Do Fiduciaries Recommend Annuities? How They Can Fit into a Retirement Plan
“Are you a fiduciary?”
It’s a question we hear regularly from people getting to know us. For someone familiar with annuities, that question can come with another one: How can a fiduciary recommend a product that may pay a commission?
The answer starts with understanding what being a fiduciary actually means. From there, we can look at why an annuity might come up in a retirement planning conversation, what purpose it could serve, and how we determine whether it has a place in a particular plan.
What Does “Fiduciary” Actually Mean?
Annuities are insurance products, and some can pay a commission to the person who sells them. That compensation doesn’t remove the fiduciary responsibility. The recommendation still needs to be made in the client’s best interest.
An annuity is a tool, and like other financial tools, its usefulness depends on what you’re trying to accomplish. Rather than starting with whether annuities are good or bad, we can look at the role one might play in a retirement plan and what would need to be true for it to make sense.
Why Retirement Changes the Income Conversation
For decades, you may have had a paycheck or business income arriving every month to cover your expenses. Retirement changes where that income comes from.
Social Security may provide part of it. You may have a pension. The rest generally needs to come from the assets you’ve accumulated and saved for retirement.
To help visualize retirement spending with clients, we break down needs, wants, and wishes.
Needs are the essentials you have to cover every month, such as groceries, utilities, and other basic living expenses.
Wants are the things that make retirement enjoyable but aren’t essential, such as dining out, travel, or a newer car.
Wishes are things you’d love to accomplish if the plan supports them, perhaps a beach house or an elaborate family trip, but they don’t have to happen for you to have a good retirement.
Understanding those layers helps us think about where retirement income will come from to make sure your needs are covered, regardless of what the market is doing.
Cash, Growth, and Income/Safety
We use a three-bucket strategy to help clients organize the different jobs their retirement assets may need to do.
The cash bucket is there for near-term needs. How much a household keeps there can depend substantially on what makes them comfortable.
The growth bucket is invested in the market for bigger long-term returns.
The income/safety bucket is designed to cover your needs and some of your wants through retirement.
When Social Security, pensions when available, and the income/safety bucket are working together to make sure your needs and a good chunk of your wants are taken care of, there’s often less of an emotional rollercoaster over a rough spot in the market.
This is where sequence-of-returns risk becomes relevant.
If you’re withdrawing money to pay for essentials from growth bucket investments while their values are down, you may need to sell more shares to generate the same amount of income. Those shares are no longer invested when the market eventually recovers. When withdrawals and market declines happen at the same time, particularly earlier in retirement, the sequence of those returns can affect how long the portfolio lasts.
Having different assets assigned to different jobs gives you more to work with when those periods occur.
Where an Annuity Might Fit
For the income/safety bucket, our general target is an average return in the 5% to 8% range over a 10-year period without taking on stock market volatility. That target is informed by historical performance, isn’t a guarantee, and the strategies used to pursue it can vary depending on the plan.
Cash, CDs, money markets, Treasuries, and annuities can all serve different purposes when we’re thinking about the safer portion of a retirement plan. Their rates, guarantees, access to money, growth potential, and other characteristics can differ.
So rather than starting with, “Do I need an annuity?” we first want to understand what job the money needs to do.
Annuities are insurance products, and depending on the type and how they’re structured, they can provide contractual guarantees that may make them useful for certain jobs within a retirement plan.
Two of the primary reasons we may consider one are protected growth and guaranteed income.
Protected Growth
An annuity may be considered when part of the plan calls for growth potential while protecting principal from stock market declines.
That can give a portion of the income/safety bucket a different purpose than the growth bucket. Instead of replacing long-term market investing, the goal is to determine how much of the plan should be exposed to market movement and how much may benefit from different safeguards.
Guaranteed Income
Annuities can also be structured to provide a guaranteed stream of income.
Depending on the contract, money may be allowed to grow for a period before being used to create income for one person or, in some cases, for both spouses over their lifetimes.
For someone transitioning from a regular paycheck into retirement, that can be one way to create another source of predictable income alongside Social Security or a pension.
Certain annuities can also be used as part of a strategy for potential long-term care costs. We recently explored those strategies more deeply in our article, “Planning for a Cost We’d Rather Not Need: Long-Term Care.”
What About Annuity Fees?
If you’ve spent any time researching annuities, you may have encountered warnings about high fees or heard about someone who had an experience with an annuity they didn’t like.
Part of the confusion comes from treating every annuity as though it works the same way.
Variable annuities, for example, can include multiple layers of costs associated with the annuity and the underlying investments. We’ve seen internal costs in that category run around 3% to 5% annually. Variable annuities are a rarity in the plans we build today.
Other types of annuities can have very different cost and compensation structures.
Fees and compensation are worth understanding with any financial product. When we evaluate an annuity, we want to understand what it costs, how the advisor or insurance professional is compensated, what guarantees are being provided, what access you have to the money, and what the product is expected to accomplish within the plan.
That brings us back to the fiduciary conversation we started with.
The Plan Comes Before the Product
We start by building a financial plan and understanding the household’s income needs, goals, and potential gaps. We also have an investment strategy conversation to better understand risk tolerance and how the household approaches investing.
Once we understand those pieces, we can evaluate what belongs in the cash, growth, and income/safety buckets and which strategies could help each one do its job.
Sometimes an annuity may have a useful role. Another plan may call for different tools.
There’s opportunity is to explore how much retirement income you want supported outside the stock market, what you need from your income/safety bucket, and whether an annuity could serve a specific purpose there. If it could, you can then look more closely at the costs, guarantees, access to your money, and tradeoffs involved.
That gives you something much more useful than deciding whether annuities are simply “good” or “bad.” You can evaluate what a particular strategy would actually do within your retirement plan.