How to determine if you need an annuity.
Do you even need an annuity? Use the P.I.L.L. Strategy to determine whether you need an annuity-or not!
I am nationally known as Stan The Annuity Man, and I am the first one to say that an annuity is not for everyone. They are not one size fits all panacea products, even though that’s how they are typically sold. Annuities are transfer of risk products that solve for specific things. In my annuity world, annuities only solve for 4 specific goals:
- P = principal protection
- I = income for life
- L = legacy
- L = long term care
The easy to remember acronym is P.I.L.L. When I say “transfer of risk”, it means instead of you shouldering the risk to solve one of these problems, you will give that responsibility in full to the insurance carrier.
I describe the P.I.L.L. method in depth in the article Annuity P.I.L.L. Strategy. A quick review of the strategy is followed by some comments on variable and indexed annuities.
Principal protection is pretty much self-explanatory. If you want to make sure you do not lose any money, and want to defer taxes on gains in a non-IRA account, then a fixed rate type of annuity might be a good choice for you.
Income for Life
When you are considering the purchase of an annuity, the primary transfer of risk many people want to solve for is lifetime income, or as I describe it in the P.I.L.L. acronym, Income for life. This guaranteed income can start immediately as described in Income Now Strategies, or down the road at a specific date as described in Income Later Strategies.
Legacy can be described as that which you leave to your heirs or beneficiaries. Some annuities can offer guaranteed growth amounts that can be used as a death benefit that goes to your heirs or beneficiaries as part of your legacy for them. Life insurance is still the best legacy product on the planet, but if you can’t qualify for that product, then annuities with an attached death benefit rider are good solutions.
Long Term Care
Long Term Care is a concern of most baby boomers and seniors because of its expense and potential financial drain on family members. A traditional long term care product (not an annuity) is definitely the best solution. If you cannot qualify for them, then Long Term Care annuities can help address long term care from a transfer of risk standpoint.
Annuities are Not Investment Products
I believe that annuities are not growth products, which is contrary to the view of most people who sell annuities. Unfortunately, the vast majority of annuities sold are variable and indexed annuities. Most are bought and sold under the false assumption that market return dreams will be realized. That typically never occurs.
Variable Annuities use what’s called separate accounts (aka: mutual funds) for their growth component, but the average annual fee of a variable annuity is around 3% and is charged for the life of the policy. In addition, variable annuities have limited investment choices as well. The combination of high annual fees and limited investment choices does not equate into real market growth in my opinion. If you want market growth using mutual funds, then go buy mutual funds. You certainly don’t need a variable annuity to do that.
Indexed Annuities (aka: Fixed Index Annuities)
Agents will inappropriately call indexed annuities “hybrids” to make you feel like you are getting something cutting edge (not!). The dream sold is full downside protection with market upside. Indexed annuities were actually designed to compete with CD returns. That’s exactly what they have historically done. Again, if you want index type returns, then go buy an actual index mutual fund. Indexed annuities limit the upside, and you can only lock in gains (if any) one day per year. That, my friend, is not in the same category as an index mutual fund. The way that I use indexed annuities is with attached income riders for future or target date income planning, and only for the contractual guarantees. Visit the fixed indexed annuity area of the site to flesh out the burly truth about indexed annuities. Indexed annuities do have redeeming qualities if placed properly within a portfolio, in fact indexed annuities were designed to compete with CD returns.
Originally posted on the educational platform About.com which is now thebalance.com