Is an Annuity Right for Me?
December 8, 2017
When planning your retirement it is important to remember that you have a lot of options available inside your financial toolbox – and annuities play an important part. Some people may feel very comfortable directing their own investments inside a 401k, 403b, or IRA and some people may not due to the fact that they may have any experience with investing or financial products. There are products out there for each person and one isn’t necessarily better than the other – it depends on each person’s unique situation.
Your Risk Appetite
Whether you are just beginning your retirement planning or are going to retire in the near future, its important to take some time to self-reflect and determine your own investing ability as well as your appetite for risk. The risk portion of this self-reflection assessment is the most important because any investment decision that you make is driven by your emotional ability to tolerate the risk of having a market fluctuation dictate your returns. Everyone is different – while some people would enthusiastically tie a bungee cord onto their leg and jump off a bridge, others would never even consider it. Keeping this psychological distinction in mind, we need to realize that any tool we pull out of our financial toolbox has a risk/reward component to it.
So how do non-variable annuities play into all this?
While frequently lampooned online by self-styled financial “experts”, annuities fill in the important role of being able to guarantee payouts over the course of many decades. Other financial products simply do not provide that guarantee. While an annuity will not earn the same amount of returns that other products may offer, the interest that an annuity does provide comes risk free. When there is a market downturn like in 2000 or 2009 – there is no risk to the amount that you have saved. Thus, your risk tolerance will largely determine the suitability of an annuity for your retirement goals.
Here are a few questions to ask yourself to determine if an annuity is right for you:
- How many years away from retirement am I?
- Annuity products are meant for the long-term. Some have surrender charges that may take place if you decide to withdraw all of your money too soon.
- If you are within 10 years of retirement you may want to consider moving some of your money into an annuity to diversify your investment risk. While it will still earn income (how much depends on the product) it may not be as much as other investments, but is far safer.
- Am I OK with losing 10% or more of my investment if the market takes a downturn?
- Are you comfortable looking at your 401k or IRA statement and seeing a loss? Over the course of our investing timeline we will experience times when the market takes a turn for the worse. Are you OK with losing money? If so – then maybe the 401k/IRA strategy works for you, but if you cannot accept any loss then an annuity may be a better product.
- Do I need guaranteed and predictable income so that I can budget my retirement expenses?
- Annuities are specifically designed to make regular payments out of an invested lump sum and are great for the budget conscious who need to plan on how to pay their regular expenses during retirement or for those who are more comfortable with treating the annuity payout as they would a normal paycheck.
- Will I need early access to my retirement funds for adverse events such as a disability, terminal illness, or long-term care?
- Do you already have long term care and disability plans? If so – great! LTC and disability are major factors that everyone needs to consider before retiring. However if you do not, you may want to look closer at an annuity as they have options for dealing with these situations.
- Do I need to know exactly how much interest I will be earning on my investments?
- Are you more comfortable with earning a fixed rate of interest or with earning returns that are based on some of the market upside but with none of the downside? Annuity products today can offer a fixed rate or a rate tied to the performance of an index that offers total protection against a market downturn. If you feel that you need to calculate your performance down to a dime, then a fixed annuity may be right for you. However, if you are more accepting of a dynamic rate of return with no risk, then an index-based annuity may be right for you. If you have a healthy appetite for risk and do not need any sort of guarantee about performance, then an annuity would probably not be right for you.
Annuities, like any other financial product, are a specific tool for the right person.
While they offer the benefits of having a very low risk and regular, predictable payments; they may not earn the returns that a riskier tool such as mutual fund, stock, or ETF may offer. But this in itself does not make them a lesser product – it all depends on your specific needs.