There’s a certain very large investment manager located in Camas, Washington that has become known for its founder’s strong opposition to annuities. In fact, many of this firm’s advertisements go something like this: “I hate annuities and you should too.” These ads – which can be found in newspapers and magazines, online and on television – encourage you, if you have at least $500,000 to invest, to request their “free report” about annuities. The report includes a detailed explanation about why they are such terrible investment products. If you own an annuity, the pitch goes, you would be wise to dump it and invest your dollars with the big firm in Camas.

Well, like many other kinds of investments (e.g. mutual funds, exchange-traded funds, stocks, bonds, etc.), there are certainly some annuities which are just plain bad. We will come back to why, a bit later. But, in general, annuities are excellent investment products.

Let’s take a look at annuities with a fresh perspective and consider the role they may play in your financial plan. Before we start, we’ll remind you that Springwater does not sell annuities (or any insurance or investment products, for that matter). So, we have no financial incentive to entice anyone to buy an annuity. Rather, we have a fiduciary duty to give you advice that is in your best interest.

So, what is an annuity? For our purposes, as investors, we will say that an annuity is a stream of fixed (amount) payments received by you over a defined period of time. You buy an annuity from an insurance company. You pay the insurance company either a single, lump-sum payment or a series of payments, in exchange for the insurance company’s promise to pay you a series of fixed payments for a defined period. The real magic of an annuity is that it can be set up so that the payments continue as long as you live. No other investment provides lifetime income (we do not consider Social Security an investment).

There are a variety of features and options that can form part of the annuity contract. Here, though, we will consider just the basic options. As we noted above, you can buy an annuity through a series of payments or by making a lump sum deposit. The payments that you’ll receive from the insurance company can begin immediately, or at a later date. The former is called an immediate annuity, and the latter a deferred annuity. Your payout period can be structured in a variety of ways, including 10 years, 20 years, lifetime, and so on. The lifetime benefit is the most popular and, in most cases, the most compelling payout option.

There are also annuities that will pay out over the lives of two people (the annuitants), such as a married couple. As an example, you and your spouse could buy an annuity that will pay the same fixed monthly payment for as long as at least one of you is alive. This is called a “joint-and-survivor” option. This option can be very attractive for couples who’d like to have the income they receive continue after the first spouse has passed.

In our next post, we’ll consider how annuities are invested, their tax characteristics, and why some, including the firm in Camas, say they don’t like them. Stay tuned!

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