Happy new year to everyone! I hope you made it through the holidays happy and healthy.
With the new year I thought I would get back to basics and define and explain what certain investment vehicles are. Behind stocks, bonds and mutual funds, I feel that annuities are one of the most misunderstood yet widely held investments out there. Annuities in some circles have a less than stellar reputation which I believe is undeserved. However, this is something I have run across with many investment programs over my career. A client or prospect has a quality investment but they have nothing but rotten things to say about it. Why? Most of the time this is because the objectives of the investment did not match the objectives of the client. Thus, the investment may not have lived up to the expectations of the client. Unfortunately, in my experience, this what has happened with annuities.
So what is an annuity? By definition an annuity is an investment contract entered into by an investor with a life insurance company. Typically a lump sum or periodic payments are made into the policy with the agreement that the insurance company will pay out lifetime income to the investor at some point in the future. The payments are guaranteed and backed by the insurance company’s assets.
With life insurance you make periodic payments into a policy with a face value of say $500,000. The insurance company is hoping you live a very long time and continue to make payments into the policy without ever making a claim against it. Because if you die too soon the insurance company would be liable for the $500,000 even though the payments made into the policy may not have covered the face amount. I believe the insurance company doesn’t want this to happen.
Conversely, with an annuity you typically make a large contribution to the policy and the insurance company agrees to make periodic payments to you for the rest of your life no matter how long you live. This is referred to as annuitization. Some investment professionals also refer to this as a SPIA (Single Premium Immediate Annuity.) But what if you outlive the value of your annuity policy? The insurance company is legally bound to keep making payments as long as you live. If you die long before the annuity value is exhausted, the payments stop and the insurance company keeps your money.
So, the easiest way to remember all of this is that life insurance protects you if you die too soon and an annuity helps to protect you if you live too long.
I know that at this point some of you are saying that one or the other or even both of these plans may not apply to your financial situation. To this I will agree. Annuities are absolutely not right for every investor. However, as I said earlier, in my 30-year career I have found this not to be the case. I could write another full article on how annuities have been applied inappropriately to client’s needs and objectives.
An example of client situations I encountered years ago where an immediate annuity worked out perfectly for the client was when I worked as a financial advisor for the NFL Players Association counselling professional football players on their finances. I had a number of players who were retiring from the NFL and knew going forward that they would not be earning the kind of money that they were when playing football. But retiring athletes are usually quite young, very healthy and generally live a long time after retirement. In a number of client cases I recommended using an immediate annuity with a large lump sum to fund it. This way the athlete had a lifetime pension over and above what the league was paying them. Now as you can imagine, the insurance companies I used, in my opinion, weren’t too happy about it. But so what?
So this is where an immediate annuity made sense and was a suitable investment. But how many of us are retiring professional athletes? This is the dilemma with annuities. I feel that they can be an appropriate investment vehicle when applied properly. But there is news regarding annuities. For the past number of years the life insurance companies have been engaging in what I refer to as an arms race when competing for the investors’ business. They are regularly adding new features to their products to make them more flexible. Features such as lifetime income without having to give up your principal, the ability to participate in the stock market (variable annuities) to name a few.
So if you think an annuity will work for you, give me a call. Have a great new year everyone!
Rudy Eidenbock, Financial Advisor, RJFS
Office: 480-307-9909, Cell:480-295-9556, Fax:480-907-1413, 4111 E. Valley Auto Dr. #104, Mesa, Arizona 85206, www.puritywealthadvisors.com; firstname.lastname@example.org
Purity Wealth Advisors is an independent practice. Securities offered through Raymond James Financial Services Inc. Member FINRA/SIPC. Purity Wealth Advisors is not a broker/dealer and is independent of Raymond James Financial Services Inc. Investment advisory services offered through Raymond James Financial Services Advisors, Inc.
All investing involves risk and you may incur a profit or a loss. There is no assurance that any investment strategy will be successful.
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation.
Variable annuities are long-term investment vehicles designed for retirement. There are risks involved when investing in a variable annuity, including possible loss of principal.
A fixed annuity is a long-term, tax-deferred insurance contract designed for retirement. It allows you to create a fixed stream of income through a process called annuitization and also provides a fixed rate of return based on the terms of the contract. Fixed annuities have limitations. If you decide to take your money out early, you may face fees called surrender charges. Plus, if you’re not yet 59½, you may also have to pay an additional 10% tax penalty on top of ordinary income taxes. You should also know that a fixed annuity contains guarantees and protections that are subject to the issuing insurance company’s ability to pay for them.
Any opinions are those of Rudy Eidenbock and not necessarily those of Raymond James.