MYTH: I Hate Annuities

This is a myth.  I don't use some of them, the expensive ridiculously high commissioned restrictive poorly performing ones.  But I agree with the authors of the article below:  I neither like nor dislike "annuities" as a class because they are a widely divergent collection of financial tools.  Some are indespensible and some are useless.  It just depends on your goals.

By John L. Olsen and Michael E. Kitces | November 06, 2019 at 03:32 PM

 

As advisors who often talk about annuities to financial advisors, we are often asked whether we “like” annuities. To that question, our standard answer is that we neither like nor dislike them—because they’re just tools, which work well in certain circumstances and do not work well in others. Occasionally, that response will elicit what may appear to be a better follow-up question:
“When—that is, in what planning situations—does an annuity make good sense and when does it not make good sense?”
That’s a core question, and one that might be in the mind of you, our reader. What’s our answer? One answer might be that “it depends… on the specific facts and circumstances of the case.” That’s a reasonable and rather obvious reply, and what our audiences often expect to hear. But it’s not our answer.
Our answer to that question is that the question in unanswerable—until we know what the questioner means by an annuity in the first place. Are we talking about a variable deferred annuity or a fixed immediate annuity? Those contracts are hugely different.
Each is an “annuity,” but the two contract forms are designed to meet completely opposite needs. Generalizations, always hazardous, are especially unproductive when used with annuities. A true statement about fixed annuities is likely to be false when applied to variable ones, and vice versa. The same is true when the annuities are immediate versus deferred. Yet many, if not most, consumers—and all too many advisors—routinely generalize about annuities, often to the extent that their conclusions are so flawed as to be worthless.
If we bear in mind this caveat—that we must generalize only when our assessment can be generally accurate—can we now attempt to answer the question posed earlier: “When, and in what planning situations, does an annuity make good sense and when does it not make good sense?” We believe that we can, and should, construct bright line tests to help us determine when an annuity is likely to be suitable for our client.
1. Where the Goal Is Immediate Income
When immediate income is the primary goal, an immediate annuity may be appropriate, so long as it is understood that it may provide no benefit at the annuitant’s death. Indeed, if the annuitant lives beyond the point where any refund element is payable, an immediate annuity will not provide any death benefit.
2. Where the Goal Is Income in the Future
Where the goal is income in the future, several annuity strategies may be appropriate.

1. Accumulating money now, to purchase an immediate annuity later
2. Purchasing a longevity now
3. Purchasing a “ladder” of longevity annuities over time
4. Purchasing a deferred annuity now, and activating the Guaranteed Lifetime Withdrawal Rider later.

3. Where the Income Amount Must Be as High as Possible on a Guaranteed Basis
Where the primary goal is income and where the amount of that income must be as high as possible on a guaranteed basis, an immediate annuity is ideal. The key word, here, is guaranteed, given that other alternatives (e.g., portfolio-based strategies) merely have the potential of generating greater retirement income, but the investor/retiree cannot be fully assured that they will.
Where the income period is a fixed number of years, a Period Certain fixed immediate annuity will generally provide a greater amount per year than can be assured from any investment alternative because the non-annuity alternative must often preserve principal.
4. Where the Goal Is Accumulation of Capital
Where the goal is capital accumulation, an immediate annuity is clearly not suitable, but a deferred annuity may be. If preservation of principal is a requirement, a fixed deferred annuity might be appropriate, but a variable one, in the absence of a Guaranteed Living Benefit rider, might not. This is because a variable annuity, except to the extent that its cash value is invested in the fixed account, does not offer safety of principal.
If, however, the purchaser is willing to regard a return of purchase payments in installments, no matter what happens to policy earnings, as a guarantee of principal, a Guaranteed Minimum Withdrawal Benefit (GMWB) rider to a variable deferred annuity can serve as an instrument for capital accumulation with “safety of principal.”
Indeed, the GMWB provision of many contracts includes a step-up feature that not only assures the return of the original investment in installments, but also any contract gain accrued as of the point where the step-up option may be exercised. However, it is important to emphasize that in this context, the safety of principal provided by the deferred annuity exists only if the annuity owner accesses the principal according to the terms of the guarantee. In the context of a GMWB, this means that principal is not guaranteed, unless the annuity owner is willing to extract that principal as a series of periodic payments over a span of many years.
(Excerpted from The Advisor’s Guide to Annuities, 5^th ed.)




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MYTH: Social Security is in Trouble

This is a solid, proven myth.  The only trouble Social Security is in is the same trouble it's been in since before it was signed into law 84 years ago:  ignorant, malicious attacks by self-righteous ideologues.

As quoted in Social Security Works: 
The most important takeaways from the 2019 Trustees Report are that (1) Social Security has a large accumulated surplus, and (2) Social Security is extremely affordable. In three-quarters of a century, in 2095, Social Security will constitute just 6.07 percent of GDP. That is considerably lower, as a percentage of GDP, than Germany, Austria, France, and most other industrialized countries spend on their counterpart programs today.
The 2019 Trustees Report projects Social Security’s cumulative surplus to be $2.9 trillion. It shows that Social Security is fully funded until 2035, 93 percent funded for the next 25 years, 87 percent funded over the next 50 years, and 84 percent funded over the next 75 years.
Yet, like a malignancy, a thoroughly inaccurate New York Times article spread until one newspaper headline said Social Security would be insolvent in 6 months.

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MYTH: Annuities are a Bad Idea for Almost Everyone!

This headline precedes an extremely ignorant article by MarketWatch writer Marc Lichtenfield.  Ironically, only the first sentence is close to being true:  "You're betting the insurance company that you're going to live longer than they think you will".  Yes, of course!

But let me dissect this dangerouly stupid article line by line.  As if Wall Street is so great at comprehensive financial planning.  The truth is,

Annuities are a Great Solution for almost Everyone.

Opinion: Why annuities are a bad idea for almost everyone

By Marc Lichtenfeld

Published: Aug 18, 2018 7:56 a.m. ET

“Don’t lose money in the Wall Street casino!” the radio announcer blared.
“It could take a lifetime to make up your losses in the stock market.”
Unless your lifetime is five years — that’s how long it took the market to make a full recovery after the Great Recession — he’s dead wrong.
He was using this fear tactic to sell annuities. And getting suckered into buying an annuity with him — or any broker — could be the biggest mistake you ever make.
Marc, since the number one risk in retirement is living longer than expected and, hence, outliving one's income and assets, wouldn't income insurance make sense?  Yes, the market made a full recovery . . . as long as no withdrawals were being made.
You see, annuities aren’t wrong for everyone… Just most everyone.
I would love to do a comprehensive plan comparison, your way and my way.  Just ask any retiree how important their existing public annuities (Social Security and pensions) are to them.
If you’re unfamiliar with annuities — you give an insurance company your money and in return they pay you an income stream, usually for the rest of your life. In some annuities, if you die before you’ve received all of your money back, too bad for you. The insurance company keeps the money.
Seriously, that’s how it works.
No, that's not how it works.  Some annuities (single premium immediate annuities or SPIAs) do work that way, just like pensions and Social Security, unless you exercise survivorship and/or spousal continuation options, in which case payments can continue for the life of one's spouse.  But they are neither the most effective nor common.
Now, there are plenty of annuities where that’s not the case. Family members can receive cash back or even continued monthly income after your death — but you pay extra for that.
Now you just contradicted your last paragraph.  Oh, there are other types of annuities.  And no,  those particular benefits don't cost extra.
Essentially, you’re betting the insurance company that you’re going to live longer than they think you will. They take your money, invest it and give it back to you in dribs and drabs (with steep penalties if you want to withdraw more than the contract states).
Annuities are indeed long term vehicles which still have great short term liquidity.  10% per year penalty-free is ubiquitous.  After 5-10 years you have 100% liquidity.  Upon death, terminal illness or disability, even the short term penalties are waived.  Everyone has money that they don't need 100% liquid all the time.  Tell any annuitant that the guaranteed income they're enjoying is "dribs and drabs".  I'm not familiar with that sophisticated financial term.
Annuities are such terrible investments that the minute the government passed a law specifying that financial professionals had to act in their clients best interest, annuity sales fell off a cliff.
In 2016, new rules were passed by the Department of Labor that stated that brokers have to act as fiduciaries. That means they had to put their clients’ best interest ahead of their own.
Believe it or not, prior to the rule being passed, stock and insurance brokers could sell you anything they wanted — whether it was right for your or not. So typically, they sold whatever paid the highest commissions.
Fixed and indexed annuities are not investments.  They are insurance products.  They are regulated by state insurance departments.  Variable annuities are indeed terrible, expensive and poorly regulated investments.  The best interest statutes never stuck.  What killed sales was the requirement that all compensation, even trips, etc. be disclosed to the client.  Those of us advisors who are already legal fiduciaries comply with the best interest standard anyway, even though it was eventually thrown out.  
Annuities pay extremely high commissions — often 7% or higher of the total amount. So if a client was sold a $200,000 annuity, the salesperson might take home $14,000 up front.
Needless to say, there’s not a lot of incentive for him to put you in a low-cost index fund.
Yes, the far more virtuous stock broker or money "manager" would rather you pay 1-2% of your money every year, indefinitely.  Annuities actually pay less compensation over a 10-yr. period.  Finally, I do in fact recommend low cost ETFs for the growth portion of my clients' assets.
This new law is scheduled to go into effect this year, though that will likely be delayed.
As soon as the fiduciary rule was passed in 2016, sales of annuities fell 8%. They slid an additional 18% in the first quarter of 2017.
Sales of variable annuities, which are the worst of the worst, crashed 22% in 2016.
If these were such wonderful products, as defenders of annuities will maintain, why did so many people stop selling them — even before the law went into effect?
Those were my two best years, due to the uncertainty caused by our current awful president.  Keep in mind, too, that everyone thought they were invulnerable in the market.  Stodgy old annuities weren't as sexy.
So why do people like them?
Fixed annuities prevent losses. You are typically guaranteed that the value of your principal will not go down regardless of what the stock or bond markets do.
Fixed index annuities allow the investor to take part in some upside, though it is usually very limited — about 4% per year in this low interest rate environment. So the investor is trading upside potential for downside protection.
If the market soars 20%, the investor will only make 4%. But if the market falls 20%, the investor won’t lose any money.
More top-of-the-head opinionating without doing any research.  I had indexed annuities credit close to 20% last year.  Virtually all indexed annuities offer monthly caps of 1-1.5%, meaning you could earn 12-18% any given year.  But this misses the point.  The primary purposes of indexed annuities are income insurance & principal protection that beats other principal insured options like CDs and bank accounts.
Another way they screw you
Let’s say you take out an annuity and your circumstances change. You need the money urgently. If you’re still within the surrender period, it’s going to cost you. Big.
A typical surrender period is seven years and the surrender charge starts at 7% and falls by 1% per year.

So if after two years, you need your money back, it’s going to cost you $10,000 ($200,000 x 5% = $10,000) to get your own money back.
 This is why fiduciary advisers build income plans to prevent having to access long term money.  That's what emergency funds are for.  Wall Street shills don't seem to be able to grasp this.
Instead, take the money and invest it in Perpetual Dividend Raisers — companies that raise their dividend every year.
Yes, they did so well in 2008.  Investors spending down such account allocations would never have recovered.  This is referred to as "sequence" risk, losing money at the wrong time while you're drawing down savings.  Wall Street shills don't seem to understand sequence risk either.
But I don’t want to risk any money, you say. After all, that’s one of the most attractive features of annuities.
Annuities are typically long-term contracts. People buy them in their 60s, 70s and even 80s, expecting to collect income for years in the future.
And most do indeed collect income for years in the future, usually well beyond the "average" life expectancy used by brokers in their plans, if they've even done a plan.
Consider that over 10-year periods, the stock market has only been down seven times in the past 80 years. And those seven times all were tied to the Great Depression or Great Recession.
In other words, you had to sell in the depths of historic financial collapses to not make money in the stock market over 10 years.
Again, this ignores sequence risk.
If you invested in 2000, near the top of the dot-com bubble and sold in 2009, near the bottom of the Great Recession, you were down 9%. Not good, but not horrendous considering you endured two epic stock market meltdowns.
But what if you were having to meet your budget during that period?
Or consider this scenario… If you have the worst timing of any investor and put your nest egg into the S&P 500 SPX, +0.62%   at the absolute top in 2007 — right before the financial collapse — you’d be up 91% (including dividends) 10 years later.
Just stop and think about that the next time market naysayers talk about the “Wall Street casino.”
Securities are indeed a casino.  Where else can you lose everything?
As an industry saying goes, “Annuities are sold, not bought.”
Don’t be one of the people who gets sold.
Actually, I disagree heartily.  Annuities are bought.  By people who want principal protection, and a solution to the three greatest retirement risks:  Sequence risk- having to spend your money after or while it shrinks, Longevity risk- outliving your income, and Withdrawal Rate risk- e.g following Wall Street's 4% rule and then going broke.
A well designed income allocation plan includes market investments.  But no one should have all their money in the market, not in a well-crafted income allocation strategy.

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