7 myths about annuities, debunked

Annuities have attracted both fans and critics throughout the years along with a variety of perceptions about their value as a retirement income tool. As we observe National Annuity Awareness Month in June, TIAA’s Dan Keady, CFP, chief financial planning strategist, debunked a few of the more common myths about annuities.

2 basic types of annuities

There are two basic types of annuities – fixed and variable. Fixed annuities are very stable and earn basic interest, while variable annuities are often attached to investments and can fluctuate with the market.

Within these broad categories, there are a wide variety of products as well as riders that control different aspects of the annuity and different fee structures that can impact their complexity and expense.

Within the benefits space, annuities are drawing increasing interest and are more frequently becoming part of portfolios offered in workplace retirement savings plans. Those take the form of both in-plan annuities and the relatively newer concept of custom target date funds, said Keady.

These funds have the look and feel of a target date fund except along the way they replace some of the bonds in the fund portfolio with an annuity, he said.

Adding lifetime income options such as annuities into a retirement savings plan is a good way to diversify. In-plan annuities allow savers to diversify their savings and investments during the accumulation phase while also setting up a diversified income and withdrawal structure during their decumulation phase that also includes Social Security and withdrawals from mutual funds, said Keady.

Annuities offered at institutional prices as part of a workplace plan also can eliminate the sticker shock individuals encounter when purchasing retail annuities.

Keady said the popularity of in-plan annuities is on the rise thanks to favorable legislation that makes it easier for plans to add in-plan annuity options.

In addition, today’s retirement savers who have lived through the Great Recession of 2008/2009 and the COVID-related market fluctuations of 2020 are increasingly savvy about the need for reliable income beyond Social Security.

Education is important

Still, education is crucial, said Keady, especially for younger savers for whom retirement seems far in the future. One focus of that education is that we insure many things in our lives from our cars to our homes, and annuities are an insurance product against the risk of living too long.

“We all know people that are 95 years old,” said Keady. “You’re literally transferring risk to an insurance company and retirement income is of course a valuable important asset to us all.”

In addition, annuities can provide protection against cognitive risk, providing a reliable stream of income to an individual’s bank account without needing decision-making and management around those funds.

However, for some people, annuitization may not make sense, including those who are in poor health and those who already have lifetime income through a pension or defined benefit plan, said Keady.

Keady said studies have found that many retirees struggle to spend money in retirement, even if they’ve saved adequately. That is typically a result of the unknown about how long the retiree might live, what their investment returns will be, and worries about money requirements in the future.

Annuities guarantee an ongoing income that can give such retirees “the freedom to spend” by reducing anxiety and allowing them to achieve the retirement lifestyle they’ve imagined.

Keady addressed some of the perceptions and myths around annuities.

1. Annuities are too hard to understand. Keady said he’s not surprised to hear this myth in the market because some annuities are complicated even for experts. However, not all annuities are that complicated. “If you take the humble fixed annuity, you earn interest and you convert it into a payment. It’s not really that complicated. They’ve been around, actually, since Roman soldiers (who were paid annuities as compensation for military services), so the concept of some annuities is actually pretty straightforward.”

2. If I have retirement savings, I don’t need an annuity. Keady said this is a common refrain and stems from a reliance on target date funds and retirement savings calculators that give savers the impression that their income needs are taken care of. However, he noted 401(k)s have traditionally been built to supplement Social Security and pensions, not to completely fund a person’s retirement. To overcome market volatility and longevity risks, a source of income is needed along with a nest egg.

3. Annuities are expensive. Different features and options can make annuities more expensive and complicated, but they don’t have to be, said Keady. In fact, annuities can provide income that will allow retirees to keep some of their nest egg in a portfolio that provides some equity exposure. This creates what Keady termed an “efficient income frontier” that provides reliable income along with continued potential for growth.

4. Annuities are unpopular. Keady said while the word ‘annuity’ may be unpopular, largely because of the perceptions surrounding them, the underlying concept of lifetime income is in fact increasingly popular. “You’re getting that monthly income for the rest of your life and not being pulled into market volatility. The vast majority of people think that’s a great idea. I would argue that the word itself is often thought of as being more expensive and complicated, but it just doesn’t have to be that way.”

5. Annuities don’t yield favorable financial results. When people say annuities don’t yield favorable financial results, they are typically talking about fixed annuities, which are a very conservative investment rather than a growth investment. If you want to have favorable financial results, said Keady, combining fixed and variable annuities provides the best of both worlds.

6. Annuities reduce the legacy I can leave to my family. When a retiree is considering how to manage income and savings throughout retirement, it’s easy to think that converting a substantial chunk of a nest egg to an annuity would reduce the amount they could leave to their heirs after they pass away.

“It’s very intuitive,” said Keady. “We would all think that intuitively. But the math actually doesn’t show that for a couple reasons. The first one being if you live a long time, because of the fact that more of your retirement income comes from an annuity, if you live past life expectancy, your legacy could actually be larger. And because you get a bigger bite of the income apple from annuities, you’re pulling less money out of your remaining portfolio and your investment portfolio can grow more.”

7. If I buy an annuity and get hit by a bus the next day, all of my money is lost. Most people are not buying pure life annuities, said Keady. Instead, they are purchasing products the provide continued income for their spouse and in some cases other family members through guaranteed periods built into the annuity.

“Most people are picking, for lack of a better word, various refund options where if they pass away early, their heirs get money. And, of course, those people who do in fact live for a long time, are going to get those checks for the rest of their lives.”

Kristen Beckman is a freelance writer based in Colorado. She previously was a writer and editor for ALM’s Retirement Advisor magazine and LifeHealthPro online channel. She also was a reporter for Business Insurance magazine covering workers compensation topics. Kristen graduated from the University of Missouri with a degree in journalism.