Annuities are a little bit like Cadillacs; if all you know about them is what you learned when your grandfather drove one, you’re probably harboring some outdated ideas about them. Over the past decade, insurance companies have supercharged these combination investment/insurance products with a slew of new features that make them more responsive to the needs of a broader range of consumers. Check through this list of five common misconceptions and see whether you’re misjudging today’s annuities.
Buying an annuity means giving up control of my money.
Sure, you can still trade your cash for an annuity that pays you back in fixed monthly installments till you die, no substitutions allowed. But today, it’s no more necessary to buy an inflexible annuity like that than it is to buy a car without air conditioning. According to Bill McDermott of AXA Equitable, today’s annuities provide the ability to control your underlying investment portfolios, similar to how you can manage mutual funds, while giving you access to assets if your situation changes. Annuities today also offer added benefits that provide a guaranteed lifetime stream of income which won’t decrease when the market performs poorly, but which has the potential to grow when the markets perform well. “It is simply no longer the case that when you buy an annuity, you write this check representing the biggest amount of money you’ve ever had in your life, hand it over to an insurance company, and never see it again,” says Mark Foley, vice president for innovative simplicity at financial services firm Prudential Financial Inc. “If you want an annuity that is highly liquid, you can certainly find one.”
Annuities are too expensive.
There is a cost to buying the protections that annuities offer, such as investment returns guaranteed against market declines and monthly income checks that you receive no matter how long you live or how poorly the markets perform. Twenty years ago, these costs were often high. But since then, insurers have introduced annuities that cost far less than their predecessors. “It’s very common for people to compare an annuity sold through a financial advisor with a no-load mutual fund that’s sold direct from the fund company,” remarks Nationwide Financial’s Eric Henderson. “But that’s comparing apples to oranges. If you’re going to compare, you have to compare annuities sold through a financial advisor with funds sold through a financial advisor, or annuities and funds that are both sold direct. Annuities will be more expensive, of course, but you have to consider what you’re getting. Our clients who have purchased annuities with lifetime withdrawal benefits are breathing a lot easier right now than those who haven’t. Their asset base is down, but they know they’re going to get their promised level of income even if the market doesn’t recover anytime soon.”
Annuity riders that protect against market volatility aren’t worth the money.
Given the upward bias of the stock market over long periods of time, it’s been tempting to argue that buying optional riders on annuities to get guaranteed investment returns or guaranteed lifetime withdrawal benefits aren’t worth the cost. But the carnage in the stock market over the past year has shown that its not long-term average returns that matter, but the sequence of the actual returns. Many people who just retired or were planning to do so in the next few years have suffered such major hits to their retirement portfolios that they are in jeopardy of having enough money to see them through retirement. “You may be able to choose when you retire, but you can’t choose where the market is going to be when you retire,” says Hugh McHaffie, president of wealth management for John Hancock Financial Services. “There is real risk to being exposed to the markets, and I would say that individuals who bought these riders over the last five or six years are probably quite satisfied with the value they’re getting.” In fact, adverse market conditions are far more common than many investors had come to expect. Michael McCarthy of AXA Equitable notes that if your investment portfolio is split 50-50 between stocks and bonds and you withdraw six percent of your initial account balance each year, you have a 50 percent chance of running out of money within 25 years. And if the market gets hammered right around the time you retire, you could run out long before then.
When I invest in an annuity, I no longer get to invest in the stock market.
It’s true that with the typical fixed annuity, you forego exposure to the stock market and the inflation-fighting characteristics it brings to an investment portfolio. But deferred variable annuities offer investment options that can include substantial exposure to the stock market. The big difference between getting that exposure through a mutual fund and getting it through an annuity is that the annuity can protect you against market losses.
If the company that issues my variable annuity gets into trouble, my investments are at risk.
“Investing in a variable annuity issued by an insurance company is not the same thing as investing in the stock of an insurance company,” says Henderson. “When you buy a variable annuity, the money you have invested in the financial markets is in a separate account under your name and segregated from the company’s other assets and liabilities. Even if the company were to file for bankruptcy protection, it would still have reserves set aside to cover the benefits it is responsible for paying. I’m not saying that you should ignore the financial strength of the insurance company issuing an annuity; far from it. That strength is the ultimate backstop for any withdrawal guarantees you purchase with your annuity. But in many respects, the value of your investments within a variable annuity are no more at risk than the value of your investments in a mutual fund, and in most cases, they are at less risk.”