Should I Buy an Annuity? Six Questions to Ask Before You Decide

Should you buy an annuity? Before you compare rates, bonuses, riders, or guarantees, start with a more useful question: What retirement problem are you trying to solve?

That question changes the conversation. An annuity is not a retirement plan. It is one possible tool that may address a specific need, such as creating lifetime income, protecting part of your savings from market losses, or adding tax deferral after you have fully used other retirement accounts.

My view is straightforward: an annuity should earn its place in your retirement plan by solving a specific need on terms you understand. The goal is to know what the contract would do for you, what it would cost, and what you may give up in return.

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This article was adapted from Episode 119 of The Simply Retirement Podcast. The episode page includes both the audio player and the YouTube video: Listen to or watch How to Decide If an Annuity Fits Your Retirement Plan

1. What Retirement Problem Am I Trying to Solve?

Begin with the need, not the product. Are you looking for income you cannot outlive? Are you concerned about how a market decline could affect the money you plan to spend during retirement? Have you already contributed as much as you can to other tax-advantaged accounts and still want additional tax deferral?

Those are different goals, and they may lead to different types of annuities or to a different strategy altogether. If an annuity has already been recommended, ask the person making the recommendation to state the retirement problem it is intended to solve. You should be able to explain the answer in your own words before moving forward.

If the purpose is unclear, it is too early to decide whether the annuity is appropriate.

2. Is an Annuity the Best Way to Solve It?

The same retirement goal can often be addressed in more than one way. An annuity may be one of those options. It may even be the most appropriate option for your circumstances, but it is rarely the only option.

One of my favorite questions to ask is: If you were not recommending this annuity, what would be your second choice?

The answer can tell you whether other strategies were evaluated and why this contract was selected. It can also reveal whether the person making the recommendation has access to a range of solutions or primarily offers annuities. That does not make the recommendation right or wrong, but it gives you another reason to ask how the alternatives compare.

3. What Am I Giving Up in Return?

Every financial strategy involves a trade-off. An annuity may provide benefits you value, but depending on the contract, you may give up some access to your money, growth potential, or flexibility.

Surrender charges are one example. Annuities are generally designed as long-term contracts. If you withdraw more than the contract permits during the surrender period, the insurance company may assess a charge. The schedule might last several years and usually declines over time, although the details vary by contract.

Some contracts allow a portion of the value to be withdrawn each year without a surrender charge. That provision should not be assumed. Ask how much you may withdraw, when the withdrawal right begins, and what happens if you need more.

The timeline also needs to match your retirement plan. If you expect to need income next year, a contract that restricts access or does not provide the intended benefit when you need it may be a poor fit, even if the benefit sounds attractive.

4. What Is Actually Guaranteed?

The word guaranteed appears frequently in annuity conversations, but the guarantee may apply to different parts of the contract. It could refer to lifetime income, a minimum interest rate, principal protection, or a limit on certain market losses.

Those promises are not interchangeable. A contract that buffers part of a market decline, for example, does not necessarily guarantee your full principal. A guaranteed income benefit may also have rules about when the income can begin, how withdrawals affect the benefit, and whether the quoted value can be taken as a lump sum.

Ask the person making the recommendation to identify exactly what is guaranteed and show you where it appears in the contract. Annuity guarantees depend on the claims-paying ability of the issuing insurance company, so the insurer also deserves consideration.

You do not need to memorize every page. You should understand the provision you are counting on before your retirement plan has to rely on it.

5. What Am I Paying For?

Nothing is free. Someone is being paid when you purchase an annuity, just as someone is paid when you receive professional financial advice or investment management. Paying for a product or service is not automatically a problem. Paying for something you do not understand is the problem.

Annuity costs depend on the type of contract and how it is purchased. There may be contract expenses, investment-related expenses, optional rider charges, commissions paid by the insurance company, or an advisory fee. A surrender charge is different from an annual fee, but it can still affect what you receive if you leave the contract early.

Ask for a clear explanation of:

·         How the advisor or insurance professional is compensated

·         Which charges are ongoing and which apply only in certain circumstances

·         What each optional rider provides and what it costs

·         How the costs affect the contract value, income benefit, or withdrawal value

A lifetime income rider may be worth its cost when the benefit fills an important role in your retirement income plan. The decision depends on whether you need the benefit and whether the contract delivers it on terms you understand.

6. What Happens If Life Does Not Go as Planned?

An annuity may remain in place for many years. During that time, your income needs, health, family circumstances, or priorities may change. A contract that works under one set of assumptions should also be evaluated against less convenient possibilities.

Ask what happens if you need more money than expected, want to change the timing of your income, or no longer need the benefit you purchased. If the annuity has a death benefit, ask what your beneficiaries would receive and how the contract must be handled after your death.

It can be easier to understand these provisions through examples. Ask the person making the recommendation to walk you through several what-if situations using the actual contract, including one in which you need access to a larger amount during the surrender period.

Use the Free-Look Period

Annuity contracts generally include a free-look period that gives you time to review the issued contract and cancel within the permitted window. The length and terms vary by state and contract, so confirm the deadline shown in your paperwork.

Use that time. Review the actual contract rather than relying only on a presentation or illustration. Confirm that the guarantees, costs, surrender schedule, withdrawal provisions, and beneficiary terms match what you understood when you applied.

If something is different or unclear, ask questions while you still have the opportunity to reconsider the decision.

Warning Signs That Deserve More Questions

A recommendation deserves closer review when:

·         The retirement need the annuity is supposed to solve cannot be stated clearly.

·         The conversation focuses on a bonus or headline rate without explaining restrictions and trade-offs.

·         The person recommending it cannot explain a reasonable alternative.

·         The product is described as having no cost without an explanation of compensation, fees, spreads, caps, participation rates, or surrender charges that may apply.

·         You feel pressured to act before you have reviewed the contract and asked questions.

None of these points automatically proves that an annuity is inappropriate. They are reasons to slow down and get clearer answers.

The Decision Begins With the Need

An annuity is a contract that may solve certain retirement planning needs. Whether a particular annuity belongs in your plan depends on the job you need it to do and whether its terms support that job.

Start with the retirement problem. Compare other ways to address it. Then evaluate the guarantees, restrictions, costs, and flexibility of the actual contract. If those pieces fit together and you understand the trade-offs, an annuity may deserve consideration. If they do not, a persuasive feature or sales presentation should not be enough to move you forward.

Does an Annuity Fit Within Your Financial Plan?

Our free guide organizes the questions to consider before purchasing an annuity or reviewing one you already own. Download Does an Annuity Fit Within My Financial Plan?

If you would like to see how retirement income, investments, and taxes work together in your situation, learn more about the Simply Retirement Roadmap™.

Disclosure

Content here is for illustrative purposes and general information only. It is not legal, tax, or individualized financial advice; nor is it a recommendation to buy, sell, or hold any specific security, or engage in any specific trading strategy.

Information here is provided, in part, by third-party sources. These sources are generally deemed to be reliable; however, neither Blake Wealth Management nor RFG Advisory guarantee the accuracy of third-party sources. The views expressed here are those of Blake Wealth Management. They do not necessarily represent those of RFG Advisory, their employees, or their clients.

This commentary should not be regarded as a description of advisory services provided by Blake Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.