Why Most People HATE Annuities (And What They Get Completely Wrong)

Instead of asking if annuities are good or bad, let's ask a better question: What problem are you trying to solve for in retirement?

Welcome back to the channel. My name is Michael H. Baker, and for almost two decades, I've been helping people prepare and plan for their retirement years. One topic that constantly comes up is annuities, because we have thousands of baby boomers right now barreling into their retirement years, and annuities are a very popular product marketed specifically to people preparing and planning for retirement.

One of the things that comes with the financial industry is just the fact that so many different thousands of annuity types exist, and so many different types of people are talking about annuities in many different ways. This includes professional journalists who often write articles about annuities—many times they don't even know exactly what they're talking about.

So let's talk about specifically what annuities can do and how I look at them as a product, a solution, or some type of strategy for retirement.

The Overwhelming World of Annuity Types

First, I've done several videos on different types of annuities, and you can find those on the channel. I encourage you to watch them. But there are many different types of annuities out there:

Immediate income annuities

Deferred income annuities

Fixed annuities

Fixed index annuities

Variable annuities

Registered index-linked annuities

Are you confused yet?

The Better Question: What Problem Are You Solving?

Here is the thing. The question you need to ask yourself is: What problem am I trying to solve for?

Specifically, for most of our folks preparing for retirement, the one thing they are trying to figure out is: How are they actually going to do income in retirement?

You see, when we're working, we have a pretty consistent and reliable paycheck that hits our bank accounts either twice a month or monthly, and we get accustomed to that cadence. That paycheck is where we organize and design our lifestyle. We live within our means around what that monthly paycheck looks like.

In my experience, most of the folks that come to the table wanting to figure out how they're going to do retirement and plan for retirement want that lifestyle to continue. In fact, they're very adamant that they want to maintain the same standard of living and lifestyle that they have now, and they may even want a few extras. They may want to do some additional trips. They may have some grandchildren and want to do some big family trips or vacations together—things that they don't necessarily have the time to do because they're working or employed full-time. Maybe they want to travel the world as a couple.

So there are lots of things that go into trying to figure out exactly how we're going to do income in retirement. But one thing remains true: when those paychecks stop from work, we want to have a plan for how to replace them and have them continue.

Most of the people that we talk with want those paychecks to actually be stable.

You Already Have an Annuity: Social Security

The good news is that for just about everybody here in the United States, you already come built with your very own personal annuity, and that annuity is Social Security.

In fact, you pay into Social Security and you qualify, and the promise is whenever you retire and are eligible to claim benefits, there will be a Social Security check ready for you to claim. You can claim on your terms, and that number is already predetermined. They have a formula in advance. They'll start sending you statements. You can go online to ssa.gov and see exactly what your annuity payment check from Social Security will look like.

That's exactly what an annuity is—if you look up the definition, one of those definitions is a stream of payments.

So most people come already locked and loaded with Social Security as a primary income and annuity strategy for retirement. Other people that are super lucky may also have a defined benefit or a pension where they have the option to choose that pension as a lifetime income payment, which is also an annuity payment.

Reframing How You Think About Annuities

These are the things I want you to start reframing when you think about annuities, because annuities are marketed to be the Swiss Army knife, and that's not, in my opinion, what they are designed to do.

I think annuities are really designed to do maybe two things:

Provide some type of consistent, predictable, reliable income

Protect some assets

If you are trying to protect some assets, there are many different ways people go about doing it. They may put the money in money markets, savings, or CDs. I tend to think that when interest rates are relatively decent, like they have been in the last couple of years, there are some annuity strategies that may allow for a little bit higher savings rate and maybe defer some taxes on that interest. For certain people, that may make sense.

But for the vast majority of folks looking to create a structured retirement income plan, one of the things we're trying to figure out is: What is that lifestyle? What does our lifestyle cost? And how are we going to solve for that? What layers or levels of income do we already have in place?

Many people, unfortunately, only have Social Security, because a lot of companies either froze their pensions or discontinued them. So not everybody has a pension, but we all have Social Security. And for couples, it's very important to coordinate your Social Security claiming strategy.

Red Flags: How Annuities Are Often Framed Incorrectly

Let me take a moment and share some of my thoughts on how I think the framing of annuities is wrong or incorrect. If you're listening to this video or watching this video and you've heard an annuity framed in this way, I would say it's a red flag.

Red Flag #1 : Annuities as Growth Vehicles

I don't believe annuities are growth vehicles. Certain annuities, like fixed indexed annuities, are often pitched by advisors or insurance agents as a way to get market-like returns without taking any risk. Meaning there's a floor of 0%—in a bad market year, you don't lose money, so you stay level. But in good years, you have the opportunity to grow the accounts.

That on its face is reasonably accurate. However, what I often hear is people trying to pretend that these are actually growth vehicles and they are designed to actually compete with market-like performance. I just fundamentally disagree with that.

If we're wanting to actually talk about what they may do well against, if you want to take a really good accumulation strategy inside of a fixed index annuity—one that's not one of these volatility-controlled indexes or some black box index, but a good vanilla S&P strategy with a nice cap, very simple and easy to understand—and you want to compare that with maybe a bond allocation in a portfolio over time, that may be a more fair comparison.

But trying to pretend that these annuities are growth vehicles and that they're going to keep pace with a market-like portfolio without the downside risk? I think that framing is wrong and misleading.

Red Flag #2: Maximum Liquidity Claims

Another one is the idea that you get maximum liquidity. Most annuities have some type of surrender schedule or surrender period. Meaning if you want to get out of the contract early, you're going to pay what's called a surrender charge, which is a penalty for early withdrawal or early termination of the contract.

Now, many of them have what are called free withdrawal features, meaning you can access portions of your money penalty-free—usually between 5% and 10% per year. But if you need to have access to 100% of your capital, that's going to cost you.

So I think the framing of liquidity is oftentimes confusing to people because most people think, "Oh, I get all my money whenever I want it." That's not necessarily the case, especially within the first several years of owning one of these contracts.

Red Flag #3: Bonuses and Guaranteed Growth Rates

The other one I want you to be really, really aware of is when you hear words like "bonus" or maybe some type of guaranteed growth rate. Insurance companies are in business to make money. They're not in business to put themselves at risk unnecessarily.

So understand when you hear a word like "bonus" or some type of step-up, you want to be very clear about what that bonus actually means. Because in many cases, it's not on money that you can tangibly access. It's accessible through some type of income rider or some type of maybe death benefit rider. There are multiple ways that these things can be structured where they sound really, really good, but it's not exactly what you may think when you first hear it.

So you want to get clarity on when someone tells you there's a bonus or some guaranteed growth rate. That's another one: "Oh, it's going to grow. I've got a contract that grows at 9% per year." That's a big one.

Well, I don't know anything right now in this interest rate environment that gives you a guaranteed growth rate of 9%. That sounds too good to be true. So when you hear something that sounds too good to be true, your first line of defense is to start asking questions.

One of the big things that I hear a lot within the business and within people explaining what they may own or are considering to purchase is something that has a growth rate that seems outlandish for the current environment. Usually what we find is that that growth rate is not an actual growth rate on cash.

These are still things that we want to understand. It doesn't mean that the product itself is a bad product. It may just be positioned in a very misleading way. And that's what we want to get to, because with the right education, I think a lot of people can make really informed decisions about what's best for them and their retirement.

But we want to make sure that people aren't being misled or buying the brochure. We want you to make sure you're buying the contract and you know exactly what that contract is going to do.

A Real-World Example

Let me wrap this up with just a brief example. Let's say we have a married couple in their early 60s, and they're planning to work for another four to five years. They feel like they're doing well. They've got their mortgage paid off. Kids are grown and independent, and they're really looking forward to getting past the finish line with work and entering into their retirement years.

They're thinking, "Hey, at 65, 66, we're both eligible for Medicare, so we don't really have to worry about healthcare expenses the way we would now if we wanted to retire early." They're looking at their savings rates and thinking they're going to be close to a million, 1.1 million by the time they get to 65 if everything continues.

Well, of course, that is making some great assumptions, but you also have to think about risk. One of the things they start thinking about is, "Well, gosh, the market has done really well for us in the last couple of years, but as we get closer and closer to our retirement date, we really can't afford to have a major market setback. We can't afford a 30%, 40% decline in our portfolio value because that would set us back years as it relates to income in retirement. We don't want to keep working and hope that our portfolio recovers and then we can go live."

This is the point in time where they've got some runway left where they might say, "Why don't we look at building in some guaranteed income pieces that can grow and defer while we're finishing out our working, finishing our saving, and getting ourselves ready to go? We may even give ourselves a retirement test drive, start living on our 'retirement budget' for a couple of years, make sure that we're dialed in on those numbers."

When their expected retirement date does arrive, years in advance they could know contractually: "Okay, when we retire, we walk away at 65. Here's what Social Security looks like. Here's what our annuity income looks like. Where does that leave us as far as lifestyle?" And hopefully, those two combined can coordinate a really nice lifetime income paycheck where their lifestyle is actually protected.

These are the types of things you want to be doing well in advance of retirement. Of course, if you haven't made a plan and you're going to retire in three months, then time is of the essence for you to make a plan. But I think as you get five, ten years out from your retirement, the more you start planning, the more you allow yourself to have options and flexibility as you approach your future retirement date.

The Core Message: Think in Terms of Trade-Offs

This is what I think my core message to you is: You have to start thinking in terms of trade-offs when it comes to just about every decision you make.

If you were to take your assets—think about your portfolio that you have now, all the assets that you have that you would dedicate towards some type of retirement—I want you to think about:

What portion of those assets should be dedicated to creating income?

What portion of those assets should be dedicated to long-term growth, hedging against inflation, liquidity, and ad hoc purchases?

Because to me, you don't want to put your retirement paychecks at risk in the market. There's always going to be risk, and we're not afraid of market risk, but we want to make sure that our timeline lines up with how our assets are allocated. We've put the right matching in place. We've got income assets that are working to create paychecks for us. And we've got long-term growth assets allocated in a way that we're expecting to see the rewards for those deferred growth on those assets down the road when we're going to need those assets the most.

Annuities Are Just a Tool

One of the things that I think about: people are going to talk about annuities all the time. There's so much marketing noise out there. There are people saying annuities are great. There are people saying annuities are terrible.

What I would say to you is like anything else, annuities are just a tool.

No one walks around and says hammers are terrible. The only people that think hammers are terrible are the people that always get told that they should just buy a hammer, right?

Understand that every tool has a purpose. And that's what we want annuities to be—they're a tool.

What problem are we trying to solve for?

If we're trying to solve for income, they may be a great tool for you to consider.

If we're not trying to solve for income—we're trying to solve for growth or legacy or something else—maybe they're not a fit.

But the key thing is that you understand exactly what they are for and designed to do and whether or not that works for you and your plan.

The Bottom Line

Just remember, everyone's goals are different and their timelines are different. Your appetite for risk is different. So the right approach for you is going to depend on your goals, your timeline, and your appetite for risk.

But if you're at a point where you're trying to figure out how this may all fit together for you, or if you've been considering annuities and you're just not really sure what makes sense or doesn't, or there's just a lot of confusing information out there, then click on that link and let's schedule a retirement vision call together. There's no pressure, just a conversation to see what we can do to help.

As always, thanks for watching. If you found this video to be useful, give us a like. It helps us out on the YouTube algorithms.

Investment advisory and financial planning services offered through Advisory Alpha, LLC, a SEC Registered Investment Advisor. Insurance, Consulting and Education services offered through Vertex Capital Advisors. Vertex Capital Advisors is a separate and unaffiliated entity from Advisory Alpha, LLC. All written content on this site is for information purposes only. Opinions expressed herein are solely those of Michael H. Baker, unless otherwise specifically cited. Material presented is believed to be from reliable sources and no representations are made to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation. This website may provide links to others for the convenience of our users. Michael H. Baker has no control over the accuracy or content of these other websites. Please note: When you access a link to a third-party website you assume total responsibility for your use of linked website. Links and references to other websites and third-party content providers are offered for your convenience. We do not necessarily prepare, monitor, review or update the information provided by third parties. We make no representation or warranty with respect to the completeness, timeliness, suitability, or reliability of the referenced content.

An Annuity is a long-term financial product designed largely for asset accumulation and retirement needs. All guarantees are backed by the claims-paying ability of the issuing insurance company. Annuities generally contain fees and charges which include, but are not limited to, surrender charges, administrative fees and for optional contract riders and benefits. Withdrawals and death benefits may be subject to income tax. If withdrawals and other distributions are received prior to age 59 ½, a 10% penalty may apply. Annuities typically carry surrender charges for several years that may be assessed against withdrawals. Certain annuity product features, such as stepped-up death benefit, a bonus credit, and a guaranteed minimum income benefit, will generally incur additional fees. If you are investing in an annuity through a tax-advantaged plan such as an IRA, you will get no added tax advantage. Any comments regarding safe or secure investments or guarantees of income refer only to fixed insurance products and do not refer in any way to securities or investment advisory products.