Ask an advisor: The Great Annuity Debate

Ask an advisor: Annuities, what are they good for?

December 20, 2022 4:44 PM

In wealth management, few words are as polarizing as "annuity."

Welcome back to "Ask an Advisor," the advice column where real financial professionals answer questions from real people. The topic can be anything in the world of finance, from retirement to taxes to wealth management — or even advice on advising.

This week, we're taking a different approach once again: The question comes not from an advisor or client, but from yours truly, Financial Planning retirement reporter Nathan Place. Here's my question:

Of all the topics I cover in my beat, few are as polarizing as annuities. The products provoke strong feelings, both positive and negative; advisors seem to love them or hate them.

At first glance, annuities don't seem that controversial. Sold by insurance companies, they provide a pension-like income to the purchaser during retirement. And in recent months, they've been booming: In the summer of 2022, annuity sales reached $80.7 billion — their highest quarterly total ever recorded. This shattered the previous record, which had been set just one quarter earlier.

On the other hand, many consider annuities excessively complex and expensive, or complain that they're "sold" to clients rather than demanded by them — sometimes without the client's full understanding. The products' defenders counter that today there are plenty of cheaper, simpler annuities, and the hidden fees of yesteryear are an outdated stereotype. And the debate goes on.

My question is simple: Where do you stand on annuities? Are they ever a good option for clients preparing for retirement? Does it depend on certain factors, like the age of the client or the type of annuity? Or are these products just no good?

Here's what advisors wrote back:

Not my first choice

David Bize, certified financial planner at

First Allied Securities

in Oklahoma City:

I think most annuities are overly expensive, so I don't recommend them. However, some people think their peace of mind is worth the reduced return due to extra expense. No financial advisor in their right mind can say that a deferred fixed annuity with multiyear guaranteed interest is not a good fit for conservative clients who would otherwise purchase a bank CD.

A four-letter word

Rick Raybin, certified financial planner and CEO of

Lifetime Capital Group

in Burlingame, California:

While I have yet to meet an annuity that I liked and believe the name of the product should be treated as a four-letter word, my issue is with the implementation, not the concept.

When developing a financial plan for a client, I always look to provide for longevity risk. Similar to the benefit gained from increased monthly payments retirees get when delaying social retirement payments until age 70, having a reliable stream of payments that you cannot outlive can help retirees later in life when they are otherwise unable to find needed resources.

However, the costs, often hidden, are too much. In the current interest rate environment, fixed annuities pay too little to keep up with inflation, and we can create equivalent payment streams at a lower cost. For those enticed by variable annuities with features like minimum returns, the costs are often hidden and always excessive. Similar to fixed annuities, the equivalent of variable annuity performance can be obtained at much lower cost.

Last but not least, most annuity products are commission-based and often sold to buyers who do not know what is reasonable or realistic or how it will limit their financial future.

Don't go to extremes

Kashif Ahmed, certified financial planner and president of

American Private Wealth

in Bedford, Massachusetts:

Yes, annuities are polarizing. And it's because advisors love to dig in and not budge from entrenched positions. The annuities conversation has been balkanized!

Much like some commentators who are on a crusade against a particular fee structure, some people feel they need to become carnival barkers against them, simply for exposure and visibility. And on the other side are those who claim an annuity will solve every problem for every client. And that's the problem I have with them: how they are sold. And yes, they are sold. I have yet to come across anyone who proactively asks for an annuity.

Keep an open mind

Chris Urban, certified financial planner and founder of

Discovery Wealth Planning

in McLean, Virginia:

My view is that no products and/or services should be completely ruled out. Generally, if the client(s) have more than enough assets to meet their retirement goals and spending needs, I tend to lean away from annuities, primarily to give the client(s) liquidity and optionality during their retirement. However, if the client(s) have limited to no guaranteed income sources (e.g. Social Security, pension, etc.) and their asset pool may not be enough to carry them through the rest of their lives, then I definitely think you want to consider an annuity.

These days, there are annuities with lower embedded fees available in the marketplace. Single Premium Immediate Annuities (SPIA) are the least complex and probably are suitable for most of the candidates. There are other more complex annuities available. However, I would make sure you completely understand how they work, how much they cost, etc., before purchasing one.

Finally, in my opinion, any financial planner/advisor that is truly looking out for the best interest of their client(s) is not doing their job if they rule out certain products and/or services before getting to know their client(s).

Proceed with caution

Scott Vance, certified financial planner and owner of

Trisuli Financial Advising

in Holly Springs, North Carolina:

As an advisor, I am neutral on annuities. I worked for an advisor when I first started who swore that annuities were great, that they solved every retirement question. Of course, this advisor was well reimbursed by the annuities she sold.

That being said, I learned that annuities have specific instances where they are great options. For instance, I have used longevity annuities for my clients. These clients had a fear of running out of money in their IRA at a point in their lives when they would be elderly and probably unable to work. We exchanged a lump sum payment for the promise that the annuity would pay a fixed monthly amount starting at the future time for their life ensuring they would never "run out of money."

The truth is in the middle

Ron Guay, certified financial planner and founder of

Rivermark Wealth Management

in Sunnyvale, California:

The "A" word has earned a stigma, likely due to aggressive selling tactics and also a fair amount of negative opinions from advisors who are compensated solely based on assets under management. I'm fee-based, but I work with a younger clientele where annuities might make sense at some point, but as I write this, I haven't sold any annuities.

In my view, annuities have a role to play in a retirement plan for clients who place a high value on the guaranteed income aspect of the product. I think as practitioners, we underestimate the fear of the market and try to tell clients that the market will reward them over the long term with higher returns than they can get in an annuity. But 2022 has shown us that it is possible for stocks and bonds to decline simultaneously. And there are products in the market that don't require that the account owner annuitizes, which is understandably a detractor for many people (i.e., what happens if I hand over a lump sum and pass away soon afterward?).

Long story short, there are plenty of cases where an annuity makes sense. The right answer usually doesn't exist at either extreme (i.e., love/hate) and that's the case here as well.