12/26/2020
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When You Should Buy an Annuity: 5 Real Life Scenarios
Jeff Rose, CFP® | July 08, 2020
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Table of Contents
When to buy an annuity
When not to buy an annuity
Bottom Line
Many advisors think they’re doing their clients big favors by telling them that they’ll never put them in an annuity. And with all the negative press that annuities get, it’s not too surprising.
However, I think annuities are fantastic – in the right situation.
There are at least 15 reasons why some people shouldn’t buy an annuity. If you’ve done much research on the subject, you’re probably already aware of a few of them.
But you also need to know that annuities serve very specific purposes, and if you happen to fall into one of these scenarios, then an annuity can be a game-changer.
When to buy an annuity
Typically, you want to consider an annuity only after you’ve maxed out other tax-advantaged retirement accounts, such as 401(k) plans and IRAs. But beyond that, there are at least 5 other situations where buying an annuity makes a lot of sense:
The stock market freaks you out
You want to know how much interest you’re going to make
You want guaranteed and predictable income
You can’t get life insurance
You want long-term care protection
1. The stock market freaks you out
Typically when a financial advisor offers you a guarantee, you have to tread carefully. But if just watching CNBC elevates your blood pressure too much, then an annuity is the answer.
Equity-based investments tend to fluctuate in value, which is to say that they can go down as well as up. But annuities can protect your principal value, ensuring that your investment remains fully intact to earn income in the future.
This can be especially important if you are very close to or already retired. Annuities can provide an immediate income and eliminate the worry of making up potential losses.
2. You want to know to the penny how much interest you’re going to make
Annuities – mostly fixed annuities – offer guaranteed returns. Once again, if a steady income is your primary motivation for making the investment, annuities can provide just that.
Some annuities will provide you with a variable return, allowing you to participate in higher risk/higher yielding options, but will also assign a guaranteed minimum return. This might be just what you’re looking for.
Fixed annuity rates usually pay more than bank CDs, although you’ll have to lock up your money for 3-5 years to get it. Last year I had a client that wanted absolutely nothing to do with the market and wanted a guaranteed return. CDs were paying nothing and the best rate I could find him was a 5 year fixed annuity paying 3%.
I even tried to talk him out of buying it but that was the only thing that would make him and his wife feel safe (he had a bad experience with a previous advisor). If a guaranteed is what you’re after, an annuity might make the most sense.
3. You want guaranteed and predictable income
As I wrote earlier, annuities are investment contracts, and one of the more important provisions you can include is guaranteed income. You can do this with immediate annuities or the income riders that fixed index annuities offer.
You can buy an annuity and have it begin paying out an income stream immediately. Some deferred annuities with income riders will increase each year until you decide to start taking an income (like how your social security benefit increases each year you don’t touch it).
With annuities that offer an income stream, you’ll know exactly how much you’re going to get and for how long, once you decide to take it.
This is an excellent option in retirement since it operates as something very much like a standard pension. The big difference though is that unlike a pension if something happens to you or your spouse, the remaining funds would be passed on to your family.
4. You can’t get life insurance (and want to leave more to your heirs)
You can use an annuity to provide some of the same benefits as a life insurance policy. But, because an annuity is an investment contract, you don’t need to qualify for it the way you do life insurance.
If you have a health-related condition that makes life insurance impossible to get or prohibitively expensive, an annuity might be a really good alternative.
Name your spouse as a beneficiary and the contract will automatically pass to him or her after your death.
Some annuities also offer death benefit riders that can pay out a bit more than others. With an annuity, you won’t get as much death benefit as a life insurance policy, but you will get some.
5. You want long term care protection, but don’t want to pay out of pocket
With people living longer than ever, there is growing concern for long-term care. Straight long-term care insurance policies are expensive, particularly as you get older.
Most of my clients who have purchased long term care policies have done so because they had a personal experience with a loved one (usually a parent) that spent time in a nursing home. For them, purchasing the insurance was a no brainer. For others, however, learning how much a premium costs each month is enough to convince them to risk it.
But there’s another solution: buy an annuity. Here are two to consider:
Hybrid Annuity or Insurance Products w/ LTC Benefit. There are products that offer either an insurance benefit to your heirs or a guaranteed return (albeit small) as the primary function. In the event you needed nursing home care, then policy would convert to a LTC policy paying a portion of the costs for a determined period of time. The amount and time depends on how much you pay up front and your age. Clients like this option because it’s not a sunk cost of paying the LTC premiums each month and offers some flexibility of getting your money back if you need it.
LTC Double Benefit from Income Riders. For the annuities that offer a guaranteed income stream in the form of an income benefit, some carriers will also offer a “LTC doubler” benefit. How this works is let’s say that your income benefit is determined to be $20,000 per year from the annuity, and you needed LTC care. Instead of $20,000 per year, your benefit would then double to $40,000 per year while you’re in the nursing home. This benefit would last for 5 years and then revert back to the original $20,000 annual benefit lifetime income. Every carrier is different so it’s important to understand all the moving parts.
Both of these options aren’t meant to completely pay for 100% of your LTC costs, but it does help pay a portion of it.
