Annuities are commonly sold by insurance companies as a solution for retirement. Unlike stocks and bonds, they provide guaranteed income for as long as you live – at least to the extent supported by California’s Life & Health Insurance Guarantee Association.
But getting help with choosing annuities can be surprisingly difficult. Here’s why.
The first thing to understand is that an annuity is a contract between you and an insurance company. You give them money up front and they promise you a stream of income over your (and possibly your spouse’s) remaining lifetime.
For the simplest types of annuities, like single premium immediate annuities (SPIA), the documentation is fairly straightforward. But for more complex types, such as equity indexed annuities (EIA) and guaranteed minimum withdrawal benefit (GMWB) annuities, the contract can run to 20 or 30 pages, and the details of the various calculations and limitations, which can have a significant impact on your actual withdrawal or income benefits, are often obscured among lots of legal jargon.
Where to seek advice
If you do not have the inclination to figure it all out yourself, where do you turn for advice? A good insurance salesperson should be able to provide you with a detailed explanation about a specific annuity from his or her company but wouldn’t have the expertise to provide a straightforward comparison of that annuity with annuities from competitive insurance companies or with alternative investments like bonds that might be more appropriate for your situation.
And because there is no standard structure or format for annuities as there is for auto and home insurance, consumer publications like Consumer Reports, ordinarily a good source for comparisons of such products, are limited to providing only general information and advice.
The Financial Industry Regulatory Authority provides some helpful advice for consumers on the topic (see finra.org/investors/alerts/variable-annuities-beyond-hard-sell), but, again, it is generic in nature.
That leaves Certified Financial Planners (CFPs) and Registered Investment Advisors (RIAs). They have a fiduciary responsibility to their clients (a higher standard than insurance salespeople), meaning they must put their clients’ interests ahead of their own. When evaluating an annuity, they must consider alternatives and recommend what they believe is the best choice specifically for the client.
But that can take a lot of time and effort. Each annuity is different, and even similar-sounding annuities from the same insurance company can have different terms and conditions. And the premiums for annuities with identical benefits can vary widely from company to company.
The only way a financial planner can do a cost-benefit analysis of a complex annuity is to read the contract in detail and then compare it to other annuities as well as to other investments. Imagine how many hours all that takes. As a result, CFPs and RIAs generally eschew the more complicated annuities the insurance industry has been promulgating over the past decade or so to try to capture more of retirees’ savings.
This is not to suggest that all annuities are problematic. The simpler ones can be very helpful in diversifying your income sources during retirement and in increasing the likelihood that you don’t run out of money. Two types in particular (SPIAs and Deferred Income Annuities) are effective and easy to understand. But the decision whether or not to include any kind of annuity in a retirement portfolio depends on a number of factors specific to each family’s situation.
If you are considering purchasing one, especially a complex one such as an EIA or GMWB, there’s a lot of due diligence needed to ensure that you’re getting what you think you’re getting. And until such time as the states or the federal government decide to impose standards on annuity contracts, you should plan to devote many hours learning about them before making a purchase. Caveat emptor!