While I sit here, the market is moving as usual and financial writers are having a heyday telling you what to do now. I’m often asked why I use annuities in my clients’ portfolios or why I feel some clients should own annuities. Here’s my answer and an opportune time to explain.
Annuities have numerous costs. Most already know this. We also know we lose some flexibility in investments when we use an annuity. So why do we use them?
A variable annuity is a contract between you and an insurance company, under which the insurer agrees to make periodic payments to you, beginning either immediately or at some future date. When appropriate, I recommend annuities. I also will recommend additional living benefits they offer in the form of riders when appropriate. Riders are additional guarantee options that are available to an annuity 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. Guarantees are based on the claims paying ability of the issuing insurance company. When invested in an annuity we know what the worst case return will be based on guarantees within that annuity. The account value may go up, or may go down, if an added living income benefit is chosen, it can guarantee a minimum return, no matter what the market does.
Much like the wheat farmer who hedges his crop because he knows he cannot afford to receive less than a certain amount and still survive the next year. Some of my clients feel that they want future income guaranteed, at least partially.
Everyone is different. Some of my clients have requested to have 100% of their portfolio in annuities, even though I have tried to dissuade them from doing this. I have many clients that have no annuities, nor guaranteed income, in their portfolios. Much of this depends on risk tolerance. Much of this depends on worldview. It also depends on what we can stand in the good times and in the bad times, both of which are inevitable.
So before we decide if annuities make sense for you, there is a process we go through when building a portfolio:
- We determine how much conservative assets you need to cover for the next 5 years cash flow.
- We find out what your true risk tolerance is.
- We discuss how much income we need for retirement, and how much of that income we want to be guaranteed. Guaranteed income sources include any pensions and your Social Security benefits. If there is a difference between what we want and what is guaranteed, we evaluate if the cost of an annuity is worth the difference.
- The rest of the portfolio we invest in mutual funds that we believe have necessary allocation, diversification, lower correlation and are academically more fact-based. We use this strategy to strive for better predictability.
Regarding the above, you may look at number four and say, “Why would you invest any in annuities?” The reason is, we are all different. Different about what we want, what we want guaranteed, and what we are comfortable with. Annuities are a choice. Yes they cost more and have less flexibility, but they provide guarantees in a manner, which if appropriate, might not be reached in portfolios that do not contain annuities.
Are annuities for you?
Before you decide, we need to go through a process so that we make intelligent, thoughtful, and planning-focused decisions, not decisions based on emotion. Annuities are not for everyone!
There is no assurance that the techniques and strategies discussed are suitable for all investors or will yield positive outcomes. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk. The purchase of certain securities may be required to effect some of the strategies. Investing in mutual funds involves risk including potential loss of principal.
Variable annuities are long term, tax-deferred investment vehicles designed for retirement purposes and contain both an investment and insurance component. They have fees and charges, including mortality and expense risk charges, administrative fees, and contract fees. They are sold only by prospectus. Guarantees are based on the claims paying ability of the issuer. Withdrawals made prior to age 59 ½ are subject to 10% IRS penalty tax and surrender charges may apply. Gains from tax-deferred investments are taxable as ordinary income upon withdrawal. The investment returns and principal value of the available sub-account portfolios will fluctuate so that the value of an investor’s unit, when redeemed, may be worth more or less than their original value.
Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through von Borstel & Associates, a registered investment advisor.