Annuities seem to be in very popular right now. Why is that? Join us in discussion with financial expert Pam Krueger who will explain everything about annuities and why you may – or may not – need them. Enjoy the show!

 

 
 

Margaret Manning:

My guest today is Pam Krueger who is a financial and investing expert. She’s also an author and a co-host on the PBS show MoneyTrack. Pam has developed a web tool called WealthRamp which connects consumers with fiduciary advisors. Welcome, Pam.

Pam Krueger:

Thanks, Margaret.

Margaret:

I am so glad you’re with us today as we have lots of questions about annuities. What are they and how do they work? In your opinion, are they a good idea?

Pam:

At the point of retirement, annuities suddenly become all that brokers and insurance agents talk about. So much so that it feels like they’re trying to push annuities on you. There is an old expression in the financial services world which goes like, “Annuities are never bought, they are always sold.”

In short, this means that indeed, annuities are always pushed on you. That’s because no one wakes up in the morning with the idea to go buy an annuity. Instead, when you walk into a brokers’ firm or an insurance company, they see your age and size you up.

They know you’d be looking into ways to have income later in life, and so they see a huge opportunity to sell an annuity to a potential client. They tell you an annuity is an investment that will only make your money grow, but an annuity is not an investment.

There are different types of annuities, but the basic underlying idea is this: you go to a broker or insurance agent where you sign a contract and give them a huge chunk of your savings. In return, they promise to invest the money and then give it back to you in payments, after a time.

Here’s what they do with the money, in actuality. Sure, they will invest it – much like you could do on your own. However, they will also take a huge chunk of the returns in commission – up to eight percent! And then they also take two to three percent per year in fees.

That’s a huge cut off of your money. Whatever is left they spread it out and pay it to you per whatever the terms of your contract.

Margaret:

So how is that different from opening a savings account? Annuities certainly sound like a potentially better savings deal, given that you only get a small percentage of return in the bank.

Pam:

That’s actually true. The annuity is used for a very specific purpose. It’s a tool you can turn to if you’re in a certain financial situation. But it is not an investment though it is often presented as such. The only, and biggest, advantage to an annuity is that it may give you some tax benefit.

So, if you’re in a really high tax bracket and you’ve already exceeded all your contributions to all your other tax favored types of accounts like 401K’s – or if you are retired your individual retirement accounts (IRAs) – and you don’t have any more tax benefits left, you can turn to an annuity.

However, there’s still a problem. Annuities are being sold to mainstream, middle income people, with the idea that the annuity is the ultimate solution to turn to. Brokers make it sound so complicated, but there’s nothing difficult about it.

You give them your money to invest. Then, at a certain point of time, they give you back your money with some return – but they keep most of the earnings in commission and fees. That’s what the annuity is.

Margaret:

Annuities play into older women’s insecurities, don’t they? Oftentimes we are living on our own, and brokers expect us to be confused and in financial difficulty. They make it sound like they’re taking the financial burden off of us by having us buy their product, i.e., the annuity, which is going to solve all our problems.

Pam:

Statistics show that nine out of ten, that’s 90 percent, of people who buy an annuity end up regretting the decision. The annuity is a tool, and it is absolutely worth using if it happens to answer your needs. But you’d better be that one out of ten people.

Vanguard, one of the largest financial advisor groups in the world, recognizes that the annuity is a tool. They actually offer a range of annuities you can buy from them, but with lower fees and none of the usual promises you get from brokers and insurance agents.

At Vanguard, the annuities are stripped of all the promises, and are made to accomplish a couple of your goals. They know an annuity is not going to deliver, so they’re being smart about the products they’re offering.

The one thing you absolutely must do before buying an annuity is go to a fiduciary advisor. You don’t want to go to a broker or an insurance agent, because they are there to sell you the product, not to advise you. Instead, find a fiduciary advisor.

He or she doesn’t get paid to tell you that the annuity is good for you. They are paid to tell you the truth. And maybe you are that one out of ten individuals for whom the annuity tool will work well. Maybe you need that tax deferral, and the fiduciary advisor will make sure you buy it at the lowest possible cost.

Margaret:

Whether you buy a product or not, it all has to do with being aware of your choices. It’s really important for women in our community to realize that all those different products are there to make you feel good, not to necessarily help you.

One thing I don’t understand is why people who don’t have much cash would put their money in an annuity that holds their cash when they can clearly do something else with it.

Pam:

I know. It doesn’t make sense. That’s why I’m here – to stop your community of women from doing that exact thing. I don’t want you to be one of the thousands of people who buy an annuity only to regret it when they suddenly need their money. So, if you only have a little bit of cash, this tool is not for you.

The annuity sounds so tempting with all the promises it’s told to offer. And the more packaged these products are and the better they sound, I guarantee you, the higher the fees and the more restrictive their clauses.

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It’s almost like withdrawing from a bank CD where there is a 2% penalty. The only difference is, you know about this fee ahead of time. With annuities, you don’t know anything about fees and penalties.  This is the worst type of tool for someone who is short on cash.

When you’re in that situation, you don’t need to be tying your money up. You need it to be liquid, to have your money close so it’s there when you need it. If you put it in an annuity, they won’t let you take it back.

Margaret:

So then, what are our options? What else is there?

Pam:

When you’re approaching the starting line of retirement, you should divide your money into segments. Realistically, if I am 60, I am probably going to live another 25–30 years. I need to have ‘now’ money and ‘then’ money, and if possible, ‘money in between.’

You only invest based on time and risk, trying to get a higher return. In your ‘now’ bucket you want to have at least a year’s worth of money that you spend on a monthly basis. It should be in some a short term bank account that is not going to earn you any interest, probably around one percent.

Then you have the other bit of money. Maybe it’s not much, but you want it to go to work for you. That’s the money you’re not going to spend within the next year or two.

With this in mind, you can afford to look at things like short term bonds that might pay higher interest. Or you could look at dividend paying stocks that have a history of paying three to four percent in dividends. Maybe you can get some stock market appreciation there as well.

By the time you have to start to tap into the later money, that money wasn’t just sitting there eroding. It was actually working for you. That’s how you want to relax into it, knowing that you have enough money liquid.

You absolutely cannot take the money that you need to spend in the next year or two and invest it, no matter what anybody tells you. You just can’t. It’s too risky. You need to keep it close, and you need to keep it real safe in a guaranteed, government insured bank account.

Margaret:

What about the third bucket?

Pam:

The third bucket could be your longer term money. So, if you were to divide your money up in terms of time you get your three buckets:

Bucket #1 holds your immediate expenses for the first year or two after retirement. You must keep that money constantly flowing.

Bucket #2 is your medium term money. You may have to make minimum withdrawals at some point, like in the case of 401K where you have to make a withdrawal when you are 70 ½. You don’t want to have to sell stock to raise the money and certainly not when stock is down.

You don’t want to put yourself in that situation. So, the second bucket consists of short term bonds that match well for that type of maturity or you have the option of dividend paying stocks.

Bucket #3 is the longer term bucket which could be different types of stock funds and index funds. Sure, your money is going to fluctuate up and down with the stock market, however you are giving it a lot of time and you’re not going to sell it out of weakness.

This division of your cash allows you to have some of your money growing for you and some of your money right here when you need it. That’s concept.

Margaret:

I think a lot of women, when they retire, are simply swimming in that first bucket for the first one or two years. They’re just trying to keep things under control while they figure out their lives. They may not be able to invest too much anyway.

But then, if they are able to minimize their expenses and live below their means, then they may find themselves with an extra couple of hundred or thousand a month. Then they can start spreading their finances in the pattern you just described.

It is a time of adjustments, and we do need to get a hold of living a life without a monthly paycheck.

Pam:

You are absolutely right. See how it feels to not do anything in a hurry. Then you might realize that your short term bucket is not full enough so you might decide to go back to work.

Or, your other option may be to sell your house – if you still have it. Perhaps downsizing to a condo will bring you freedom from all your emotions and from your financial problems.

Margaret:

I really appreciate how growing older changes our way of thinking as we get to focus on experience and not on stuff. I recently walked into a shop with a huge sale, and as I was picking item after item I realized that I didn’t need any of it. I just didn’t get any emotional gratification from buying.

Pam:

The reward isn’t there, yeah. Downsizing to a smaller home makes you visualize your space every time you’re in the store. When you know you literally don’t have space for the item you’re looking at, it’s much easier to choose not to buy it. And that’s liberating.

Margaret:

Freedom is more important, I agree. Thank you, Pam, for talking with us about financial freedom and giving us such great advice.

 

How many times have you been offered to buy an annuity? Why do you think people get caught into the lie that the annuity is the best option for them? Have you looked into other options? Please join the conversation.

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