THE MONEY MINUTE: The truth about annuities

by Jac M. Arbour CFP®, ChFC®, President
J.M. Arbour Wealth Management

There is much confusion in people’s minds today about annuities and whether or not to purchase one. If you read the financial section of certain newspapers, you might have seen articles titled things like “Why I Hate Annuities and You Should Too.” If you pick up other papers, though, you might have seen “Why I Love Annuities and You Should Too.” So which perspective is correct? Which article should guide you in making financial decisions? The answer depends on your circumstances.

In the case of annuities—and, for that matter, stocks, bonds, mutual funds, index funds, exchange traded funds, money markets, certificates of deposit, or any other interest-bearing account—it isn’t accurate to say that they are generally “good” or “bad.” Like other types of accounts, annuities have their pros and cons, and you have to answer the question of which is which—a pro or a con—for you and your family.

So, how about this: Instead of loving or hating annuities, let’s take a peek at what annuities can and can’t do for you and why you may or may not want to consider one for purchase.

  • Risk. Do you have the need or the desire to position some of your money where there is absolutely no stock market risk? If the answer is yes, a fixed annuity or a fixed index annuity might be worth considering. (In this case, a CD could be a valuable consideration as well.) If the answer is no, although a variable annuity would give you access to market performance, it typically comes at a much higher cost (this is the major reason why some literary contributors “hate annuities”); you would likely be better off investing in something other than an annuity.
  • Guaranteed Income. Do you have the need or desire to have a percentage of your retirement income contractually guaranteed? If the answer is yes, be sure the annuity you consider offers an income rider, and that the rider comes at a fair cost. If the answer is no, do not buy an income rider: you do not need to pay for something you will likely never use.
  • Costs and Fees. With the wrong annuity, you can quickly spend a bundle: some variable annuities cost up to 4% per year, once you consider all the bells and whistles. (In my opinion, this is way too much, no matter what.) On the other hand, fixed index annuities typically do not have an annual fee—unless you add an income rider, which typically costs around 1% per year. Fixed annuities are usually straightforward and offer a guaranteed rate of return—again, with no annual fee. Regardless, make sure you run the numbers, and make sure that what you buy has the highest probability of future applicability.
  • Liquidity. Annuities come with what is called a surrender charge schedule. When you open an annuity contract, you are usually limited to free withdrawals of up to 10% per year. This means that not all of your money is available to you without a penalty. Be sure to know how, when, and how much of your money you will be able access without penalties, including how circumstances such as chronic, critical, and terminal illnesses might affect the liquidity of your money.
  • Interest. Be clear about how your contract will earn interest. Annuity contracts earn either a guaranteed rate of interest (in the case of a fixed annuity) or a variable rate of interest that is linked directly to the upward and downward movements in the market (as a variable annuity), or the annuity can participate in a portion of market upside with no downside market risk (this is a fixed index annuity).

These five points do not cover all the bases, but I hope each promotes further clarity during your decision making process. For everything you need to know to make fully informed financial decisions, always consult with a financial professional who has a fiduciary responsibility to you.

See you all next month.

Jac Arbour is the President of J.M. Arbour Wealth Management. He can be reached at 207-248-6767

Investment advisory services are offered through Foundations Investment Advisors, LLC, an SEC registered investment adviser.


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