Says Chamberlain: Fixed annuities can work in a high interest rate environment, where despite the possibility of falling rates the annuity would continue to pay out based on the initial higher rates for an extended period of time. Conversely, they would not be as good an option in a low-interest environment, where the payout would be lower and there’s the prospect of rates climbing over time.
Variable annuities, he adds, aren’t always a good alternative option either, since the guarantees associated with many of these products are less generous than in the past and their performance is hurt by the high fees they carry. Unfortunately, Chamberlain notes, their high commission structure makes these contracts popular with financial services salespeople, who play off of investors’ confusion over what they are being sold.
“As a fee-only advisor, I get paid only for advice and don’t receive commissions,” he explains, “but if I feel that annuities are in fact in the best interest of my clients, I make the recommendation and refer them to where they can best obtain the contract.” Chamberlain explains. Recently, for instance, he was able to help a client swap out a high-priced, heavily-expensed contract in favor of a lower priced contract, without having to pay any surrender costs or incurred income tax.
Chamberlain acknowledges that some academics maintain that if a client obtains an immediate annuity, it pays an income stream for life and the individual is less likely to outlive his or her money. But the planner sees several issues with this in many real-life situations. “In my experience, people don’t like to give up control of their assets, and a fixed annuity decreases the money they’d leave to their beneficiaries,” he says.
Another problem is inflation. “If the annuity pays out a set amount each month, the client losses purchasing power with inflation,” he points out. But he also allows that “If a person has no spouse, children or other beneficiaries, if he or she comes from a long-lived family and it’s a moderate interest rate environment, then perhaps intermediate annuities could be part of an income plan.”
One annuity that Chamberlain has recommended in the past several months is a product with a 2% current interest rate. “I have recommended this product for the cash component of clients’ investment allocation as well as for a few clients who want to park money safely.” For instance one such client, he says, wanted to set money aside to buy a new house in the near future. “The option is sort of like a stable value fund that some 401(k)s offer. It’s not guaranteed by the FDIC and it’s part of the insurance companies’ balance sheet. However, 2% these days is somewhat reasonable compared to what people are getting in a money market account.”
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