In our previous article, An Annuity: Should You Consider One?, we explored such items as:
- Basics of annuities
- Different types of annuities
- Key retirement risks
- Annuities for retirement income
In this post, we continue our discussion of annuities. In particular, we explore the key advantages and disadvantages of annuities, to help you decide whether or not an annuity is suitable for you.
Advantages of Annuities
Annuities offer investors some very attractive advantages, including:
1. Guaranteed income
Annuity investors can enjoy the security of a fixed and guaranteed income stream, regardless of market ups and downs, interest rate fluctuations, or other financial and economic unrest. Guaranteed by whom? Refer to below. When an investor purchases an annuity, the timing, frequency, and amount of each annuity payment is determined in advance. This can provide investors with significant peace of mind, as the annuity payments are calculated in advance and must adhere to a pre-determined schedule. In addition to providing peace of mind offered, annuities also present investors with a great opportunity to carefully plan their own income and spending in accordance with their annuity payments. This is often highly desirable, especially for retirees.
2. Creditor protection
While creditor protection may not be of great concern to some investors, it can be highly beneficial to others. In particular, self-employed professionals and business owners typically value creditor protection, as they often have higher exposure to situations where creditors can make a claim against their assets. As highlighted in a previous ModernAdvisor post about beneficiary designations, the key to creditor protection with annuities is naming specific beneficiaries rather than naming the investor’s estate as beneficiary. When an investor names a spouse, child, grandchild or parent as beneficiary of an annuity contract, or when anyone is named as an irrevocable beneficiary, the amount deposited to an annuity contract cannot be claimed by creditors.
3. Investor protection
A key consideration for many potential annuity investor is, what happens if the insurance company can no longer meet its obligations? That is, what happens if you give the insurance company a lump sum to purchase an annuity, and they fail to provide you with the promised payments? Annuity investors can rest easy, as annuities are protected by Assuris – an organization that protects Canadian policyholders if their life insurance company fails. For annuity payments up to $2,000 per month, Assuris guarantees the investor will receive 100% of the promised payments. When the benefit is more than $2,000 per month, Assuris guarantees the investor will continue to receive at least $2,000 per month or 85% of the promised benefit, whichever is greater. To find out more about Assuris protection, for annuities, click here.
Disadvantages of Annuities
Despite their many advantages, annuities have some drawbacks as well. Some of the key disadvantages of annuities include:
1. Restrictions on withdrawal or surrender
You could compare this to a pension plan. Note that payout and accumulation annuities are treated very differently in terms of withdrawals and surrender. In general, there is little to no flexibility with annuities. In particular, payout annuities simply do not permit withdrawals – at all. This represents a loss of control for the investor. While withdrawals are permitted from accumulation annuities, the investor may be charged a market value adjustment (MVA), which is a penalty administered by the insurance company that issued the annuity.
2. Inflation risk and interest rate risk
Prevailing Interest rates are a key determinant of determining the annuity payment – higher interest rates at the time of purchase mean higher annuity payments for the life of the annuity. But what happens if you purchase an annuity when interest rates are low, and rates subsequently rise in the following years? Higher interest rates would dictate higher annuity payments for new purchases, but the investor would be locked in at the lower rate at the time of purchase. Similarly, if the cost of living increases over time, but the annuity payments are fixed, the investor will suffer a loss of purchasing power. Granted, these risks can be somewhat managed during times of low interest rates by buying a series of annuities instead of buying a single annuity. In doing so, the investor may be able to benefit if interest rates rise in the future.
3. Potential loss of capital
With certain types of annuities, the investor could suffer a loss of capital. In particular, a life annuity contract without a guarantee poses this risk. For example, consider an investor, age 60, who purchases a single life annuity for $100,000 without a guarantee. Assume the annuity payment to the investor is $500 per month, for life. But what happens if the investor dies two months later? In this case, the investor would have given the insurance company $100,000 but only received $1,000 in return. Again, you could compare this to a pension plan. While this is an extreme example, it illustrates the risk of how an investor can suffer a loss of capital in this situation. In order to protect against this risk, an investor can purchase a life annuity with a guarantee, so that in the event of an early death, the remaining capital would be paid to a named beneficiary.
Bottom Line – Annuities
Are you wondering if an annuity may be right for you? Contact your insurance specialist to find out more. If you have any other questions about our investment advisory services at ModernAdvisor, just contact us.