Teresa Kuhn: Should you add an annuity to your retirement plan?

By Teresa Kuhn

While I firmly believe that a properly structured and optimized whole life policy is the cornerstone of effective financial planning, some people may benefit from another popular safe money product to their portfolio-the annuity.

Baby boomers, Genxers, and Millenials are all nearing or in retirement. Unfortunately, many retirees and pre-retirees have had vast chunks of their life savings drained away by the pandemic, inflation, market volatility, tax hikes, and other situations. For this reason, many in these generations look for safer ways to grow and preserve wealth and add a reliable income stream to their portfolios. Annuities are one choice for accomplishing these money goals.

It’s not just boomers and millennials driving surging annuity sales. These financial tools have also become popular with younger people. Many younger Americans have witnessed the struggles of their parents and grandparents and, as a result, have lowered risk tolerances and concerns about the future of government programs such as Social Security.

Annuities may make sense for younger investors, especially those who have inherited money and need greater tax efficiency or who don’t like exposing their savings to market risk.

These younger “pre-retirees” also share a concern with their Boomer counterparts: the well-founded fear of outliving their money.

Research from Boston Research Group and other financial think tanks has found that most respondents admitted to having gaps in their portfolios and having not addressed the need for income in retirement.

Since pensions are virtually non-existent in the 21st Century, it’s possible many retirees won’t have sufficient income to support themselves in the latter phases of their lives.

With their various iterations of structured payouts, annuities have an advantage over other investments. Some specific annuities rise to the top because they create a safe, steady source of income for the rest of your life.

When you add these to the tools I use to design my “Untaxable Wealth Transformation” process, an annuity could further increase your peace of mind about your financial future.

What is an annuity, and how does it work?

Contrary to what you may have heard from some over-zealous annuity salesperson, annuities are not a magic bullet to cure all your retirement problems. Annuities are insurance products that take a lump sum of cash and turn it into periodic payouts to help supplement your other retirement accounts or Social Security. The product, like life insurance, has been around in various forms for hundreds of years and has proven beneficial in addressing different financial challenges.

Typically, the purchaser of an annuity agrees to a series of several payments or one lump sum payment to an annuity company.

In exchange for that money, the annuity issuer agrees to pay you for a definite time or the rest of your life. Generally, these payments occur in one of two ways:

A deferred annuity will let you pay either monthly installments or a lump sum. Money deposited in this account is tax-deferred until you begin receiving payments. While the tax-deferred status of these annuities can be a desirable benefit for some retirees, some potentially adverse tax consequences may occur later. You’ll want to thoroughly discuss the potential annuity tax implications with your financial advisor or tax planner.

On the other hand, an immediate annuity starts paying benefits the same year you made your deposit. Payment amounts may vary based on age, gender, and the total amount invested.

Which annuity works best?

Many annuity companies and marketing organizations promote products featuring intriguing whistles, bells, and custom options. These features may or may not have utility for the average consumer and are likely there only to convince consumers to choose one particular annuity company over another. Don’t let yourself get carried away by exaggerated claims and empty promises. It’s essential to understand the features of any financial product you’re considering and objectively determine if its offers apply to your situation. As writer and podcaster Stan the Annuity Man says, “Choose as annuity for what it DOES, not for what it MIGHT DO.”

Customization options aside, there are basically only three kinds of annuities:

A variable annuity gives the buyer a say in how their money is invested. Each variable product has multiple options, including mutual funds. A variable annuity’s rate of return correlates to the performance of the selected investment options and the amount of deposits made.

Some choose this kind of annuity because it could have more growth potential. However, you could also wind up with smaller payments or lose principal if the stock market falters. I’m not too fond of variable financial products because they have the additional burden of unpredictability.

Fixed annuities are contracts with a purchaser providing an agreed-upon interest rate during the account’s accumulation phase. The purchaser, in return, makes periodic payments of specified amounts.

Indexed annuities claim you can participate in the stock market upswings without downside exposure. Indexed products provide investment returns based on fluctuations in an index tied to the stock market. Indexed annuity contracts stipulate guaranteed minimum contract values, regardless of the index’s performance. I often recommend indexed annuities to clients who want to add more safety to their portfolios. I particularly like indexed annuities customized with guaranteed income riders because they address concerns about inflation and the need for predictable, reliable income in retirement.

Do annuities have fees and expenses?

As with most financial options, annuities have associated fees and expenses. Looking at your annuity expenses to determine their potential impact on your future wealth is worthwhile.

Arguably, the surrender charge is the fee to which you should pay the most attention. A surrender charge is similar to a 401k’s early withdrawal penalty. Costly surrender charges have tremendous potential to damage your retirement income. Since life can be unexpected, you can never know what challenges will force you to use your money. For this reason, you must know the precise amount of the surrender charge and how long the surrender period is.

The commission structure is another factor when determining the actual cost of your annuity. Salespeople sometimes get commissions of 10 percent or more on an initial investment. Plus, they may also receive residual commissions as the account grows. Don’t be afraid to ask your annuity expert how for a breakdown of commissions they receive from products they recommend.

Depending on your kind of annuity, there may also be an annual fee or fees. These fees may contribute as much as 2% annually to the cost of your annuity.

When comparing annuities, thoroughly evaluate all expenses and have your advisor do serious number-crunching.

Other things to watch out for when considering an annuity.

• Ensure the issuing company is stable and has a history of paying claims. At my firm, I am careful to contract with only the top-rated carriers with records of financial stability.
• Before switching one annuity for another, thoroughly analyze surrender charges (if applicable), commissions, fees, and potential tax issues. If you are considering replacing your current annuity, consult an expert to help you make the right decisions.
• Talk to your financial planner if you are using an annuity to create a legacy for a loved one. Not every kind of annuity is suitable for this objective.

Summing it up. Many financial experts agree that having the right kind of annuity can be a fantastic way to diversify your portfolio and create an income stream you won’t outlive.

If you want to know more about annuities and other tools I use to create an “Untaxable Wealth” lifestyle for my clients, visit my website at TeresaKuhn.com.