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Opinion

Annuities vs. Greed

A point of contention in finance is the use of the word “guarantee.” When it comes to investing in the stock market there are no guarantees. Using the word should invite a reasonable suspicion of doubt. It’s “Voldermort”. All investment products represent some degree of gambling. Stocks and bonds are poker chips you cannot see or touch. These products should be considered in the same vein as giving money to a card dealer in Las Vegas. However, many people are persuaded into thinking this vice can define their retirement strategy.

However, there is one time it is suitable to say something can be guaranteed. Annuities are insurance products that are marketed for investment-like features. They are appropriate for people with extremely low risk tolerance and often considered as being a zero-maintenance retirement strategy. With annuities you can be guaranteed against loss during dark days of the markets and you can be guaranteed regular, predictable income in retirement.

The way annuities achieve guarantees are fees. It’s the biggest turn-off for them, but they are the only financial product that can, by definition, not get smaller, only bigger—guaranteed.

Whereas fixed annuities offer payments defined in contracts, variable and indexed annuities offer additional income potential linked to the performance of the market or a particular investments you can select. Variable annuities have an accumulation phase when the money you paid to the insurer grows. This is followed by a payout phase where the insurer sends you checks. Variable annuities offer death benefits which means if you die before the insurance company has started making payments, a beneficiary will continue to receive those checks. This all delivers a certain amount of control and reliability.

Money in a variable annuity grows without being taxed. It is taxed in the future at the time of withdrawal of the balance. Your participation rate measures what amount of return you can receive during the accumulation phase. Many people index an annuity to the S&P 500. In many cases it will operate as follows. If your benchmark index gains 10% in a year and if your participation rate is 100%, your return would be 10%. However, with many annuities there are caps to how much return you can receive. In this one-year, 10% scenario, a cap of 7% would limit your return to 7%, instead of the original, entire 10% index gain. To measure the full gain you would also need to subtract the amount of the annual fee. Consider a 2% fee for this scenario and a 10% gain of the S&P 500 index results in a 5% increase in the balance of your annuity.

If the scenario is reversed and the market drops any amount year-over-year, your balance is unchanged. You are protected against loss. With annuities, you benefit when things go well and protected when things look grim. Long story short, annuities are a cautious, safe bet. They can be modified to resemble something more like stock investment and they can be amended with a number of “riders” which will guarantee almost any variable of the product.

Philosophically, this represents the most moderate and humble retirement strategy. In volatile times, this option is like a steady hand that will instill confidence when you think about your future.