What Clients, and Advisors, Misunderstand About Annuities: Advisors' Advice

The most common misunderstanding we continue to see from advisors when it comes to annuities is the idea that "An annuity shouldn’t go in a retirement account, because you don’t need a tax-deferred vehicle in a tax-deferred account." In reality, annuities are often bought for the investment or income/retirement guarantees they provide, and not for tax deferral in the first place. And if those investment options or income/retirement guarantees are best suited for retirement dollars, there’s nothing wrong with putting an annuity in a retirement account!

— Michael Kitces, MSFS, MTAX, CFP, CLU, ChFC
Chief Financial Planning Nerd, Kitces.com
Reston, Virginia

One of the most misunderstood parts about annuities is that the only method of distribution is a series of payments over one’s lifetime. The concern is that if you die early, the insurance company would “win.” However, that is incorrect. There are many different ways a client might take that money in retirement: lump sum, spontaneous withdrawals here and there, or even possibly after death, by means of the beneficiary designation. Flexibility is a component that most insurance companies include in today’s annuity products. If used correctly in a retirement plan, an annuity's Swiss Army Knife-like versatility can be a very powerful tool in a client's post-work life.

— Tom Henske, CFP
Financial Advisor
Fifth Avenue Financial
New York City

The most misunderstood thing about an annuity is that it has an insurance component to it, and just like any other insurance product, it's a way of transferring risk — the risk of outliving your sources of retirement income and the risk of portfolio loss. And like all insurance, you may never need it. Most people won't need the protection. But if they do, it can have a significant positive financial impact on their lives. For those people, it will provide outsized value. Having a lifetime income guarantee is just another way to address risk.

— Mark Cortazzo, CFP, CIMA
Senior Partner
MACRO Consulting Group
Parsippany, New Jersey

What’s frequently misunderstood is how an annuity can help someone who wants to be insulated from market volatility, needs secure lifetime income, likes the idea of a guarantee and is reluctant to invest in equities at retirement. Annuities can often act as a market hedge, efficient alternative to bonds and/or complement other assets. The key is to understand if one of those situations applies. Individually assess annuities and their applications to each situation. You can then decide whether they belong in a portfolio or not.

— Kevin Donohue, CFP, AIF
Partner/Senior Advisor
Legacy Planning Partners
West Chester, Pennsylvania

Many people do not fully understand how annuities are taxed. They will not incur income tax while the value grows, but the growth will be taxed as ordinary income when withdrawn. All the taxable growth must come out first before the owner can begin to withdraw the tax basis, which is not taxable. At the death of the annuitant, any tax-deferred gain will still be taxable to the beneficiary (unless the beneficiary is a charity), but the beneficiary may be able to spread this over a period of years.

— Todd Hall, CFP, AEP, CAP
Director of Financial Planning
Homrich Berg
Atlanta

What's most misunderstood about annuities? The behavioral finance benefit of owning a guaranteed stream of income that you cannot outlive. If you have all of your fixed expenses in retirement met between a pension, Social Security, and an annuity, then when market downturns happen, you are more likely to stay invested and take on the risk necessary to not outlive your savings. Longevity is the greatest risk in retirement, and annuities help meet this head on.

— Jody D'Agostini, CFP, CDFA, RICP
Financial Advisor
Equitable Advisors
Morristown, New Jersey

People say “annuities are expensive” and “annuities tie my money up for a long time.” Frankly, some annuities are expensive. But with commission-free annuities for fee-based advisors, expenses are decreasing dramatically. Second, many of these annuities no longer tie up your money for a long time. I foresee the surrender period becoming the exception rather than the norm. The removal of commissions allows advisors to take a truly fiduciary approach in building strategies that can create guaranteed income or tax deferral.

— Bryan Montemurro, CFP
Two West Advisors
Overland Park, Kansas

Simply put, annuities are not all the same. Many investors do not understand that there are many different types of annuities. They are not all created equal. There are many financial problems that can be addressed by the right annuity product, but the wrong annuity can be a big problem. A good advisor can help clarify their needs and recommend the best product for the job.

— Russ Story, RFC
Financial Advisor
Story Wealth Management Group
Douglas, Georgia

Too many people don’t realize that buying an annuity is like buying an insurance policy, in that you pay a commission and/or an actuarial cost to compensate the salesperson and the issuing company for your mortality risk. This means loss of liquidity in the early years of ownership. And because of the costs charged for bells and whistles like minimum rate guarantees, income riders, and others, much less of the owner’s money ever gets a chance to earn a return. Finally, with variable annuities, the fund management expenses also get passed on to the annuity owner, which further reduces the actual working power of the investment. The tax deferral is great, but you can get that with your IRA or 401(k), and pay way less in fees and expenses.

— Kimberly Foss, CFP, CPWA
Founder and President
Empyrion Wealth Management
Roseville, California

Our team has extensively used fixed indexed annuities (FIAs) over the past seven years, implementing them as a safety base for balanced portfolios. With record low interest rates, we have little faith in traditional bond funds' ability to preserve capital. Knowing that some clients mentally raise a “red flag” upon hearing the word "annuity," we first discuss the macro-economic landscape, then the general investment merits of a FIA — the guaranteed principal and interest, index options, features, etc. Only then do we mention the actual name of the product, and gauge their reaction to diffuse any prejudices against annuities.

— Mark P. Oberlin
Senior Vice President of Investments
Oberlin Group Wealth Advisors of Raymond James
Grand Rapids, Michigan

One of the most misunderstood aspects of annuities is that they come in so many different types and can have greatly varying features. Some are fully liquid, some are fixed in return, some have a larger menu of investment choices, some provide an upfront bonus to the investor, and more. It’s really important to work with an experienced financial advisor who has dealt with these insurance-related investments for years and can carefully break down the features, the health of the provider, the pros and cons of each product, before buying. I’ve seen too many clients stuck with annuities they don’t understand.

— Winnie Sun
Managing Director
Sun Group Wealth Partners
Irvine, California