When the Worst Investment Turns Out to be the Best Plan

Most of us know that annuities are not an outstanding investment, at least most of the time. But there are exceptions to that general rule, and these exceptions are particularly relevant right now. Why are annuities a bad investment? And when should you consider them as part of your portfolio anyway? 

Let’s dig deeper into this conundrum by looking at the challenges with annuities in general, specific arguments that many investors make against annuities, and why you might want an annuity despite their challenges and limitations as investments. 

A few of the key points we’ll be exploring: 

• Understanding annuities may seem daunting to the average investor because there are so many types with multiple modifications and customizations.  

• There’s rampant confusion because annuities are contracts with insurance companies, regulated at the state level, and may track growth through market indexes which are regulated federally by the Securities and Exchange Commission.
• Judging annuities only through a financial investment perspective for maximizing returns misses the significant benefits, in certain situations, that come from the safety and security of guaranteed lifetime income.  

What is an annuity? 

An annuity is a contract between you and an insurance company where you make a lump-sum or series of payments in return for regular disbursements at some point in the future.  Fixed annuities pay a fixed amount of return on your investment and offer less growth potential. Some fixed income annuities may base their performance on a particular financial index, allowing buyers to get better returns.

As a retirement investment strategy, annuities are designed to offer very low risk of losing principle and with that security typically offer lower opportunities for growth. 

Annuities are complex and varied. 

Two main difficulties have created confusion around annuities historically. Many investment products are regulated at the federal level by the Securities and Exchange Commission SEC. Annuities, however, because they are contracts with insurance companies fall under the regulatory jurisdiction of each state’s insurance regulation department. This results in different regulations that may vary state by state. Without a single consistent set of rules, it is more difficult to compare products.

The second difficulty that stems from the state regulation situation is that a person selling annuities need not be registered with the SEC in order to sell them. The SEC has strict regulations designed to limit financial mismanagement including and especially fiduciary responsibility. A fiduciary financial advisor, registered with the SEC, is not legally allowed to sell you a product that doesn’t benefit you financially.  An annuities salesperson who is only state insurance licensed, however, not being registered with the SEC, need not keep your financial interests in mind when selling you any annuity products. This makes it more difficult for you to determine if the annuity product meets your financial retirement goals or if the salesperson wants you to think so because they receive a commission for the sale.

Are you sure your annuity salesperson is a fiduciary? It really matters.

Many of the large financial planning companies play very tricky word games with the way they define their employees and salespeople and may claim fiduciary responsibility when, in practice, they are not required to have your best interests in mind. Buyer beware – just because your financial advisor says they are a fiduciary does not mean that they are in all situations with all the different products they sell. The easiest way to make sure your advisor is a fiduciary is to look for the Certified Financial Planner designation. Advisors who have met the strict and highest criteria in the financial advising business are by default required to offer you financial products that meet your goals.  

All of this creates a challenging situation for the average consumer to understand a wide-ranging group of products. In addition, the sheer number of different kinds of annuities with different riders, rates, cap rates and spreads means there’s a vast difference in how well a particular product will perform.  

The reasons why annuities are considered bad investments.

Here are some of the basic arguments that many people list when criticizing annuities as financial investments:   

• They are long- term contracts, likely difficult (or expensive) to break should your investing needs change 
• Higher Fees in some annuities decrease your return on investment 
• Your ability to access your funds are limited 

• Death benefits may not be automatically included, requiring additional fees to take care of your loved ones 
• Many annuities have penalties if you need to cash them in early 
• Guaranteed returns provide a limited up-side in growth 

Despite the varied and significant challenges above, the total amount of retirement assets in annuities in 2021 reached $2.5 trillion in the US in 2021.  If annuities are complex, varied, difficult to understand and have real downsides as investments, why do people continue to choose annuities?  

The different goals between growth investments and annuities.  

The answer lies in whether you view an annuity as a purely investment vehicle or as something else that actually helps you meet your retirement income goals. Don’t let their connection to financial markets make you think that they should be compared to investing in stocks, for example. Just like you might choose a higher risk and return when you redistribute your investments into a more aggressive stock portfolio, you get a consistent and guaranteed monthly payment when you purchase an annuity.    

Consider this line of questioning: Do you have enough saved to live a secure and fulfilling retirement? Are you afraid of running out of money in retirement? Do you want all of your money in the stock market, subject to potential huge declines in value right when you want or need your funds? What if there is way to get a lifetime of steady monthly income guaranteed not to decrease? Would that make you feel more secure in your retirement planning?

As you think about your answers to these questions, you may begin to see why annuities remain popular despite their challenges. Coming from insurance companies, and not investment banks, annuities are not designed to compete as the best return for your investment, but to guarantee a lifetime of steady income. Wall Street cannot guarantee that because they do not use actuaries with experiences in life expectancy in order to determine long term profitability. The insurance companies use several different sources to pay a monthly fee: the principal paid into the annuity, the growth on the insurance company’s investment of that capital, and finally the assets of other participants who did not outlive their other two sources.

For homeowner’s insurance, the insurance companies charge enough per policy and sell enough policies that they know they will not have to pay out more than they take in. These calculations are baked into their homeowner insurance products. A similar concept plays out in annuities. The insurance companies that issue annuities use statistical analysis to maintain their ability to keep up the monthly payments they have promised.

Choosing the emotional safety of a lifetime of guaranteed and secure monthly payments may not return the best annual rate of growth. Knowing your monthly income will keep you from being a financial burden on your children no matter how long you live is priceless.  

In addition to choosing lifetime income annuities in certain cases, there are other kinds of annuities that make great sense. One example whare choosing an annuity makes sense is while also creating a Medicaid asset protection trust. The Medicaid Asset Protection Trust does not maximize annual return. Carefully planned and implemented with a financial advisor and experienced elder law attorney, this kind of trust turns assets into income in order to qualify for Medicaid’s long-term care benefits. Rather than answer the question, “How much can I make?” it answers the question, “How can I plan to pay for my long-term care costs?”

Because of their state level regulation, complexity and the sheer number and options, annuities are often misunderstood or rejected. Judging annuities only through a financial investment perspective that prefers maximizing returns misses the significant benefits that come from the safety and security possible with annuities. Being unaware of their benefits could put you at risk of missing out on a powerful tool for retirement income planning.  

Postscript: Why do we spend time helping our clients understand complex and subtle income and financial strategies? The basic answer is that there’s no point in having an estate plan to pass your assets to the next generation if you don’t have any assets left when you die. Traditional estate planning is about avoiding taxes and preserving assets. Modern estate planning, including a holistic approach to the investment of your assets, asks questions that illuminate deeper and more powerful goals than solely the financial ones. What are you passing on to your children? Why? What do you want them to know? How do you want them to live? How do you want to live and be remembered? What really is your contribution to the world?  

Written by Brian Van Way, Copyright 2022 Hammond Law Group, PC

Dive Even Deeper into Investment Strategies:

Retirement Assets in Annuities in 2021  

Insurance information institute Annuities Basics

Marketwatch Opinion: Why annuities are a bad idea for almost everyone 

Grantor Retained Annuity Trust

Roth Investments 

Long Term Care Options

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