What do annuities contractually solve for?
This is an article by Stan "The Annuity Man" Haithcock, who has written several books on the topic of annuities. I will also add some additional comments because the article isn't complete and has a couple of inaccuracies, but I like the overall message.
Annuities are contractually guaranteed transfer or risk strategies
Annuities are contracts between you and the issuing life insurance company. In my opinion, they are not investments. They are contracts. So it's important to fully understand those contractual guarantees before signing any paperwork, and to know exactly what goal that transfer of risk policy is solving for. So the question is, what do annuities actually solve for?
I’ve come up with an easy to remember acronym that tells you whether you need a specific annuity type or not.
The acronym is P.I.L.L.
P stands for Principal Protection
I stands for Income for Life
L stands for Legacy
L stands for Long Term Care/Confinement Care
If you don’t need to solve for one or more of those four P.I.L.L. items, then you do NOT need an annuity. Yes…it’s that simple. So you need to own any annuity for what it “Will Do.” (i.e. the contractual guarantees), not what it might do.
As you can see, there is no “G” for growth (i.e. market growth). My approach is contrarian to the current annuity industry push of FIAs (Fixed Index Annuities) and VAs (Variable Annuities) that “sell the dream” of market upside using annuities. With both products, your upside is contractually limited. FIAs have caps or spreads (i.e. limitations) on any upside attached to their index options and VAs have limitations on the separate accounts (i.e. mutual funds) that you can choose from.
By the way, I’m right about this…and the annuity industry knows it. To me, true market growth means no limitations to the upside. Under that factual premise, annuities of any type should never be purchased for market growth.
So let’s go over the annuity product types that address each letter of the P.I.L.L.
Principal Protection is covered by MYGAs (Multi-Year Guarantee Annuities) and FIAs (Fixed Index Annuities).
Income For Life is covered by SPIAs (Single Premium Immediate Annuities), DIAs (Deferred Income Annuities), QLACs (Qualified Longevity Annuity Contracts), and Income Riders.
Legacy is covered by MYGAs, FIAs, and Income Riders that also provide a death benefit.
Long Term Care is covered by specific Income Riders that provide confinement care coverage along with actual Long Term Care annuities (which are a health insurance product).
2 Questions to Answer
There are only two questions that you need to ask yourself and answer to determine if you need an annuity, and if so, what specific type fits your situation.
1. What do you want the money to CONTRACTUALLY do?
2. When do you want those CONTRACTUAL guarantees to start?
That's it. That's how simple the process should be. If you answered that you want a lifetime income stream to start now, then the specific type of annuity you need to quote is a Single Premium Immediate Annuity (SPIA). If you answered that you needed a lifetime income stream to start a five years from now (i.e. in the future), then you would need to quote both Deferred Income Annuities (DIAs) and Income Riders. If you answered full principal protection with total control over the asset, then you would shop for the best Multi-Year Guarantee Annuities (MYGAs) and Fixed Index Annuities (FIAs).
Saying that you “hate all annuities” is like saying you “hate all restaurants.” It’s total nonsense. I’m the first one to declare that annuities are not for everyone, but they do have their place as a transfer of risk contractual guarantees. You just have to be specific about the contractual goal you are trying to achieve in order to use the correct annuity type.
So before you buy any annuity, always remember to take a P.I.L.L. to find out if an annuity is the right move for you...and by answering the 2 questions. Never forget that annuities, regardless of type, are commodity products that need to be shopped with as many carriers as possible for the best contractual guarantee for your specific situation. It's really that simple.
Now for the 'inaccuracies':
1. All annuities offer income for life, not just SPIAs, DIAs, QLAC's, and income riders. The reason these are singled out is because it's easier to quantify and calculate the expected income stream. Without these, you'd need to contact the office of the insurance company and simply ask them about "annuitizing" the contract. (By the way, for variable annuities, that's what that M&E charge is for - the ability to annuitize the contract for lifetime income.)
2. All annuities (other than SPIAs) have a death benefit. Unless the principal balance has been spent due to longevity, there's a death benefit. It may be taxable and not the best way to leave a lump sum legacy, but it's there.
Tom Hegna talks about leaving an income legacy using annuities:
3. Regarding Long Term Care benefits: Sheryl Moore (CEO of WINK, Inc who provides lots of research regarding life insurance and annuities) made this particular comment: "Long Term Care (LTC) kickers on annuity GLWBs don't provide TRUE long term care? They don't get Pension Protection Act treatment; perhaps a combo product should be considered." There are different riders available and there will be different tax treatments depending on the true nature of the insurance contract. However, I'd rather have the money available if and when needed and sort everything else out later, everything else being equal.
A note about principal protection: Annuities CAN be used for accumulation for what they 'might' do. There are various fixed indexed annuities that have various index segments for accumulation purposes. However, I would suggest that if you have a higher risk tolerance OR if you are healthy enough, I wouldn't use an annuity for accumulation purposes... but it can be done.
Principal protection isn't just a risk tolerance issue. It can really depend on the goal for the money being discussed. Just because one may have been invested in the markets for 40+ years doesn't mean that the lump sum should be at risk of stock market volatility - depending on the needs or uses for the money. For example: if you are wanting to fund a life insurance policy for a 10-year period, I wouldn't want the capital to be put at risk so that your funding may not happen, if and when a market crash should occur in the next 10 years. By transferring the capital to an annuity, you know that you can guarantee the plan you have in place and not subject your plan to stock market risk. Just my thoughts. I thought this was an excellent article.