What are the top five reasons not to allocate funds to an annuity? Based on many years of experience and an informal office survey the top five reason are…
- Too old or too young.
- A lack of sufficient assets.
- Expectation of an unrealistically high return.
- Probability of needing annuity dollars prior to maturity.
- Missing a reasonable understanding of how annuities work.
Dick and Eric examine these five reasons in this weeks commentary.
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Annuity Guys® Video Transcript:
Dick: We have an empirical study. Is that correct, Eric?
Eric: The Top Five?
Dick: The top five reasons why a person should not buy an annuity.
Eric: Yeah, that’s right.
Dick: And where’d this empirical study come from, Eric?
Eric: Well, we did a survey here in the office.
Dick: Of you … and I…
Eric: That’s right, the two of us.
Dick: So we have a slight margin of error.
Eric: It’s plus or minus five.
Dick: Five, yeah. We don’t know why five.
Eric: The five reasons that you shouldn’t buy an annuity.
Dick: Yeah, but we do really run into some very legitimate reasons. Why folks should not buy an annuity and people should know about that.
Eric: That’s right.
Dick: Reason number one, too young.
Eric: Too old.
Dick: Or too old. Age, that’s right. Let’s take the extreme ends, let’s say, too old. How old is too old?
Eric: Too old is when you start to lose benefits, so it’s age 81.
Dick: They’re gone, basically.
Eric: Basically, very few choices left.
Dick: Right, a few companies will give you a little bit, but usually the yields are low and there are no additional riders or benefits, this type of thing. One real exception to that now, on the 80-year-old, is if we find that they have a younger spouse.
Eric: Okay, and then that makes it a good deal, because the spouse is…
Dick: The spouse can get a lot of benefit, by putting the annuity in their name.
Eric: Right, so really they’re still within the guidelines of getting some of those benefits.
Dick: Right, so that does work well. Let’s go to the other extreme. Let’s talk about the younger. When’s it too young?
Eric: Well, definitely before, I would say age 25, but anything younger than that…
Dick: 16-year-olds, no way.
Eric: It’s obvious, but most of the time there, you’re in your stock accumulation stages.
Dick: Right, you might make a case occasionally, for someone in their early thirties, but probably somewhere in your mid-thirties to early forties, before it starts to make real sense, depending on your risk aversion, I would say.
Eric: Most of these income benefits are usually set for a 10 or the maximum I’ve seen, is a 20-year period, so really it’s the 20 years prior to retirement. So if you think of 65 being the logical retirement age, really your mid-40’s; when you get to 50, you definitely should be…
Dick: Yes, you should be moving in that direction or have a plan.
Eric: So really before that it’s another bucket, you’d probably not fit. So that’s reason number one, reason number two…
Dick: You don’t have enough assets.
Eric: You don’t have a nickel to rub.
Dick: I mean really, folks, and Eric and I were discussing this prior to going on camera here. If you’ve got less than $100,000 dollars in overall assets and we’re not talking about your home, or your furniture, or your car. We’re just saying if you’ve got less than $100,000, realistically you just don’t know what’s going to come up. You don’t know what kind of an emergency situation you might have, and it’s probably wise, not to put that money into an annuity.
Eric: We call it the liquidity issue. You don’t have enough liquid assets, to be able to do and take care of the things that may come up, and you definitely don’t want to put all of your eggs in one basket.
Dick: Correct.
Eric: So when you’ve got limited assets…
Dick: Right. It’s really iffy, and there’s always an exception. There’s going to be some exception that’s going to come along, where someone has lots of income and they may not be worried about needing liquidity.
On the other hand, I’ve seen a few situations where someone had so little income that they needed an annuity to produce enough income, just so they could live on and know that they weren’t ever going to run out of money. So there is this balance. You have to look at each person’s situation and evaluate it to be fair.
Eric: But largely, basically you have to have, typically $100,000.
Dick: Or more, and then I guess the other caveat to that, though I would say is a lot of people may only want a $75,000 dollar annuity or $125,000, but they’ve got several hundred thousand dollars in other assets.
Eric: Right, it’s an allocation.
Dick: It’s an allocation.
Eric: So we’re not saying you have to use $100,000 up. We’re saying if you don’t have at least $100,000 available, then that’s not a wise choice.
Dick: Right, moving on.
Eric: Number three, expectations of unrealistic, high returns. Annuities are a safe, stable allocation.
Dick: That’s right.
Eric: So if you don’t get, if you don’t have high risk, you don’t have high reward. You have more of a level, safe, stable…
Dick: Right. Your reward is sleeping securely at night. Sleep insurance, and knowing that you’re not going to be affected by the ups and downs of the market or of a Japanese-style situation, where the market loses 75% of its value and it doesn’t return over a 20-year period.
Eric: Right. As long as you expect, if you’re using it for income, primarily it’s a great vehicle.
Dick: You don’t have of longevity risk. It doesn’t matter how long you live, right? So it’s great for the pension-style income.
Eric: Yeah, perfect.
Dick: And growth, growth can be reasonable.
Eric: We always talk about beating the bank, by a couple percentage points.
Dick: And then if we wanted to pre-issue annuities, it could be maybe higher than that, so maybe we’re beating the bank by thre3.0-4.0%.
Eric: Yeah, so it’s expectations. If you want your cake and eat it too, this is not the vehicle for you. Because I’ve had people ask me, “I want the cake-and-eat-it-too annuity.”
Dick: Right.
Eric: Well, you have to pick and choose, and it doesn’t exist in the double-digit community.
Dick: Well, and this is where I find that people have a lot of unhappiness with the annuity they purchased, when an advisor has told them that they’ve got this unlimited upside potential and no downside risk, and they’re expecting something pretty close to a stock market gain, when the market’s going well and they don’t have it and they’re disappointed, because they were over-sold, overstated, under-delivered.
Eric: No, so don’t buy an annuity if you have unrealistic high-return expectations. All right, so number four, the probability of needing annuity dollars prior to maturity.
Dick: Well and when we say probability, there’s always a possibility for anyone that they could need the money, but if we talk of it in terms of probability we have to use some reasonable assumptions. And if you’ve got plenty of income, you’ve got other assets then the probability when you put your money in an annuity should be very, very low that you’re really going to need this money for anything.
Eric: Right, I mean if you go into it with the expectation of saying, “I’m going to go buy a new house in three years, I might use that money.”
Dick: I might use that money.
Eric: Don’t put the money there to begin with.
Dick: No, it makes no sense.
Eric: It’s not a good decision. So that one pretty much stands on its own.
Dick: Yeah. And number five, this is probably my favorite.
Eric: This is my favorite. It’s truly the number one reason not to buy an annuity and that’s that you don’t have a reasonable understanding of how annuities work.
Dick: Right. Before you can make an intelligent decision on an annuity, and there is a certain degree of perplexity and sophistication to an annuity, you need to really work with an advisor that gets it. That has access to multiple annuities. That has a great understanding of these annuities. How they work, how they inter-relate and function, and someone that can help you to understand. Not that you’re going to have the same knowledge level that the advisor has.
Eric: And I don’t think they have to understand how every annuity works. You have to understand how what you own works, the ins, the outs.
Dick: And that it’s going to meet your objectives… your stated objectives.
Eric: I talk to clients about working backwards. You work backwards from the goal and then find the annuity or the pieces that fit that goal. But you have to understand how it works and how that piece works as part of your goal. If you don’, and if you’re not comfortable, don’t do it.
Dick: Yeah, you shouldn’t do it. You’ve got to be careful. There is a point sometimes where you do rely on the advisor’s expertise, because you do have certain stated objectives, so there is this balance that you have to hit, but you do want to at least a cursory understanding of what it is you’re doing, why you’re doing it, how it works.
Eric: Right. Don’t spend more time planning your vacation than you spend planning your retirement.
Dick: That’s right, or understanding your annuity. So folks, these are the five top reasons that we’re aware of.
Eric: And based off our empirical survey.
Dick: Yes, yes, and so we think that this will give you a good basis as you’re considering putting money into an annuity, doing an annuity allocation. If these don’t really apply to you, then an annuity may be a good choice.
Eric: Good deal, I think we’ve hit the top five.
Dick: Next week, maybe we’ll talk about the five least reasons not to buy an annuity.
Eric: We’re having too much fun, we’d better go.
Dick: Thank you.