Retirement Investor

How to Think About Annuities


I Love Annuities!

I Hate Annuities!

That’s the way it is with these unique financial vehicles. People seem to either love them or hate them. Annuities remind me of politics. They ignite polarized beliefs that sometimes make it difficult to have fruitful discussions. Well, I’m here today to offer you a lesson in how to think about annuities. And whether you are currently on the “love” side or the ”hate” side of the annuity debate, or just don’t know what to think, my objective is that, after reading this, I will have brought you to a thoughtful, sensible, and accurate understanding of how annuities may fit into your financial life.

 No Money Vehicle is Perceived As “Great” All the Time

Polls regularly track the popularity of politicians. At any given time, the current president of the United States may be popular or unpopular as expressed in polls that measure “popularity.” Much of what drives the judgment of “popularity” has to do with current economic conditions. When people perceive the U.S. economy as strong, the president tends to be the beneficiary of a higher rate of approval.  

It’s much the same for various savings and investment vehicles. Their popularity may surge or wane depending upon prevailing psychology and economic conditions, Let’s look at a couple of examples.


Few savings instruments have seen their popularity vary as extremely as CDs. Back in 2000, you could have purchased CDs and earned interest of about 7%. Today, that interest rate has plummeted from 7% to, perhaps, 0.10%. That’s what? A 99% drop? In 2000, you may have thought that CDs were great. Today, you might not give them the time of day. Your feelings about CDs changed due to something important: your self-interest. A generous rate of interest appealed to your self-interest. When interest rates turned almost invisible, your self-interest told you, “No thanks!”


In recent years, stocks have been wildly popular. That makes perfect sense. When stock prices are moving higher, as they have been for 13 years, your self-interest may say, “I know it’s risky, and I’m retired, but everybody else is making money.” You listen, and maybe it works out. Or perhaps you read about someone like Jeremy Grantham, the veteran money manager who correctly predicted the 2008 market crash. Grantham now predicts that stocks are in a “superbubble” that will explode and cost investors losses totaling $35 trillion. If you’ve noticed that lately, stock prices have turned downward, your self-interest may change its opinion and tell you to pass on stocks.

Annuities and Your Self-Interest

The essence of my advice to you when considering annuities is to trust what your self-interest tells you. Ask questions of the insurance agent or financial advisor who is recommending the annuity. Ask as many questions as it takes for you to feel comfortable. If an annuity isn’t right for you, the answers to the questions I’m suggesting below will inform your self-interest.

In general, annuities can be used in one of two ways. To accumulate savings, or, to pay you monthly income. Depending upon the annuity that is being recommended and its purpose,  your discovery process should include questions like these:

  1.     What is the term of the annuity? Five years? Seven years? Ask yourself, “What time commitment am I comfortable with?”
  2.     What are the liquidity provisions? Am I able to withdraw money annually without penalty? How much? 10% annually? (That’s typical). Ask yourself if you are likely to withdraw more than 10% annually. Retirees typically will not need to withdraw more than that amount unless they encounter an emergency situation that requires them to get their hands on additional money. The annuity may offer a liquidity provision if, for instance, you encounter a health emergency or require home health care or confinement in a nursing home. Ask about these types of liquidity provisions.
  3.     What is the annuity’s surrender charge? This is important because the surrender charge is the penalty you will pay if you cash in the annuity before its term. The surrender charge is similar to the penalty you’d pay if, say, you cashed in a five-year CD before its maturity date. Be certain to ask about the level of surrender charges. Ask if the surrender charges decline on an annual basis.
  4.     By what method does the annuity credit interest? This can be a complicated issue because, increasingly, the interest rates annuities pay are linked to the performance of one or more stock indexes, such as the S&P 500. Many annuity owners really like the indexed approach because they see it as a way to “sort of” participate in the stock market, but without having to actually take on true market risk. If stocks turn downward, the annuity typically guarantees that you won’t lose any money. If stock prices move upward, you will receive interest based upon a portion of the growth in the stock index.

Here’s an example. Assume that over the course of one year the stock index increases by 10%. The annuity may credit interest based upon, say, 50% of that, or 5%. In this example, 5% may offer high appeal to a retiree who doesn’t want to expose savings to principal risk, but who does seek the potential to earn an interest rate that is higher than what CDs are paying. Five percent, of course, is a great deal higher than current CD rates. Essentially, the annuity owner trades away some of the upside growth potential found in investments in return for strong downside protection. For many retirees, this is a compelling value proposition.

Annuities for Providing Monthly Retirement Income

Personally, this is my favorite aspect of annuities. Annuities are unique among all financial vehicles because they alone can guarantee the payment of an income for as long as you live. Never forget this: In retirement, it’s about your income, not your wealth. Income is what creates your standard of living. Financially, nothing is more important to a retiree than his or her income. I wrote an article about just this.

In their purest form, annuities are similar to Social Security. In fact, Social Security is actually a great big annuity system, one that pays its beneficiaries retirement benefits in the form of monthly income for life. If you like receiving income from Social Security, you should equally enjoy receiving income from an annuity.

 In order to pay someone an income for life, annuities – including Social Security – must be funded with dollars. Social Security is funded over your working lifetime, with small, week-by-week deposits which are deducted from your paycheck.

Annuities are typically funded by depositing a lump sum of money with an insurance company. For example, a retiree, Susan, has accumulated a nest egg of $1 million. At retirement, Susan is concerned about meeting her living expenses. She likes the idea of receiving an income that she knows will last as long as she lives. For Susan, the assurance of additional monthly income gives her peace of mind. To supplement her foundational annuity, Social Security, Susan might allocate a share of her savings, say 25%, to the purchase of an annuity.

Why would Susan place $250,000 in an annuity in exchange for 12 monthly “paychecks” of, say, $1,250? In other words, to receive $15,000 per year for life. Well, for a couple of reasons.

First, Susan is female. In general, women live longer. Susan’s mom lived until age 92. In good health, Susan believes she could live even longer than her mom did. What would the financial implications be for Susan if she lives ten years longer than her mom? By retiring at age 65, and living until age 102, Susan will need retirement income that lasts for 37 years! With certainty, only an annuity can deliver income for that long. Again, in terms of peace of mind, the certainty of the annuity income allows Susan to feel confident that her financial future will be secure.   

All of This Sounds Great. Why the Annuity Hate?

At times, criticism of annuities has been warranted. Some annuity contracts were designed with extremely complex provisions, such as withdrawal penalties that went on for exceedingly long periods of time or imposed strict limits on the amount of money the annuity owner may withdraw, or may have had excessive costs, or maybe incorporated all of these poor qualities in one annuity. I call this the “bad apple” type of annuity and, happily, they have been mostly thrust out of existence. The truth is, it’s easy to find annuities with consumer-friendly features.

The most vociferous critics of annuities tend to be certain investment advisors who are, in my view, compromised in that they have a competing financial agenda. Some investment advisors view annuities as competition for an investor’s savings. If the investor’s money is sent to an insurance company to purchase an annuity, that’s money the investment advisor can’t manage and earn fees on.

The tendency among annuity critics is to keep hurling insults at annuities by implying that all of them have high fees and poor liquidity. Blanket condemnations such as, “I hate annuities and you should too” only do a disservice to consumers who may become influenced to such an extent by shameful advertising that they forgo the benefits that annuities uniquely provide. I have no doubt that this happens, and it’s a tragic outcome. Fortunately, not all investment advisors view annuities in this manner. In fact, the current trend among investment advisors is that increasing numbers of them are recommending annuities when doing so serves their clients’ best interests. The growing popularity of annuities among investment advisors is a genuinely positive development.

Another factor that has led to criticism of annuities arose out of poor marketing practices, especially in the solicitation of seniors. These practices led to high-profile regulatory actions and class-action lawsuits. Although these issues occurred in the past, and they involved only a tiny fraction of the insurance agent population and just a small percentage of annuities, they tarnished the reputation of the annuity industry as a whole and made it harder for people to differentiate between annuities to avoid versus annuities to welcome with open arms.

The good news is that virtually all of this  “bad stuff” has been relegated to history. Years ago, the annuity industry cleaned up its marketing practices. It is easy to find annuities with low costs, generous withdrawal provisions, and excellent overall benefits. In other words, annuities you would be proud to own.

In Conclusion

Let your self-interest tell you if purchasing an annuity is the right thing for you. Keep these questions in mind:

  •   Do I need lifetime income to supplement my Social Security? This is a key question to which many retirees will answer, “Yes.” Remember that annuities are the only financial vehicles available that can guarantee you a lifetime income.
  •   What is the term of the annuity? If you are considering an annuity to grow your savings, you will benefit from the income-tax-deferred growth that annuities provide. That said, pay attention to the term. If you are comfortable with, say, 5-years or 7-years, then tell the insurance agent or financial advisor that that is what you want.
  •   What are the withdrawal provisions? Be sure that you can access a portion of your money without penalty, and in an amount that works for you.
  •   How is interest credited? You may be comfortable with having interest be a function of the performance of a stock index. Or you may prefer a simple and more traditional rate of interest that the insurance company declares periodically. Typically, the rate of interest the annuity offers will be higher than current CD rates, Some annuities can simultaneously offer both types of interest crediting. Choose the type of interest crediting that makes you comfortable.
  •   What are the financial ratings of the insurance company? Rarely do insurance companies fail. However, some insurers are financially stronger than others. Agents or advisors that represent financially strong companies will be anxious to share the financial strength ratings of various insurers.

Do you feel better equipped to evaluate the purchase of an annuity? I hope so. If you follow this question-and-answer process, your self-interest will speak to you. Listen to it. It will tell you if the annuity being recommended is the right thing for you.

David Macchia

David Macchia is an author, public speaker and entrepreneur focused on improving the current state of retirement income planning. He is the founder of Wealth2k, Inc, and the developer of the widely used retirement income solution, The Income for Life Model®. Recently, David developed Women And Income™, the first retirement income solution developed to address the differentiated needs and preferences of female investors. David is the author of the consumer finance book, “Lucky Retiree: How to Create and Keep Your Retirement Income with The Income for Life Model®.”

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