As advisors who often talk about annuities to financial advisors, we are often asked whether we "like" annuities. To that question, our standard answer is that we neither like nor dislike them—because they're just tools, which work well in certain circumstances and do not work well in others. Occasionally, that response will elicit what may appear to be a better follow-up question:
"When—that is, in what planning situations—does an annuity make good sense and when does it not make good sense?"
That's a core question, and one that might be in the mind of you, our reader. What's our answer? One answer might be that "it depends… on the specific facts and circumstances of the case." That's a reasonable and rather obvious reply, and what our audiences often expect to hear. But it's not our answer.
Our answer to that question is that the question in unanswerable—until we know what the questioner means by an annuity in the first place. Are we talking about a variable deferred annuity or a fixed immediate annuity? Those contracts are hugely different.
Each is an "annuity," but the two contract forms are designed to meet completely opposite needs. Generalizations, always hazardous, are especially unproductive when used with annuities. A true statement about fixed annuities is likely to be false when applied to variable ones, and vice versa. The same is true when the annuities are immediate versus deferred. Yet many, if not most, consumers—and all too many advisors—routinely generalize about annuities, often to the extent that their conclusions are so flawed as to be worthless.
If we bear in mind this caveat—that we must generalize only when our assessment can be generally accurate—can we now attempt to answer the question posed earlier: "When, and in what planning situations, does an annuity make good sense and when does it not make good sense?" We believe that we can, and should, construct bright line tests to help us determine when an annuity is likely to be suitable for our client.
1. Where the Goal Is Immediate Income
When immediate income is the primary goal, an immediate annuity may be appropriate, so long as it is understood that it may provide no benefit at the annuitant's death. Indeed, if the annuitant lives beyond the point where any refund element is payable, an immediate annuity will not provide any death benefit.
2. Where the Goal Is Income in the Future
