Annuities Are for Savers and Spenders

Since joining Principal in August 2018, Sri Reddy, senior vice president of retirement and income solutions, has continued his long-running efforts to clear up common misconceptions about annuities and guaranteed income products.

On this point, the firm recently commissioned and published a white paper by Michael Finke and Wade Pfau. The research looked at how retirees can use guaranteed income annuities to not only improve financial outcomes, but also increase confidence and reduce stress in retirement.

The white paper data shows retirees who had guaranteed income through an annuity were more likely to feel confident and accept more market volatility with their other assets. Reddy points to supplemental simulations detailed in the paper, which suggest adding an income annuity to a retirement portfolio allows a retiree to get the same or higher income with lower risk of outliving savings than an investments-only approach. The paper emphasizes that using both annuities and investments can enhance the value of assets for heirs over the long term.

“On an emotional level, retirees are more confident when there’s certainty to their monthly income,” Reddy says. “The certainty an income annuity provides increases confidence and reduces stress in retirement. The head and the heart come together here to show that annuities really do help people have enough, save enough and protect enough for their future.”

Stepping back from the research results, Reddy says he’s concerned by the common misconceptions that Americans tend to have about annuities, but at the same time he understands that skepticism is natural, considering how the conversation about retirement income is rife with complexity.  

“The situation we face when discussing ‘annuities’ versus ‘guaranteed income’ is not unlike the conversation about ‘Obamacare’ versus the ‘ACA,’” Reddy says. “The features of the Affordable Care Act are very popular among consumers, but ‘Obamacare’ is often talked about in some groups as a negative thing.”

In his experience, the No. 1 thing people get wrong about annuities is to say that annuity customers are investors.

“They are in fact savers who we are helping to invest so they can address inflation and participate in the growth of the economy,” Reddy says. “This distinction is significant. It means that our customers display very different behaviors versus what Wall Street or academics say is the optimal course for investors. Annuity purchasers are people looking for peace of mind. They want to participant in gain without losing big. They also don’t want choppiness.”

Reddy says another harmful misunderstanding is that “annuitization is an all-or-nothing game.”

“It is really not that at all,” Reddy says. “In fact, if someone is telling you to annuitize all your assets, find another adviser or provider. That’s not an outcome that anyone in our organization would promote.”

Reddy notes that one novel way advisers and retirees are using annuities is as a bridge between the working years, ending at about age 62 on average, and the full Social Security claiming age of 70 1/2.

“We see more people using annuities as an eight or nine year bridge to guarantee the non-discretionary income for the beginning years of retirement—to get clients to full Social Security benefits,” Reddy points out. “If you can delay Social Security until 70 1/2, that’s a huge benefit to the individual’s level of guaranteed income. You are basically doubling Social Security this way.”

According to Reddy, when annuities are explained in terms of maximizing income and driving happiness and confidence, people respond well. He also notes that, in the Principal book of business, the vast majority of income annuities are purchased with a cash refund provision, meaning if something happens to the person who bought them, the remainder between what they got and what they paid will be paid out to the beneficiaries.

“We emphasize that you should consider annuitizing against non-discretionary expenses, and then you can let the rest of your money work harder for you,” Reddy concludes. “In fact annuities will help you spend effectively what you’ve earned. We’ve seen the studies that show people at all wealth levels are afraid to spend down their 401(k) assets. Many people in fact end up under-spending because they are concerned about seeing their balance decline and they want to leave money behind for loved ones.”