Asking the Hard Questions

Does an Annuity Fit in My Portfolio

So, you’re considering retirement or have very recently retired. Naturally, you begin to wonder where your paycheck will come from each month now that you are no longer employed. A close friend suggests an annuity, while another says you should never put your money there. Who’s right? Is an annuity a good choice for your portfolio? And if so, what kind of annuity is best for your situation? As with most considerations in life, the best approach is to start by weighing the pros and cons.

While there are many varieties of annuities, annuities with “living benefit riders” have emerged as a popular product in the last decade or so among pre-retirees looking to replace their paycheck after retirement. A living benefit rider allows the annuity owner to draw a guaranteed amount for life, regardless of what happens in the stock market.

So, let’s look at just a few of the pros and cons of an annuity with a living benefit rider.


Pros:

Guaranteed lifetime income with little or minimal risk
This is one of the most common reasons individuals purchase an annuity product. It is a way to receive a paycheck for life, regardless of stock market performance. Annuities can provide financial assurance, especially if you are concerned you may not have saved enough for retirement through other investments. And since annuities are typically a blend between an investment in the stock market and an insurance product, the risk associated with investing in the stock market shifts from your shoulders to the insurance company underwriting the annuity.

Guaranteed accumulation
While all annuity products have slight variations in how they work, most offer an investor some form of guarantee of accumulation, between the time of purchase and the time you start making withdrawals. This can be advantageous, as a person can plan for a specific amount of income at a certain point in the future, such as their retirement date.


Cons:

Cost
Simply put, annuities can be expensive. Purchasing an annuity means you are shifting some form of risk from yourself to the insurance company underwriting the annuity and they can and will charge fees to assume this risk for you. When considering an annuity, make certain you ask about all the various fees associated with the product. What you learn might surprise you. If you don’t truly need the guarantee the product is providing, this will be an important factor to consider.

Permanence
One of the biggest criticisms of annuity products is their lack of liquidity. In most cases, once you purchase an annuity, it’s nearly impossible to get out of. And if you do, there will most likely be large penalties. In addition, any growth in a non-retirement annuity can create challenges for the beneficiaries upon your death, preventing you from being able to pass money to the next generation in the most tax efficient way.
While weighing the pros and cons of an annuity is an important first step, there are additional factors to consider when determining if an annuity is right for you and your investment portfolio.

Need for income
Thinking through monthly cash flow once the work paychecks stop is crucial. Upon retiring, some individuals may find themselves with little or no debt. Additionally, significant income may come from social security and/or pensions. Planning and thoughtful consideration of your new income and expense situation — your new budget, as it were — is an extremely important step to take before retiring. Are travel and extended vacations part of your plan? Or maybe cutting expenses is part of your retirement plan and less income is needed? Determining if your expenses will increase, decrease or stay the same after retirement are all important factors when considering if an annuity is right for you. Simply put, if you don’t need additional income to meet your income needs, an annuity product might not make the most sense.

Risk tolerance
Some investors have no issue with stock market volatility. For others, it keeps them up at night. Which type of investor are you? If you are a person who needs regular, consistent income every month even after retirement and have concerns with stock market volatility, you may benefit from an annuity. On the other hand, if consistent, regular monthly income is not a priority — or market volatility is not a major concern — there may be more appropriate investment alternatives for you.


Suffice it to say, annuities have a mixed reputation among investors, and there is certainly no shortage of opinions on their value as an investment tool. The key to determining if an annuity is right for you — and specifically, what type of annuity — is taking the time to ask thorough questions and do the work of thinking through what your budget and financial needs will be after retirement.

Annuities are suitable for long-term investing, such as retirement investing. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. Guarantees are based on the claims paying ability of the issuing company. Withdrawals made prior to age 59 ½ are subject to a 10% IRS penalty tax and surrender charges may apply. Variable annuities are subject to market risk and may lose value. Riders are additional guarantee options that are available to an annuity or life insurance contract holder. While some riders are part of an existing contract, many others may carry additional fees, charges and restrictions, and the policy holder should review their contract carefully before purchasing. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Convergence Financial, LLC, a registered investment advisor. Convergence Financial and LPL Financial are separate unaffiliated legal entities.


Travis Cook is the president and financial advisor at Convergence Financial.