Don't be afraid of buying an annuity: An annuity can be good value if you use it right.
Lots of personal finance bloggers don't like annuities. And I can understand why. But I don't agree. If you understand what annuities are for and use them right they can be a very useful addition to your portfolio.
But before I explain why I think annuities can be a valuable and useful of your portfolio, let's look at the reasons some people don't like them.
Criticisms of annuities
1. Poor value
If you look purely at a return on capital then annuities don't usually do as well as other investments. That's true - but that's because you are paying for the insurance they offer against living too long and running out of money. If you factor that in, the equation might be different.
2. Too complicated
Annuity contracts are often far too complicated with options, investment guarantees and other bells and whistles. I think the industry could do a lot to simplify this and make everyone's lives easier.
But until then, you will have to do it for yourself. Understand what you want to protect against and make sure that your contract does that. And avoid add-ons you don't need or understand. You might find it helpful to speak to a good broker, who can explain what the various terms mean.
3. Not flexible
Annuity contracts are generally fixed for life (one of the reasons it's important to shop around). Which means if your needs change you can't adapt. But if you can afford to keep some of savings for a rainy day, that can give you the flexibility you need. No one is suggesting you put all of your money into annuities.
4. Losing your capital
This I am afraid is the inevitable trade off. If you want the insurance company to pay out more if you live longer, you have to accept that they will pay less if you don't. That's the deal, no way round it.
But there are ways to soften the blow. Many annuities allow you to select a "guarantee period" (at a small price) which means if you die early in the contract your estate will get some of your money back. If you are really concerned about "losing out" because of dying before your time, look into the option of a guarantee to put your mind at rest.
Would you buy an annuity?
Will you make an annuity part of your retirement portfolio?
Investing the rest of your pot
Once you have used annuities to make sure you are financially secure, you can be more relaxed about investing the rest of your portfolio in higher reward (but also higher risk) kinds of investment.
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These and other kinds of investment can bring better returns on average over the long term than standard "vanilla" annuities can - but they don't offer you protection against running out of money.
As always make sure that the mix of risk and reward in your portfolio suits your taste and circumstances.
Annuities can be "good value" and an important part of your portfolio, if they are used correctly.
First understand what annuities are. They are insurance. They are not going to make you rich, but they might make sure you don't end up poor.
An annuity basically insures you against running out of money when you are old. If you live longer than expected an annuity that pays out for the rest of your life can really dig you out of a hole.
Remember - there is no such thing as a free lunch when investing. Passing that risk to an insurer comes at a price - remember lower risk comes with lower return. But the sacrifice of a lower return can be worth it, if it means you don't have to worry about living on hand outs in your old age.
Second, don't buy something you don't understand. Many annuity contracts are too complicated. This makes it hard to shop around effectively and very hard to know if you are getting value for your hard earned money. Buy something simple which has a payment structure you understand. You need to know what you are going to get and when in order to make sure the annuity is doing it's job of providing a stable income.
If you do decide to go for a product which includes investment bonuses or other top ups or contingent payments make sure that the base amount (assuming you get no bonuses) is enough for you to live on. Then the bonuses can be extra money to spend on little luxuries. If you are relying on payments which are not guaranteed to make sure you have a decent standard of living you might as well not have bothered buying an annuity at all.
Third, don't rely on annuities alone (if you can afford not to). Assuming you have enough money to provide more than just the basics, you don't need to put it all into annuities. Use annuities to provide a base income that you think will make sure you are comfortable and can survive your old age. Then you are free to invest the rest of your capital in more lucrative assets that will earn you a better return (but won't guarantee to feed you into nineties like an annuity will).
If you are wealthy enough that even if you took a big hit on your investments you still would be more than comfortable, then it's quite possible annuities won't be for you. You won't need that sort of protection - but you should have planned (or paid someone to plan) your investments so that they will offer you some protection in a market crash or crisis.
I accept annuities won't be for everyone. And many people are sold annuities that are not right for them at all. But don't let that stop you making annuities work for you.
Annuities can be a really good way of protecting yourself from poverty in old age and everyone should consider making them part of their retirement portfolio. Annuities won't make you rich but they can stop you from being terribly poor. And that security can let you invest more freely with the rest of your money. If you use them wisely there is no reason to be afraid of buying annuities.