. They want to participate in some potential market appreciation without having to put their principal at risk. For this reason, the downside protection inherent in a FIA appeals to many seniors.

Immediate annuities.

An immediate annuity lets investors deposit a lump sum into the account in exchange for consistent, predictable payouts that last until death or for a contractually stated time period. Immediate annuities are tax-advantaged and often offer higher payments than other annuities. These higher payments are possible because immediate annuity payouts include principal and interest. Seniors who feel they’ll need more significant lifetime income streams and are willing to sacrifice principal sometimes choose immediate annuities.

Deferred annuities.

Deferred annuities are often the annuity of choice for those desiring guaranteed income in the future instead of immediately. As the name implies, a deferred annuity delays your payments until a specific date that is generally a year or more in the future. Deferring payments allows you to increase your income stream in a less costly way because your insurance company won’t have to make payments for as long.

Variable annuities.

In a variable annuity, the value hinges on the performance of underlying “subaccounts.” The annuity owner chooses these subaccounts.

Some variable products offer a rider you can purchase that locks in a guaranteed income stream, even if your subaccounts do not perform as expected. Variable annuities, while they provide the opportunity to get potentially higher returns (and hence more income) than fixed products, also carry a degree of risk. Due to their potential to lose money, variable annuities are a somewhat controversial selection for pre-retirees and retirees. Nevertheless, they remain popular with those who want the potential for greater gains along with a stream of guaranteed income.

These are four of the most common annuity configurations you’ll encounter as you seek to build the “safe money” part of your retirement portfolio. Before you make any decisions about your finances, it’s critical that you seek the advice of a trusted retirement income professional. Your retirement planner will help you clarify what you want your money to do, determine your risk tolerance, and advise you on which products work best to help you reach your goals.