It is The Time for an Annuity Lesson
America has a financial and annuity literacy problem.
Many surveys have indicated that Americans score very low on questions about basic financial concepts. Moreover, the annual LIMRA Insurance Barometer Study constantly reports low levels of understanding when it comes to the basics of annuity products.
As the knowledge levels were not low enough, the financial media sends confusing messages regarding annuity products. Are individuals supposed to hate annuities as the long-running promotional campaigns dictate? Are they supposed to love them?
It’s time for a new idea in this continuing conflict of words and promotional messages. That simple idea is to educate consumers about annuities to understand how these products work and what their benefits and constraints are. Currently, annuity products deal directly with several key financial and life risks to which our aging population is exposed. Therefore, we have to level the playing field of annuities.
After consumers improve their understanding, they can make informed decisions on whether and how annuity products serve their financial situation. It’s on us, as an industry, to give a better picture of how these products work and their practical benefits. We have not done a good job in spreading the word. It seems we have been unenthusiastic to tell the annuity story in the right way.
Let’s explain why it’s the right time to focus on annuity literacy to support one of the industry’s core product offers.
Cutting Through the Noise
There are a lot of annuity critics in the financial media. They usually have negative things to say about almost all types of annuity products. They often respond to the suggested purchase of annuity products strictly from an investment perspective. They offer other options they say are cheaper and higher-yielding alternatives to annuity products. They also present these alternatives as more flexible. However, they do not provide information about the benefits of annuity insurance products. These are the guarantee of lifetime income, minimum returns, contractual guarantees, and others.
The alternatives are also portrayed as superior because you don’t pay an up-front commission to the financial professionals with them. Instead, they have lifelong annual fees. In my opinion, from an economic point of view, in most cases, consumers will give more money for fees throughout the investment period than for upfront commissions when purchasing an annuity. That is because the money they place into annuities will keep on being invested for the medium- to long-term before they access it. That is the point the mass media is missing, but it’s significant for most consumers.
The intrinsic value of annuities stays strong and includes guaranteed minimum returns for fixed products, a guarantee of a lifetime income, tax deferral and state-based solvency regulation, and principal protection options. There are new and original extra added benefits (e.g., income, fatal illness, long-standing care benefits, and retirement facility confinement riders) and the prospective for a fixed (indexed or declared rate) variable, or buffered-based earnings, varying on the purchased annuity product.
Critics also talk about how complex the products offered are. That is a valid point as at this time, the process can be pretty overwhelming for all the parties involved in the sale. This is due to the current sales process of disclosures, the numerous newly proposed indexing methodologies, illustrations, and regulatory forms. Still, a lot can be done to make this process simpler and more straightforward.
Keep in mind that annuity products are not bad for your health, and they won’t make you fat. Instead, they can deliver you financial security and an easy mind if properly sold and managed.
Economic and Demographic Considerations
Nowadays, there are various main economic and demographic reasons in play that encourage improving the education concerning the value of annuity products. These reasons explain why annuities need to be in the center of consumers’ attention as they invest and save for their prolonging financial future. These include:
- Increased longevity risk, because life expectancies are getting longer as medicine and technology joined forces to increase them.
- Financial risks that consumers can expect to have as they grow old. In particular, changing interest rates, volatility of the equity market, and sequence risk.
- Guarantees from parties with good financial standing are needed to help alleviate financial risks.
- Potential alterations to Social Security, Medicare, and Medicaid government programs that might cause more significant expenses or decreased incomes at old age.
- The fact that it’s been reported that many people are not ready for retirement as their savings are at considerably low amounts per family and they need to increase their retirement savings.
- To help families with their retirement savings by creating steady income flows they will receive until their deaths.
- Provide help to newly retired individuals to change their financial efforts from accumulating savings to efficiently distributing them to fund living expenses.
- The tax advantages and disadvantages of annuity products. The tax benefits of these products, tax deferral amongst others, have to be emphasized as future rates will likely rise. Meanwhile, we should also educate consumers on the tax restrictions of the products.
What Can Financial Professionals Do
It’s been widely written about the necessity of improving financial education, but not much has been done. I believe that all financial professionals should devote time or provide resources to support the industry in its efforts to target consumer financial and annuity literacy.
In the meantime, they should spend some time educating their clients about why they need to have at least some part of their retirement income in fully or partly protected sources.
In conclusion, we all need to blast the annuity speakers far louder than we have by now. Although the product is not a good fit for everyone, once it’s understood well, it’s evident that current products can deliver the necessary risk protections that are cost-effective for many aging consumers.
These three strategies will help you buy annuities for your retirement income at low rates
When rates are low, retirees need to think deeply before purchasing income annuities for their retirement. This is because nobody will like to see a rise in payouts within the next one or two years, while their payouts have been at a lower level.
When you purchase a lifetime annuity, you will receive a constant check for life after paying a sum of money to your insurer. Buying an income annuity is like purchasing a pension for yourself. The problem with lifetime annuity is that the rates have decreased sharply over time. For example, in 2008, a 70-year-old retiree buying a $100,000 annuity will receive approximately $800 every month. Still, in 2021, an annuity of $100,000 will give the 70-year-old man $565 every month. This shows a 28% monthly payout reduction.
There is no do-over in life annuities. Suppose you purchase a basic annuity this year and payout increases in the next two years; your monthly payments will be lowered for the rest of your life.
Suppose you want to enjoy the guaranteed payment of a lifetime annuity. You are worried about the change in payout, which can lower your monthly payment. In that case, you need to know some strategies before buying a lifetime annuity. Suppose you are a starter; you can avoid these lower payouts when payment is low by spreading your purchases over a longer period. When you do this, you are said to ladder your annuities. This strategy will help you buy in over a period, and you won’t regret purchasing a lifetime income annuity.
If you want to be saved from low rates and don’t want to use this strategy, you can purchase a deferred annuity. Although, this will not give you any income in the long run. However, you can wait for your payout to rise, especially if you don’t plan to take your income until you are 70 years old. Some insurers may give a dividend in addition to the guaranteed payout when you go for their income annuities. You must note that this dividend will rise as the rate increases.
Make sure to maximize your social security benefits before you buy a private annuity. You can maximize your benefits by delaying your check for as long as possible. This is because social security check increases by 8% for every year you delay it after the full retirement age.
It would help if you had an annuity since your social security benefits will not cover all your essential needs. Based on the impact of low rates on annuity payouts, it is best to buy an annuity if you are in a low-rate environment. Many people don’t want to buy an annuity when the rate is low, but experts say buying an annuity when rates are low is the best option.
Before buying a lifetime income annuity, here are three strategies you should consider:
Suppose you want to use $500,000 to buy annuities from your portfolio; you can buy $100,000 worth of annuities yearly for five years. So that if rates increase in a year or two, your income stream will still be at a higher payout level.
The major thing to consider is where you keep the money you plan or set aside to purchase annuities in the future. Let’s assume that you keep it in long-term bonds and the rate increases; you will have fewer funds because your bond value will now be lower. You may not be financially buoyant even when there is a rise in annuity payouts. You should save your money in shorter-term funds, such as money market funds. But with this shorter-term instrument, your money may not increase significantly over time.
Laddering
Suppose you want to use $500,000 to buy annuities from your portfolio; you can buy $100,000 worth of annuities yearly for five years. So that if rates increase in a year or two, your income stream will still be at a higher payout level.
The major thing to consider is where you keep the money you plan or set aside to purchase annuities in the future. Let’s assume that you keep it in long-term bonds and the rate increases; you will have fewer funds because your bond value will now be lower. You may not be financially buoyant even when there is a rise in annuity payouts. You should save your money in shorter-term funds, such as money market funds. But with this shorter-term instrument, your money may not increase significantly over time.
Deferring
Suppose you don’t need the money now; waiting may be the best option for you. The longer you delay your monthly annuity check, the higher your monthly payment. According to Cannex, a Toronto firm tracking United States annuities, a 65-year-old woman purchasing a $100,000 immediate annuity will likely get a $450 monthly payment. Suppose she purchases the annuity now and delays the payouts for five consecutive years; she will receive $590 as a monthly payout, giving her a 31 percent rise in the payout. If she delays the payments for ten years, she will receive about $860 every month.
Just like deferring your social security benefits, delaying your annuity is good if you think that you will live long. Suppose you are purchasing an annuity for your spouse with survivor benefits; you need to consider your spouse’s life expectancy.
With deferred annuities, retirees have more flexibility with their income. Let’s say you have a much-deferred income and you need money. In that case, you can start receiving another monthly check by turning on another deferred annuity.
Dividend annuities
Some companies pay dividends in addition to their guaranteed payouts. Although, these dividends may not be guaranteed. You can use this dividend to increase your future monthly payments or take it as cash together with your guaranteed payment. The majority of buyers are delaying their dividend payments in order to boost their payouts.
If you purchase a dividend-paying annuity, your annual payout will increase every year you delay the check, but this increase may occur slowly. Suppose you buy a traditional annuity; your payouts will never increase no matter how long you delay the payment.
When you purchase a dividend-paying annuity, a portion of the dividend will be used to increase the volume of your annuity. After eight years, you will get an annuity that is more than the standard annuity by about $441, and this amount continues to rise.
Unlike standard income annuity, a dividend-paying annuity offers some protection against inflation. When there is inflation, the annual payouts will increase faster because the insurers will produce more enormous dividends due to the inflation.
