Annuity income – not one size fits all
As should be obvious by now, annuities should really only be considered as part of a retirement income plan and considered only in very specific circumstances.
Those with sufficient assets or income from pensions, businesses, rental properties, or other sources likely do not need them at all.
As pure investments apart from the income feature for which annuities were designed, annuities are generally a poor choice, given high, typical costs, commissions, and rather oppressive tax treatment both at the income and estate tax levels.
Annuity protections and guarantees can come at high costs
This is even true after considering the guarantees of equity index annuities with principal protection and stock market participation. Unless you really need income, you will almost certainly make more money over the long haul by just leaving money invested in a stocks or mutual funds program (riding the ups and downs) than in a guaranteed annuity.
In fact, the insurance company is counting on that, which is one of the reasons they can offer guarantees and still make a profit; by buying a guaranteed annuity, you transfer some or most of the long-term profit potential of the stock market to them.
When to use annuities – is your money red or green?
That said, for those who have a retirement income gap (guaranteed income sources like pensions and Social Security do not add up to enough to fund a floor or minimum acceptable lifestyle), the Money Color concept could be a useful rule of thumb to help think about the issue and guide decisions.
Green money, yellow money, and red money – the annuity equation
In this concept, “green money” represents guaranteed income sources like pensions, “yellow money” represents cash and cash equivalents like bank accounts and safe, short-term bonds, and “red money” represents risk capital, like stocks, subject to market fluctuations and changes in value.
Here’s the premise: put enough into green money to fund for a minimum acceptable lifestyle, deploying capital income annuities if needed to bring the level of guaranteed payments up to match floor expenses.
Keep enough in yellow money for emergencies and lifestyle splurges (within affordable reason).
Put the rest into a sound red money investment program, which is the engine that offers the greatest potential for wealth growth, knowing you can comfortably ride out the inevitable swings since your needs are covered by green money.
Of course, this is a very gross simplification of an extremely complex problem, but it is very useful in offering a mental map to crystallize the problem and guide sound decisions. This can really help people avoid bad knee jerk decisions or deer-in-headlights inaction.