If you’ve been around the investment world for long, you’ve undoubtedly heard the case for annuities.  Billions of dollars are invested in them each year*, but we’ve found that despite their popularity, annuities are seldom fully understood. That’s likely because of the nature of the product.  Part-investment and part-insurance contract, these products were created to offer a consistent payment and/or tax deferral to investors over the course of their lives.  However, they are much more complex than they seem at first blush, and there are many different types of annuities to evaluate.  Looking at the differences between immediate, deferred, fixed and variable annuities may only add to the difficulties faced in valuing annuities as part of an investment portfolio.  So instead, Wescott offers these considerations for investors thinking about annuities.

Buyer Beware – Know What You’re Getting
Companies that sell annuities frequently advertise “guaranteed income,” and as a result many people who buy them do so out of fear.  They don’t look at the embedded costs or risk involved.  Yes, there is risk, even if the policy provides that guarantee.  Insurance companies can fail, and the maximum level of protection in that case isn’t unlimited (it varies by state).  Furthermore, annuities aren’t a tax-efficient strategy to lower income tax or in estate planning.  The upcoming potential change in tax code may further reduce the tax benefit of these products.

Regulatory Relativity – Acknowledge the Fiduciary Rule’s Impact
While the future of the DOL Fiduciary Rule is somewhat nebulous with a new administration, the rule figures to have an impact on the annuity industry regardless of whether it is implemented.  Insurance companies have already started to revisit the design of their products. Companies are increasingly limiting investment options for policy holders to cut their own risk profile.  Any investor looking at annuities needs to figure out whether the ultra-conservative nature of modern annuities compromises any expected return advantage.

Advantageous Alternatives – Know Your Options
As a general rule, investors need to approach annuities cautiously before committing to a potentially rigid and limited investment option.  By their nature, annuities do not meet all of the standards needed for a strong investment portfolio in several specific areas – liquidity, transparency, flexibility, safety of principal and diversification.  There are ways for investors to protect themselves in case of emergency or during downturns in the market without high fees or surrender charges.  For example, allocations to cash equivalents and short-term bonds can insulate portfolios from market volatility.

The investment community is in for a number of potentially seismic changes over the next several months, as a new president takes office and outlines his policy priorities.  As a result, investors need to consistently do their due diligence on all of their investments – current and potential.  There’s not enough of an advantage in annuities to outweigh the benefits of a truly diversified portfolio, and the only situation in which Wescott would consider holding onto annuities is if investors were forced to do so – for example, if they are already invested in an annuity or they are legally required to purchase one as part of a settlement.  It might be tempting to look into annuities while yields have been at historic lows, but annuities aren’t the only answer in that type of environment.  In fact, if you do the math, they aren’t much of an answer at all.

To learn more about effective yield strategies, contact Wescott Financial.