What is an annuity?

for Montana 55

We currently live in a point in history when people are living longer and longer lives. I don’t think there are many people who would complain about living a longer life, however, when it comes to retirement planning it does raise a bit of a concern. When you begin retirement you also begin a very important race: it’s your money versus your life. Which one do you want to win? This is a very serious question and an annuity can make it so that you don’t have to choose. The reason for this is because an annuity (in its most basic form) is simply a guaranteed payment for life.

Wait a minute, isn’t that what Social Security or a pension does? Yes it is; that is a key element that a pension, an annuity and Social Security all have in common. They all provide guaranteed income for life. However, recent studies suggest that a mere 19 percent of Americans have a pension that they can rely on in retirement and most of those Americans are government workers. An annuity may be a good way to provide guaranteed income to supplement Social Security without a pension plan. How does an annuity work and where can I get one?

It is an important question to ask and one that was recently explained best to me by world-renowned speaker and economist Tom Hegna. Hegna is the author of several acclaimed retirement planning books and recently spoke at a wealth management conference I attended in April. He described annuities using the term “mortality credits.” He used this term because only a life insurance company can provide an annuity and they can do this using mortality credits based on mortality tables.

I know at this point this can all be a bit confusing, but Hegna has a very simple way of explaining it. He told us all a story about five 90-year-old ladies who go on vacation every year. One year one of the ladies said to the others, “Hey how about each of us put 100 bucks into this jar, tape it up, and after a year those of us who are alive will split the money?” So, they each put a $100 in a jar and a year goes by. Unfortunately, one of the ladies passed away during the year so four of the ladies split the $500. Split four ways, $500 comes out to $125 per person.

That is a 25 percent rate of return in one year with none of the money invested in the stock market, bond market or a savings account. How is this possible? Because they got paid mortality credits from a life insurance company. I know at this point many of you are thinking “that sounds great, but what if I am the lady who passes away, won’t my money disappear?” That is an excellent question to be asking and the answer is not necessarily. In fact, less than 10 percent of annuities sold are set up that way; almost everyone wants a guarantee. You can put various guarantees on annuities that range from a full refund to a guaranteed length of payout. Product availability and features vary by state.

How much money should I put into an annuity? This is another great question and one that I have a relatively simple answer for: “At least enough to cover your basic living expenses.” That is the most universally stated answer by brokers, economists and financial journals. Many clients choose to put in more, however, economically to maximize your retirement it is recommended that you at least have your basic expenses covered by some form of guaranteed income. Again, guaranteed income is not limited to an annuity, it commonly comes in the form of Social Security or a pension.

An annuity can also provide protection to a spouse or a family member. Just as I discussed in the January issue of Montana 55 about pensions, annuities can provide protection to a spouse for an addition cost. This cost is deducted from what the annuity would payout was it just paying out for your lifetime. The additional cost is because the insurance company is taking on additional risk by guaranteeing payout over the span of two lifetimes. The larger the age difference between the primary annuitant and the joint annuitant, the larger the decrease in payout becomes.

Annuities can be extremely complex financial tools and there are hundreds, if not thousands, of types and variations. You need to do large amounts of research as annuity guarantees are backed by the issuing insurance company and are a contract between you and the insurance company. You should also consult with professionals before choosing something that is so instrumental in defining your retirement.

Jesse Ramos is a broker for Northern Rockies Financial Group in Missoula, assisting families across Montana with understanding their financial needs. He can be reached at jesse_ramos@glic.com or 406-728-6699 with any questions. 2017-41829 Exp 06/19