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Annuities have garnered fans and critics over the years and often are the subject of many misconceptions. But, especially in an environment of rising interest rates and high inflation, an annuity might be a great addition to your financial plan. I am a firm believer that there is not a bad product but a product that is a bad fit for a client. You have to determine your needs. If an annuity is the best solution, then we need to find the best annuity to fit that need. An annuity is not in itself a bad strategy. It has benefits and can be an ideal solution for clients in need of a secure income stream.
At its core, an annuity is a financial product that pays out a fixed amount in a series of payments. It can be a valuable tool in your retirement plan, especially considering that a portion of your retirement assets repositioned in an annuity can lessen your investment portfolio reliance burden and provide increased guaranteed income to supplement Social Security. However, there is often lingering confusion about what an annuity is (and isn’t).
Myths About Annuities
It’s easy for young people to grasp the basics of how money in exchange for goods and services works through simple activities like the ones below. But be careful: it’s just as easy for them to pick up any bad money habits you have as well. These three “do as I do” lessons are a great starting point:
- Money doesn’t grow on trees
Most transactions kids see happen with the swipe of a credit card. They need to understand that cards don’t represent unlimited funds, and spending more than you have creates debt. Try giving them $20 and send them to pick out snacks or to the beauty aisle. It will be a good opportunity to see their financial decision-making in action.
- Needs vs. wants
Knowing the difference between things they want and things they need is an invaluable skill they’ll use forever. Try this: let your kids know your budget for your next shopping trip. As you choose items, explain which items are needs and wants, and separate them into two carts.
- Delayed gratification
Most successful adults say they were taught to wait for things they wanted at a young age, which helps them avoid debt. Pick out an item or experience to save for as a family. Create a chart using the number of days and amount of money it’ll take to afford it. Cross off the days as they pass while adding up the accumulated funds. Factor in setbacks due to any impulse purchases along the way.
Why might an Annity be a good fit
- What occurs with many retirees is a change in mindset
it’s less about finding the “best-performing fund” and more about consistent performance. It may be less about a risk continuum—that stretches from conservative to aggressive—and more about balancing the objectives of maximizing your income and sustaining it for a lifetime. You may even find yourself willing to forego return potential for steady income.
For instance, it may mean that you hold more cash than you ever did when you were earning a paycheck. It also may mean that you consider investments that shift the risk of market uncertainty to another party, such as an insurance company. Many retirees choose annuities for just that reason.
The guarantees of an annuity contract depend on the issuing company’s claims-paying ability. Annuities have contract limitations, fees, and charges, including account and administrative fees, underlying investment management fees, mortality and expense fees, and charges for optional benefits. Most annuities have surrender fees that are usually highest if you take out the money in the initial years of the annuity contract. Withdrawals and income payments are taxed as ordinary income. If a withdrawal is made prior to age 59½, a 10% federal income tax penalty may apply (unless an exception applies).
- Maybe you are looking for more stability in a volatile market
One strategy combines two different annuities (Split Annuity Strategy) to generate income and rebuild principal. Here’s how it works:
An investor simultaneously purchases a fixed–period immediate annuity and a single premium tax-deferred annuity, dividing capital between the two annuities in such a way that the combination is expected to produce tax-advantaged income for a set period of time and restore the original principal at the end of that time period.
Keep in mind that any withdrawals from the deferred annuity would be taxed as ordinary income. When the immediate annuity contract ends, the process can be repeated using the funds from the deferred annuity (see example). Remember, the guarantees of an annuity contract depend on the issuing company’s claims-paying ability.
- You want to mitigate negative returns early in retirement
Taking withdrawals from a traditional portfolio exposes fixed-income investors to “sequence of returns” danger. In other words, experiencing negative returns early in retirement can deplete your portfolio more quickly than you planned and potentially undermine the sustainability of your assets. So, you may want to consider a couple of strategies to help mitigate this concern.
- The first is to have a pool of very liquid assets to fund two-to-three years of retirement spending; this may keep you from selling longer-term assets at an inopportune time. Through time, and depending upon market conditions, you may have the opportunity to replenish this cash reserve using gains from your retirement portfolio.
- Another complementary strategy is to integrate annuities. This can help shift the risk of market volatility off your shoulders and onto the issuing insurance company.
A successful retirement is so much more than undertaking sound investment strategies. It also requires understanding “sequence of returns” danger and taking measures to mitigate the risk. If you think an annuity might be a welcome addition to your retirement plan or you have questions about annuities, give your financial professional a call. They are there to help clients feel confident and knowledgeable about their planning decisions.
The content is developed from sources believed to be providing accurate information. The information in this material is not intended as tax or legal advice. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. This material was developed and produced by FMG Suite and Advisor Group to provide information on a topic that may be of interest. FMG Suite is not affiliated with the named broker-dealer, state- or SEC-registered investment advisory firm. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security. Copyright FMG Suite.