In the past, annuities have earned a harsh reputation. This is due to untrustworthy salespeople pushing products on investors in order to simply earn a commission. As fiduciaries, we are required by law to do what is in the best interest of the client, regardless of the compensation received. We do believe there are a handful of annuity solutions out there that might enhance our client’s financial plans. Whether it is a strong guaranteed income, great growth potential, downside protection, or simply the tax-deferred nature of an annuity, we sometimes find it appropriate to share these solutions with our clients.
The Shift from Pensions to Defined Contribution Plans
It is becoming increasingly common that employers no longer offer retirement pension benefits. Pensions are very costly to the employer as wages continue to rise and life expectancy continues to extend longer. This means that the employer may be forced to set aside larger amounts of savings or continue to pay these expenses further down the road.
This is why many employers are shifting towards defined contribution retirement plans, such as 401(k)s with employer matching, instead. These types of plans are more cost-effective for employers, but they also shift more retirement saving responsibility to employees.
Replacing the Guaranteed Income Stream with Annuity Income
Because of this shift, clients are often interested in how they can replace the guaranteed income stream that is no longer available from traditional pensions. Social Security will pay you monthly benefits throughout retirement, but those amounts are often not enough to cover all of your expenses.
Many clients, especially those who are more conservative, would prefer to have an additional income stream that they can count on regardless of the stock/bond market performance. This is an example of a need that can be solved with an annuity solution.
Understanding the Benefits of Modern Annuities
Annuities were initially designed to provide lifetime income through the annuitization of the policies. This means the contract would be turned into an income stream and distributed to the annuitant throughout their lifetime. Nowadays, these types of policies contain an income benefit or rider that replicates the income stream but also allows for an account value and death benefit feature in case the contract is not fully depleted.
Annuities are technically insurance products that are offered by life insurance providers. Life insurance is used to protect against unexpected death, while income annuities are used to protect against unexpected longevity.
This is why life insurance companies offer them – they are some of the few entities that can offer protection on both sides of the life/death coin. Their margin spreads, along with the actuarial probabilities, help ensure the companies earn a profit on the business.
Choosing the Right Annuity Income Option
A few different annuitization or income options are available within the contracts, and these are similar to the pension options available at retirement to those lucky enough to receive that benefit.
The simplest option is Single Life, and these pay out an income benefit until the annuitant passes away.
Joint Life policies typically cover spouses and will pay until both annuitants pass away, but normally, the monthly amount is lower to offset the potential of receiving benefits for a more extended period of time. The biggest downside to these options is if the annuitants pass away within the first few years since the income streams will cease at that point.
The other main income option is Period Certain, meaning that the income benefit is guaranteed to last a selected period. This option is great for protecting against unexpected death since the income benefit will continue to be paid to the beneficiary if the annuitant does not outlive the desired period of time.
Making Informed Decisions on Annuity Income
It is important to consider all the investment options available with your advisor before making any major financial decisions. Annuities can be a great solution for the right situation, but they are not appropriate for everyone.
They can also be very complicated products, and we do our best to break them down piece by piece to ensure the client fully understands what they are purchasing. As independents, we have a wide variety of options available at our fingertips, and we continue to analyze them all to make sure we are only utilizing the best options at any point in time. Income solutions are only one reason to consider an annuity policy, but there are others that fit other goals as well, and we may cover these topics in a future blog post.
Annuity Income – Highlights
- Annuities have received a bad reputation in the past due to untrustworthy salespeople, but we do believe some products may provide value to our client’s financial plans.
- Pensions are becoming increasingly rare, so an annuity may be a way to receive an additional income stream.
- There are various payout options, and it is important to consider what may be most appropriate to your specific situation.
Speak With a Trusted Advisor
If you have any questions about strategic travel budgeting, our investment portfolio, taxes, retirement planning, our 401(k)-recommendation service, or anything else in general, please call our office at (586) 226-2100. Please feel free to forward this commentary to a friend, family member, or co-worker. If you have had any changes to your income, job, family, health insurance, risk tolerance, or overall financial situation, please give us a call so we can discuss it.
We hope you learned something today. If you have any feedback or suggestions, we would love to hear them.
Zachary A. Bachner, CFP®
with contributions by Robert L. Wink, Kenneth R. Wink, and James D. Wink.
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