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Annuities: The Good, The Bad & The Alternative

“My broker suggested that I invest in an annuity. Is that a good way to replace my income when I retire?” an investor asked us recently. 

We’ve been talking with many investors lately about how to generate income in today’s market environment, and a few mentioned that they were pitched annuities by advisors at their broker. 

These investors were all nearing retirement, so they’re naturally looking for a steady source of income once they stop working. 

Is an annuity the right choice? FundX Certified Financial Planner™️ Rohan Nayak explains the good, the bad, and the alternative to annuities.

The pros and cons of annuities

With a traditional annuity, you’d take a lump sum of your portfolio and purchase an annuity, and the annuity would guarantee that you’d receive a set amount of income for life. Guaranteed income can provide much needed peace of mind in retirement, but it does come at a cost. 

With annuities, you give up liquidity (and most often growth potential) in exchange for predictability. When you buy into an annuity, you are locking up your liquid portfolio in exchange for monthly cash flow. 

If you change your mind down the road or your life changes and you want to change your annuity, you’ll pay a substantial fee to do so. We’ve talked with many investors over the years who have been in this predicament.

The annuity world has grown to include many complicated products overlapping with life insurance, but the cost structure remains unchanged. Annuities still come with a surrender charge, meaning that if you decide to surrender an annuity, you will leave a good portion of your assets as a penalty. 

If you opt for your monthly payments to rise due to inflation, there is an additional cost. If you want to make sure your beneficiary receives a payout if you happen to pass away prematurely, you’ll have to accept a lower monthly income amount (in the form of an embedded fee). 

An alternative to annuities? Financial planning 

While annuities can certainly provide the peace of mind of lifetime income, we encourage you to consider the alternatives. Your advisor, with the help of an in-depth financial planning process, should be able to help you generate income in a flexible and liquid way without locking your money up in an annuity product. 

At FundX, we value flexibility and liquidity: that’s one reason why we invest in mutual funds and ETFs. With funds, your assets are liquid, and you have the ability to change your investments as your life and needs inevitably change over time.

We use our financial planning process to help our wealth management clients determine if their money will last their lifetime and how to invest their assets in order to meet their income needs. We consider a client’s pension, Social Security, Medicare costs, and spending patterns to help them replace their paycheck in retirement. 

As part of our planning process, we work with clients to come up with a systematic withdrawal strategy to determine which accounts to withdraw from first (IRA, taxable accounts) and which part of their portfolio to tap first (aggressive, balanced, conservative). This can help clients adapt to changing market environments and changing income needs in retirement.

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