Following the post-COVID stimulus hangover in 2022, the bull market has continued to run. One of the key factors was the Federal Reserve’s decision to
Cash Flow Management: Are Annuities the Answer?
Published Date : October 8, 2014
Over the last seven years, many investors have been hard pressed to find a single investment option with a relatively safe and consistent return. The long running backdrop of low interest rates, the real estate market slide of 2007, and Great Recession of 2009 have left conservative investors anxious for certainty and security. The current environment has led many investors to become more open to the idea of introducing annuities into their investment portfolios. If you are contemplating the purchase of an annuity, it is important to clearly understand the principal, illiquidity and inflation risks that are associated.
When you purchase a traditional annuity, you are buying a contract that typically expires upon your death. Therefore, your investment is a total loss if you die shortly after entering into the contract. Since your initial investment is an sunk cost, you will not begin to see a positive return on an annuity until you have recouped through fixed payments the total value of your initial stake, which often takes many years. Alternatively, if you had purchased a bond instead of an annuity, you may not have received a comparable annual coupon payment, but the bond’s principal value would not be subject to mortality risk. Upon your death the bond would not expire, but instead would be included in your estate and ultimately be passed along to your heirs. Therefore, it is important to think about the significant risk to principal loss upon death.
Another high priority point of consideration is the need to tap into your asset base beyond the current cash flow paid by the annuity. In order for insurance companies to avoid major outflows, annuities generally charge a significant surrender fee for withdrawals greater than 10% of the value; therefore, you should be very comfortable that other assets will be available for unexpected needs beyond the annuity’s fixed payments. Investment grade bonds, on the other hand, are market traded and offer the ability to sell your bond for a fair price, thereby tapping into the original principal of your investment. It is important to consider the risk of illiquidity when purchasing an annuity contract.
Finally, we all generally understand and often hear about the negative effects of inflation. When purchasing a fixed future income stream, it is even more important to understand how inflation may impact your future standard of living. An example would be if you received a $30,000 annual payment from a $500,000 annuity paying 6% annually. Although the fixed income stream may sound like a great deal in the present, $30,000 will have the purchasing power of only $10,963 in 30 years if inflation follows the long term annual average of 3.3%. Also, there is the potential opportunity loss of yield that you could have captured using a bond ladder during a rising interest rate period. Since we do expect long term interest rates to rise, it is important that your fixed income investments adjust with the rate environment. Therefore considering the risk of rising inflation and interest rates is also very important.
Annuities, like many insurance products, offer us peace of mind for a price. If we understand the costs and potential risks brought on by early death, the need for liquidity, and rising interest rates and inflation, then an annuity can be a valuable risk management tool. Our concern as financial advisors is that the role of annuities in your financial toolkit be carefully considered prior to purchase. If you would like to learn more about annuities and the role bonds play in your portfolio, please contact your Wealth Manager at Sand Hill Global Advisors.
Articles and Commentary
Information provided in written articles are for informational purposes only and should not be considered investment advice. There is a risk of loss from investments in securities, including the risk of loss of principal. The information contained herein reflects Sand Hill Global Advisors' (“SHGA”) views as of the date of publication. Such views are subject to change at any time without notice due to changes in market or economic conditions and may not necessarily come to pass. SHGA does not provide tax or legal advice. To the extent that any material herein concerns tax or legal matters, such information is not intended to be solely relied upon nor used for the purpose of making tax and/or legal decisions without first seeking independent advice from a tax and/or legal professional. SHGA has obtained the information provided herein from various third party sources believed to be reliable but such information is not guaranteed. Certain links in this site connect to other websites maintained by third parties over whom SHGA has no control. SHGA makes no representations as to the accuracy or any other aspect of information contained in other Web Sites. Any forward looking statements or forecasts are based on assumptions and actual results are expected to vary from any such statements or forecasts. No reliance should be placed on any such statements or forecasts when making any investment decision. SHGA is not responsible for the consequences of any decisions or actions taken as a result of information provided in this presentation and does not warrant or guarantee the accuracy or completeness of this information. No part of this material may be (i) copied, photocopied, or duplicated in any form, by any means, or (ii) redistributed without the prior written consent of SHGA.
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All video presentations discuss certain investment products and/or securities and are being provided for informational purposes only, and should not be considered, and is not, investment, financial planning, tax or legal advice; nor is it a recommendation to buy or sell any securities. Investing in securities involves varying degrees of risk, and there can be no assurance that any specific investment will be profitable or suitable for a particular client’s financial situation or risk tolerance. Past performance is not a guarantee of future returns. Individual performance results will vary. The opinions expressed in the video reflect Sand Hill Global Advisor’s (“SHGA”) or Brenda Vingiello’s (as applicable) views as of the date of the video. Such views are subject to change at any point without notice. Any comments, opinions, or recommendations made by any host or other guest not affiliated with SHGA in this video do not necessarily reflect the views of SHGA, and non-SHGA persons appearing in this video do not fall under the supervisory purview of SHGA. You should not treat any opinion expressed by SHGA or Ms. Vingiello as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of general opinion. Nothing presented herein is or is intended to constitute investment advice, and no investment decision should be made based solely on any information provided on this video. There is a risk of loss from an investment in securities, including the risk of loss of principal. Neither SHGA nor Ms. Vingiello guarantees any specific outcome or profit. Any forward-looking statements or forecasts contained in the video are based on assumptions and actual results may vary from any such statements or forecasts. SHGA or one of its employees may have a position in the securities discussed and may purchase or sell such securities from time to time. Some of the information in this video has been obtained from third party sources. While SHGA believes such third-party information is reliable, SHGA does not guarantee its accuracy, timeliness or completeness. SHGA encourages you to consult with a professional financial advisor prior to making any investment decision.
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