A clear sign of stock market volatility is the proliferation of advertisements promoting the benefits of using annuities as retirement income. Many of these propaganda are similar to spreading fear and capitalize on many investors’ concerns about the stock market in an unstable economic situation.
Don’t buy an annuity out of fear
Some annuity salespeople use fear of the stock market to induce investors to buy the products they sell. However, market adjustments are a normal part of the investment cycle. A well-designed investment portfolio should provide sufficient cash or other low-risk, low-volatility investments to meet the cash flow needs for several years without the need for retirees to enter its stock portfolio.
Financial advisors have the responsibility to work with retirees to develop a plan to fund the client’s cash flow needs from all available retirement resources. These include withdrawals from tax-deferred retirement accounts, taxable accounts, pension and social security benefits, and annuities if the product is suitable for investors.
- Annuity may be a useful financial tool for retirement, but experts do not recommend buying it to prevent potential stock market fluctuations.
- Some insurance companies bite the bullet and sell annuities to customers without explaining the complexity of the product.
- There are many forms of annuity, and a financial advisor may help you find the type that best suits your situation.
- The Security Act of 2019 in the U.S. Congress sets out rules that affect retirement accounts and annuities held in employer-sponsored plans.
Precautions before buying
There is nothing wrong with annuities, but sometimes there are problems with their advertising or sales methods. Before purchasing an annuity, make sure you understand all the costs associated with the product.
The ongoing annual expenses of some variable annuities are close to 3%, which is very high. If your annuity fees and costs are high, it will affect your annuity expenditures.
Before purchasing an annuity, you need to consider the following points:
- Annuity products are usually issued in the form of monthly or quarterly regular payments or one-off distributions.
- Fixed annuities that offer much higher interest rates than similar products should be dangerous. Is the insurance company eager to collect premiums? Is the company financially sound? The motto “If it sounds too good to be true, it might be so” applies here.
- Research the company where you purchased the annuity and understand its financial viability. If something happens to the insurance company, such as bankruptcy, the corresponding state insurance department will be responsible for covering you. Annuity guarantee amount is usually limited, so you need to read the contract and make sure you understand all the rules.
Evaluate surrender penalty and index annuity formula
Annuities have basic expenses, called mortality and expenses. This can compensate the insurance company for the risk they take when the contract holder decides on the annuity, because they cannot control how long the annuity person may live.
Many annuities include surrender costs, and if you try to withdraw from the contract within the first few years, you will be severely penalized. The surrender period can range from five to ten years or longer, depending on the contract. Make sure you understand the length of the surrender period and the cost of surrender.
Index annuities, commonly referred to as stock index annuities, provide limited upside participation in stock market indexes such as the S&P 500. They also provide downside protection in the form of a certain level of minimum guaranteed return.
The sales promotion of index annuities varies from being a CD replacement to being a safe way to invest in the stock market. You must understand the basic formula that determines your return and any factors that may cause the formula to change. View FINRA’s investor alert on index annuities.
Variable annuities usually have basic sub-accounts that operate like mutual funds. Living welfare additional clauses have become a popular choice or additional clauses in many contracts. Additional clauses are an insurance policy or annuity clause that can add benefits to the policy or modify the clauses to reduce or limit the coverage. If it is a fringe benefit, the rider will pay an additional fee.
Two popular drivers are the Guaranteed Minimum Withdrawal Benefit (GMWB) and the Guaranteed Minimum Income Benefit (GMIB). Regardless of the performance of the underlying investment, the GMWB additional clause guarantees the return of the premium paid to the contract through a series of regular withdrawals. The GMIB additional clause guarantees the right to annuitize the contract at a specified minimum income level, regardless of the performance of the underlying investment.
Both types of riders will incur additional costs and require different time frames to qualify for exercise and recover the rider’s costs. These and similar contract options are important items promoted by annuity sales staff during times of turmoil in the stock market.
Dinner seminars and intimidation tactics advertisements
A typical dinner seminar presentation is aimed at baby boomers and senior citizens in a specific group of people. The meeting may be hosted by a local registered representative, an insurance agent selling annuities, or co-chaired by an estate planning lawyer. Radio advertisements for annuities often tout how their products can replace the volatility and risk of stocks.
Changes to the rules of retirement accounts
With the passage of the “Building Every Communities to Improve the Level of Retirement (SECURE) Act” by the U.S. Congress in 2019, changes to the rules regarding retirement accounts will take effect in 2020.The new rules affect annuities held in retirement accounts and employer-sponsored plans (such as 401(k)s). Please note that the changes listed here are not a complete list of all laws in force due to the Security Act.
Experts recommend consulting financial professionals to thoroughly review all rule changes that have come into effect due to the Security Law.
Previously, the IRA “stretched clause” Non-spouse IRA beneficiaries are allowed to receive only the required minimum distribution (RMD) from the inherited IRA each year. According to the “Security Law”, the extension clause was cancelled.
In 2020 and 2021, non-spouse beneficiaries who inherit the IRA must withdraw all funds from the IRA account within ten years of the original owner’s death. Inherited retirement accounts that include annuity products as investments are not subject to the ruling. However, there are exceptions to the 10-year withdrawal rule for spouses and other special circumstances.
If your employer-sponsored retirement plan has an annuity and you change jobs, the SECURE Act allows you to transfer your 401(k) annuity to the new employer’s plan.It is worth noting that the legal liabilities or risks faced by insurance companies and annuity providers have changed in the past few years. In other words, if the annuity provider defaults on annuity payments, the annuity owner may encounter restrictions when trying to sue the annuity provider.
Various types of annuities can be a viable part of a good retirement income strategy. This is where a qualified financial advisor (as opposed to a product salesperson) can help. They can determine whether an annuity is suitable for the customer’s plan and help find the most cost-effective product instead of using the salesperson’s intimidation tactics.