Moliciero Financial | Investing and Financial Planning

Benefits of Being an Annuity Owner

You have probably read articles before on the advantages and disadvantages of being an annuity owner. You can pick apart all of the contract provisions to find if they meet your overall financial objectives. Financial advisers will describe a 20, 30, or 40 year old considering the purchase of an annuity and project the amount he will have at retirement. They then proceed to zero in on expenses, flexibility, tax, and growth aspects, and compare the annuity to a stock market investment to see if you are getting a good deal. These articles will be supported by a lot of examples projecting the annuity results years into the future. After all of that, you will find that you are still left with an uncomfortable feeling no matter what you decide to do. The reason is that the articles and the financial advisers always compare putting all of your money in one investment or the other. They almost never talk in terms of an annuity as part of an overall, well diversified financial plan. It is curious that the articles and advisers will always end their analysis with a paragraph on how you need to diversify when considering any investment.

Here I am going to focus more on the psychological benefits of being an annuity owner which are either missing or downplayed so many times by the financial advisers. These benefits are general in nature and would apply if you had bought a fixed annuity, variable annuity, equity indexed annuity, or any other offshoot of these concepts.

Retirement Security and Peace of Mind

The original concept of an annuity was, and still is, for you to put money into a contract either periodically or as a lump sum, and then receive guaranteed payments in retirement. If you are in your 60’s or 80’s, and have an annuity, you already know the feeling you get from having an amount coming each month for as long as you live. You may wish it were more, but the psychological impact of having this certainty in retirement takes away that some of that daily feeling of financial insecurity that nags so many people these days.

If you are lucky enough to be working at a job where you are covered under a defined benefit pension plan, you know the concept and the feeling, even though it is your employer who is making the contribution in most cases. You work hard at your career, then retire and receive monthly payments for life. You may only receive 20% or 40% of you salary when you retire, but you know this amount will be paid month after month.

These days, most financial advisers lead their clients to more flexible savings programs with the assets being invested in the stock market. Also, companies are terminating the defined benefit pension plans and replacing them with either 401k or cash balance pension plans. Each of these trends allow for more potential growth of your assets during the accumulation phase and, therefore, a larger pot of money to live on in retirement. This can very well be true, but all psychological security has been eliminated.

The common retirement situation today is that a worker approaches retirement and has all his assets partly in a 401k, part in a cash balance retirement plan, part in an IRA, and hopefully, some outside savings. So, the new retiree looks at this pot of money and could be quite happy. He may have accumulated over $1 million and thinks retired life is going to be fabulous. Add in Social Security and he is set for life. But is he really mentally set for life?

Ask any new retiree with the above situation how he feels and he will tell you his primary concern is outliving his assets. He may have a nice pot of money, but he is scared to spend any of it. The financial adviser will guide him on how much he can withdraw each year, which will usually be in the neighborhood of 4% of assets. Yet the problem the adviser cannot help him with is determining how long will he live and need to withdraw the money. Nobody can help with this issue. Will you live to age 70, so can spend as much as you like? Or, will you live to age 105 and run out of money?  With this insecurity always present, the retiree is then scared to put any of the money in investments which can fall in value, such as stocks and bonds. This insecurity can be so intense that the retiree goes out to find a job just to relieve the mental pressure. This problem is creating a psychological neurosis in today’s retirees. This neurosis has always existed in retirees who never had a defined benefit pension plan. However, the number of retirees experiencing this mental problem these days is rapidly rising with the termination of defined benefit pension plans. It is rising so fast that articles are now being written describing the mental problem. Professional therapists are seeing a dramatic increase in the psychological effects of financial insecurity in retirees. Of course, there are other factors that produce financial insecurity, but the lack of lifetime guarantees without a job to produce current salary can be psychologically devastating.

Being an annuity owner can relieve some of the financial insecurity at retirement. This is especially true if the annuity is part of a larger overall financial plan. If a working person knows that he will have some guaranteed income at retirement, be it in a pension plan or an annuity contract, he can then focus during his career on other savings programs.

Annuity as Part of a Diversified Financial Plan

If you have a defined benefit pension plan, you are probably concentrating on putting your money in a 401k, IRA, or simply putting money in a savings account. This is appropriate and will provide the needed flexibility in retirement. You will have a monthly check coming in from the pension and will have a pot of money to supplement that.

If you do not have a pension plan, and have all your money accumulating in a 401k or IRA’s, consider starting a deferred annuity program. A deferred annuity will not give you a tax deduction when you put in the contributions, but it will grow tax free. More importantly, a portion of your overall assets at retirement will be in the form of monthly guaranteed payments which will relieve some of the insecurity issue described above.

Many advisers will tell you to accumulate all assets in a 401k or IRA during your career, and if desired, take a portion of the assets and buy an immediate annuity contract when you retire. This is a good strategy which will give you more flexibility prior to retirement and then the desired security during retirement. The problem is trying to convince a retiree to part with 30% – 40% of his money to purchase an annuity. Many retirees simply won’t take this advice. They feel this suggestion takes away all control over their money when it is time to make a decision.

If you worked for 30 years and retired with a monthly annuity or pension, and also had a pot of money in a 401k, you will be quite happy. On the other hand, if you had a much larger 401k balance, but no monthly pension at retirement, you could take a portion of the 401k balance to buy an annuity at retirement and be the same or better financial position as the first situation. Psychologically, you are not in the same position. Asking you to give up 40% of you 401k balance to buy an annuity is a very difficult discussion. You will come up with every reason why you do not want to do it. So, I am suggesting that you consider buying a deferred annuity contract during your career so you do not have to decide at retirement. I understand that you may lose some growth potential during the working years, and you may lose some tax benefits. I am making the suggestion to prevent some of the psychological issues at retirement.

Mental Security Is a Priority

As you can imagine, I could argue that there are much better financial methods to produce greater assets at retirement, which in turn produce more financial security in retirement. If the mental retirement issues did not exist, I would suggest you accumulate most of your retirement assets in a well diversified set of mutual funds while maxing out your contributions to a 401k and IRA’s. However, the mental or psychological effects of not having a guaranteed monthly pension definitely exist at retirement. Not enough attention is paid to these issues by financial planning professionals.  If you are currently working, you may have a hard time picturing these problems because you have a salary coming in. If you have been laid off during your career, you have experienced financial insecurity. Now try to picture yourself as a retiree with that daily feeling of insecurity even though you might have a large amount of money sitting in a 401k account. Retirement is the time in your life when you want to feel secure. Having an annuity at retirement will relieve some of the pressure.  Survey some retirees to see if this is true. I think you may give annuities a closer look when you hear their answers.