Annuities: A multi-purpose tool for your personal finances

When I am asked if an annuity is a good buy, I reply that it all depends on your situation and your goals.

Annuities: ©Andrii - stock.adobe.com

Once you have settled on what you want to accomplish, you can decide whether an annuity makes sense for you, realizing that different types can help you meet different financial goals.

Annuities cannot all be put into one category. But the very different types of annuities have some things in common. Savings-oriented deferred annuities are tax advantaged and guarantee principal (except for variable annuities). Income annuities are like a private pension.

They have no cash value but instead guarantee retirement income.

Annuities during your accumulation phase

Social Security benefits are not sufficient to fund retirement for most people. And given the aging of the population and projected trust fund shortfall, they may be less generous in the future.

That is one of the reasons why Congress authorized annuities, which let you put away money now and have it grow without taxes until you need the money in retirement. In the accumulation stage of your life, you are working and building wealth for retirement. Financial experts agree that during this stage, you should have diversified investments and prudently use all the tax-advantaged ways to save that you can without tying up money you need for current expenses. Annuities can be part of that mix.

Risk management as you accumulate wealth and age

In their 20s and 30s, many people are paying off student debt, raising children and saving to buy a house and thus cannot afford to put aside much for retirement. If you can salt something away, investing heavily in equities (stocks and stock funds) at this stage is not unwise because you have decades to ride out the ups and downs of the market.

But as you get older and have more money at stake and less time until retirement, your strategy should change. Most people should reduce their equity exposure and increase their allocation to less volatile instruments, such as bonds, certificates of deposit and fixed annuities.

Fixed-rate and fixed-indexed annuities build savings

To reduce your risk while getting a good interest rate, consider fixed-rate annuities, also called multiyear guaranteed annuities (MYGA). They are designed to act much like tax-deferred versions of bank certificates of deposit (CDs). They too offer a set, guaranteed rate for a set period but usually pay higher rates for the same term than CDs.

Unlike bank accounts or CDs, annuities are not federally insured. However, life insurers are tightly regulated by the states and have a solid track record of meeting their obligations. State annuity guaranty associations offer buyers additional protection. Check the AM Best rating of the issuing insurer before you buy. I recommend looking for at least a B++ rating.

Fixed-indexed annuities are another good option. Like a fixed-rate annuity, they also guarantee your principal so you are sure of getting your money back. But the interest rate varies from year to year. It varies depending on the crediting formulas used and how the stock market index or indexes you choose to align with perform. In years when the S&P 500, for example, is up significantly, you will get a portion of the upside and might receive, say, a 10% interest credit.

When the market is down for the year, you won’t lose any money but won’t get any interest either with most products. In exchange for a fluctuating, unknown interest rate, you have the potential for greater long-term returns than with fixed-rate annuities.

Fixed-indexed annuities are complex, with various crediting formulas, so it takes some careful thought to identify a product best suited to you.

Income annuities can turn cash into lifetime income

Unlike fixed-rate or fixed-index annuities, income annuities (deferred or immediate) typically don’t have cash surrender value. You are buying a contract, a promise the insurer is legally obliged to fulfill.

In return for your single premium deposit, this type of annuity guarantees an income for a certain number of years or your lifetime. Lifetime annuities are by far more popular because they provide a set, guaranteed income that will go on for your entire life. They provide “longevity insurance.”

You can choose an immediate income annuity for immediate income or a deferred income annuity for future income. With the latter, you will choose the start date.

Annuities don’t address all financial problems and are not appropriate for everyone. But like a Swiss Army knife, they offer a powerful and flexible set of tools.

Ken Nuss is the founder and CEO of AnnuityAdvantage.