Tip of the Week: The Purpose of Annuities



Hey folks, I’m Derek Merkler, fiduciary financial advisor and in this tip of the week, I’ll discuss annuities and where they might fit in a financial plan.  Since my business focuses on helping clients navigate the financial aspects of the military transition and establish their long-term financial plan, I generally do not consider private annuities as useful financial products for this type of client and for where they are at in life.

One of the challenges with annuities is that some people know just enough to hate annuities while the rest know nothing, which means they can succumb to the ‘oh so perfect’ annuity sales pitch, which opens them up to buying something that doesn’t really work for them.

Now that I’ve used the term “annuity” enough times, what is an annuity?  Well, in its simplest form, an annuity is a stream of payments.  The most common annuity, which people don’t really think of as such, is social security.  Any pension is an annuity as well… a military retirement pension, for example.

The financial product that most people commonly associate with the word “annuity” is the private annuity offered by insurance companies.  Different variations have different names such as fixed annuities, indexed annuities, variable annuities, etc.  The differences don’t really matter for this video.  In exchange for a single large payment or a series of smaller payments, the insurance company will guarantee a stream of payments in return, often monthly or annually, for the rest of your life.  The exact amount of those payments is determined by your age and life expectancy and some other variables.

The problem with insurance company annuities is that they often have extremely high fees and can be so complex that even their salespeople sometimes can’t explain how they will behave in different situations.  As a result, actual outcomes can often vary from that illustration used in the sales pitch.

I know that’s a lot of background information, but I will get to the point.  When you purchase an annuity, specifically one from an insurance company, you are transferring the risk of you living too long to the insurance company.  If you die before your life expectancy, the insurance company benefits.  If you live longer, the insurance company has to continue to pay out. In financial planning, this is called longevity risk.

And therein lies the critical factor when purchasing an annuity: if you are trying to transfer longevity risk from you to an insurance company, an annuity may make sense since it is an insurance product.  And it does cost money to transfer that risk, that’s where all those fees come in and that is okay if you are using the annuity correctly.  Otherwise, it rarely makes sense to put all of your money in an annuity… despite what the salesman might say whose commission is determined by how big of an annuity they can sell.  Think of it this way, would you buy auto insurance on 5 cars if you only had two?  Doubt it.

Thanks for watching. If you like this video, please share it. If you want to discuss more or work with me to develop your financial plan, send me a message.  Thanks!


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Remember, the topics discussed in this video are for informational purposes only and that past results do not guarantee future performance. If you would like to discuss your financial situation, please email me at Derek.Merkler@Parsonex.com.


Advisory services offered through Parsonex Advisory Services, Inc., 8310 S.Valley Hwy, Suite 110, Englewood, CO 80112. 303-662-8700.


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