Annuities - Who Cares?

Friends, family and acquaintances often ask me, "What are annuities?", "Why did I enter the annuity business?" and, basically, "Who cares?"

Though annuities have been around for some years, I believe that the current economic crisis, though ostensibly mitigated by today's "jobless recovery," has brought increased attention to annuities. While terrified of market risk only a few short months ago, most investors are still, with good reason, extremely cautious of risks inherent in today's financial markets. So, to answer the question, "Who cares about annuities?" - Anyone who cares about avoiding significant losses of principal via market volatility should care about annuities. That's why I am passionate about clearly communicating what annuities can do, especially to those over fifty (50).

To put it in its simplest form - annuities eliminate market risk while still offering the potential for healthy returns.

I know doctors, lawyers, dentists, bankers (you name it) who own investment portfolios with, perhaps, seventy percent (70%) of their money in equities. Much of these investments may be under the umbrella of 401ks or IRAs. (When savings are held in 401ks and IRAs, many people don't know where the money is invested, but assume it must be safe. In contrast, such funds are often invested in stocks, mutual funds and bonds - all of which can be significantly impacted by market movements.) While these folks are delighted at the startling market recovery these past months, they don't have the time or energy to consider the likelihood of another sharp "pull-back" in the market, what it may do to their investment portfolio and/or retirement savings, much less whether there is a wiser place to stash their lifetime savings.

The troubling aspect of all this is that, should we see a significant pull-back in the markets, many baby boomers would lose huge amounts of their savings and be forced to work many more years than they anticipate and/or retire on a modest or meager income, while foregoing their retirement dreams of travel, fun and worry-free relaxation.

As an illustration, suppose John and his wife, Pat, own an a $1,000,000 401k which has allocated 70% of their money to stock mutual funds (which they consider conservative) and 30% to high grade bonds. A 40% market contraction in the stock markets might reduce their 401K value from $1,000,000 to $720,000. The $280,000 loss may postpone retirement plans for many years, or simply require John and Pat to reduce their annual retirement budget and lifestyle significantly.

Hypothetically, had John and Pat moved $400,000 from the stock mutual fund into a fixed indexed annuity ("FIA"), they could have reduced their portfolio loss (or contrarily, increased their portfolio value) by $160,000. At the same time, the FIA has the potential to participate in market growth (via links to the S&P 500 index or and other indices) up to a certain cap - typically in the 6 to 8% range, depending upon the carrier and the annuity product. So, when the market bounces back up, the FIA, having lost ZERO value in the downturn, can pick up a good portion of the next upward bounce. By the way, with the 40% market drop, John and Pat need a 67% market gain to get back to square one regarding their stocks. I didn't understand the mathematically devastating impact of principal losses until I was fifty, and I have a CPA and MBA. I know - shame on me.

The basic math fact which kills investors regarding principal losses is that any percentage loss requires a greater percentage gain to breakeven. Thus, a 50% principal loss requires a 100% principal gain to return to square one. For example, a stock at $10/share drops to $5/share (a 50% loss). That $5/share must increase by $5 (a 100% gain) to get back to $10/share or break-even. Principal losses destroy our financial future!

So, who cares about annuities? Well, I suppose I can't really answer who cares, but I can answer who should care about annuities.

Who Should Care About Annuities?

1. Those who have significant assets in the financial markets which they cannot afford to lose (especially if they are nearing or at the end of their earnings years).

2. Those who own an IRA or 401k which holds significant investments in the markets.

3. Those who do not want to be forced to work an additional five or ten years, should the markets freefall again.

4. Those still working who are relying on welfare for retirement (it's $7 Trillion in the hole!). Instead, they might be placing savings in deferred annuities.

6. Those who dislike the stress of market spikes and dips and would sleep better if they could ignore them.

7. Anyone with substantial savings in the financial markets who cannot afford to lose those savings.

So, ask yourself, "Do you fall in any of the above categories. Should you care about annuities?

I have found two categories of people who, legitimately, don't need to concern themselves with annuities: (1) those who are so wealthy that, should the stock market turn deeply south, they would be alright. They have such deep and diversified financial pockets that a big market loss wouldn't change their lifestyle much, or at all; and, (2) those who have so little in the way of liquid assets (e.g. under $20,000), and are no longer working, such that they can't take advantage of the risk-mitigating (and/or guaranteed lifetime income) features of annuities.

There is nothing in this life without risk. While annuities take market risk out of your savings, you still carry the risk of the financial strength and longevity of the insurance carrier from whom you buy your annuity. That is why I only recommend dealing with the financially strongest annuity carriers (e.g.. those rated A, A+ or A++ by A.M. Best Rating Services for financial strength.) But remember, financially strong insurance carriers are much safer than the markets. Historically, insurance carriers are much safer than banks. The question is not "What is a risk free place to protect and grow retirement savings?" The question is, "What carries the least risk in protecting and growing my retirement savings?"

As a final note, there are many who are becoming comfortable again with the financial markets and have returned to "business as usual." I don't have a crystal ball, but the unprecedented national debt (approximately $53 trillion), annual deficits (currently about $2 trillion), and continued rising unemployment rates should give us all reason for extreme caution.

Dean C. Lovett is a CPA and obtained his MBA from the Wharton School. As an entrepreneur of twenty years, he has created and operated approximately ten businesses. He launched AnnuitySpeak ([http://www.annuityspeak.com]) and Annuity Speak TV to provide video analysis of fixed annuities and reviews of fixed annuity products in laymen's terms to enable baby boomers to better plan retirement in today's unstable markets.

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