Annuities are neither useful nor appropriate for many people.
As emphasized throughout this buying guide, a good financial plan that focuses on retirement income needs should be the foundation of any annuity purchase decision.
For the purposes of making a generalization about annuity needs, however, ruling-out broad categories of people who have little need for an annuity can be done without having a detailed financial plan. Three categories of people who have little or no need for annuities are:
- Those who are largely or entirely dependent on Social Security for retirement income
- The very old
- The very rich
Those Reliant of Social Security
The reality is that you need to have assets or a pot of savings in order to purchase an annuity, and many people have not accumulated meaningful financial capital when they retirement.
For example, it is estimated that 22 percent Social Security beneficiaries in the United States will rely on Social Security as their sole or primary source of income in retirement.
Social Security contributes 90 percent or more of income for one-third of the program's beneficiaries.
This category is not quite as clear-cut since the term “very old” is subjective.
That said, as a person progresses into their retirement years there are fewer uncertainties:
- There is less uncertainty with respect to longevity.
- Sequence of returns risk is less of an issue since.
- There is likely more visibility into how current assets can support the remainder of one’s retirement spending.
- If a person is already in financial trouble, there is nothing magic about an annuity that will help the situation.
Annuities are useful because they can help address the uncertainties or “ifs” around retirement income, so fewer uncertainties generally results in less need for annuities.
In addition, the elderly need to be very careful with annuities because their money can be locked-up during a period when they have a large need for liquidity to address health-related costs or other emergencies.
This is the least clear-cut of the three categories.
When considering the value of an annuity, net worth is less relevant than the relationship between projected retirement spending and net worth.
In other words, a person’s retirement spending may be completely unsustainable despite the fact that they are rich in terms of financial capital.
A perfect example are professional athletes who retire from their sport rich in terms of financial capital, but quickly find themselves poor or bankrupt because their spending is wildly out of control and unsustainable relative to their wealth. In these cases, there is very strong case to be made for the ability of annuities to preserve wealth by imposing realistic, disciplined spending patterns.
In any event, someone who is both very rich and has spending habits that are in proportion to that wealth may not need an annuity because their income needs can realistically be funded from their financial capital.
A natural question at this point is whether annuities make sense for younger people who are not close to retirement. The answer is that certain types of annuities—particularly variable and deferred annuities—can be used for asset accumulation. In fact, the current Chairman of the Federal Reserve, Ben Bernanke, owns two annuities through TIAA-CREF.
The key consideration for anyone in the asset accumulation stage of their lives is which accumulation vehicle best meets their needs. Expenses must be part of this consideration, and this can be an issue for annuities in the asset accumulation phase. On the other hand, there are certain tax-advantages associated with annuities that are not available through other investment vehicles.
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