It seems that the public’s perception of annuities is changing towards a positive view. Frankly, as a financial advisor, my own view of annuities has changed to a more favorable but cautious view of them. This will be the first installment in a series of articles on life annuities. The point of all this is not that someone should be pro-annuity or anti-annuity, but annuity-smart. Part of the confusion is that, like any investment, there are many options. Some annuities are suitable for a select minority of investors. For other types of annuities, I don’t know why more people have and use them. It’s more about proper use and knowing what each one is. Just to express my bias, after being personally against annuities for several years, I began to dig into and understand them. Once I did, I was able to see what kinds of people and what kinds of situations they are suitable for. My hope in this sporadic series of articles is to show you my line of thought.

Let’s start with some history. Annuities are far from new. They date back to the 1600s and even before that in the medieval era. I remember coming across them while reading Victor Hugo’s lovely long HE wretched which was mostly written in the 1850s. When they were first created, obviously, it was before pensions and social security. People would spend their entire lives saving money and would like to retire. The worry became “What if I live longer than I plan to and run out of savings income when I’m as old and frail as I ever will be?” So initially they were a guarantee (usually from a bank or insurance company) that if you gave them a lump sum, they would pay you for the rest of your life no matter how long you lived, but if you died, the institution would pay you. keep funds. They expect you to kick the bucket early (so they can pocket more of your lump sum) and you expect to live as long as possible (for obvious reasons, but also so that you receive more in payments than you gave them).

Over time, annuities changed because people also wanted to guarantee them for the lives of both spouses. Or when people were willing to accept a smaller payment if it meant that the institution would not uphold the principle if they died. However, some would want to deposit the funds now and let the funds grow at a fixed interest rate until they are ready to withdraw the payments. Or, others only wanted to commit for a short period of time and wanted the funds to be liquid after a few years. And so it was and the various products and solutions were developed to meet the demand.

We can narrow down the wide world of annuities to four different types. They are:

1. Immediate Annuities: These are the oldest type. Deposit the funds and start earning an income stream immediately. You may have different terms in them that will change the amount you receive each month. For example, you could say “give me payments for five years,” in which case you would get a relatively high payment. Or you could say, give me payments for life and if there is any money left, it will go to my heirs; this guy will understandably give you a lower payment. They work well when people are, say, much closer to their life expectancy and need to turn a lump sum into the strongest possible stream of income that they won’t survive.

2. Fixed Annuities – These are fixed-rate annuities that people most often use just to make money. They are issued with a fixed interest rate and a minimum rate guarantee, and the funds grow tax-deferred until you withdraw them (meaning you don’t have to pay taxes on the interest until you withdraw them). They can be issued with a fixed interest rate that stays the same throughout the term and then also have a minimum rate guarantee that will not drop below a certain point. I have a lot of clients where we put some funds into annuities before the financial crisis and they had a high minimum rate guarantee for life and now that the rates are very low, your rate can’t go below a certain point. Needless to say, the rates are lower on fixed annuities now along with everything else.

3. Indexed Annuities – In my opinion, indexed annuities are probably the most responsible for giving annuities a bad reputation. The way they work is similar to a fixed annuity, except the rate will change based on market performance up to a maximum rate. Let’s say the cap rate is 4%, if the market goes up 3%, you get 3%. If it goes up 10%, you get 4% (because you “capped” 4%). Conversely, if the market goes down, you get 0%, so your interest rate will not be negative. This sounds good, but I have learned from observation and experience that calculating the rate is not as simple as it seems. Also, investors should be cautious because sometimes they can be issued with extremely long time commitments. I have seen them with commitment terms of 14 years, 16 years and even 20 years! I don’t know why someone would lock up your money for so long and if you really have that much time to work there are probably better solutions for you. I always have an open mind, but so far no one has presented me with a case that satisfies me.

4. Variable Annuities – These are unpredictable and those that fail are also very responsible for giving annuities a bad reputation. A variable annuity is distinguished by the fact that the value of the contract can increase and down based on the performance of its underlying investments (or sub-accounts). These subaccounts are similar to mutual funds often run by the same companies and managers. In addition to this, the insurance company will offer “riders” at a cost that is a percentage of what you have there. Riders can guarantee the withdrawal of income or some lump sum to the heirs. You always hear that annuities have high fees. The way I look at fees is that you have to ask yourself what you get for what you pay for. Make sense. I’ve seen variable annuities with great fees that at best just give the client a tax deferral (if they’re traditional IRA funds, they’re not even doing that). On the other hand, a variable annuity can be used to protect the downside risk that the stock market may have on an income stream. Let’s say an investor has a large IRA and is two years from retirement and the stock market falls 50%; Certain annuities could have locked in profits before the market crashed and given them a lifetime income stream that can never diminish or disappear. This can have a secondary benefit in that usually when he retires, he still has 20-30 years left for which he needs to have income. Instead of switching everything to bonds and cash, for a cost, an insurance company can protect you in a way that allows you to stay in the market (which, generally speaking, someone should be if you have such a long time frame). .

It’s about how an investor uses annuities that can make people excited about them or angry about them. If used correctly, I have seen customers very pleased with them and providing results that are worth their costs.