Annuities, often vital components of retirement planning, can serve many purposes and suit many different types of clients. That can lead to many misunderstandings.

Essentially contracts offered by insurance companies, they’re often recommended as a solution for longevity risk—i.e., the fear of outliving your money. The longer you live, the more value you’re likely to get out of your annuity. But unlike life insurance, annuities can be bought without a medical checkup.

So should clients consider their own health and longevity expectations before buying this product?

Health And Longevity
The answer is a qualified yes. “A person in poor health and with a limited life expectancy may not see much of a need for protected lifetime income in retirement,” says Adam Lalla, vice president of competitive market solutions at Radnor, Pa.-based Lincoln Financial Distributors, referring to one of the key benefits of many annuity contracts. “However, many clients are unaware what their actual life expectancy could be.”

A 65-year-old married couple has about a 50% chance that one spouse will live past age 90, Lalla says. “Clients cannot predict how long their retirement assets will need to last, and annuities can provide predictable income throughout retirement.”

Still, the premise holds true. It’s the nature of the insurance business. “People that pass before their life expectancy subsidize those that live beyond their life expectancy,” says Scott Stolz, a president at Raymond James Insurance Group in St. Petersburg, Fla. “Therefore, the longer you live, the more income you will receive relative to the amount placed into the annuity.”

That means a client’s health and longevity should be on the advisor’s mind, even if they are not on the client’s. “Professional, licensed insurance agents definitely should consider health and longevity expectations in their recommendations to clients,” says Michael Zmistowski of Financial Planning Advisors in Tampa, Fla. “The financial plan must consider health and longevity.”

Forfeiting Is A Myth
One of the big myths with annuities is that once you die, you must forfeit the asset and the lifetime income, an especially painful prospect if you imagine dying young.

But that’s only if you take the income over one life—and only to maximize the payouts.

“You could buy an annuity that works that way,” says Stolz. “In fact, because such a payment would be based solely on one life, it would pay the most income per dollar invested. In reality, almost no one chooses such an option.”

In reality, most clients are looking at contracts that cover two lives and buying that guarantee for a little less income, Stolz says. Or, he says, the contract could cover a minimum number of years or a particular total amount.

“If a ‘life only’ payout option is selected, payments will stop when the client dies,” says Jill Perlin, vice president of advanced planning and sales training in Prudential’s Individual Solutions Group in Newark, N.J. “If a ‘joint and survivor’ option is selected, however, payments would continue to the remaining annuitant—typically a spouse or partner.”

You can also choose a death benefit option.

“The vast majority of annuities that are purchased for income have death benefit options for spouses and non-spouses,” says Lalla. “In fact, some death benefits guarantee a return of premium, regardless of investment performance.”

It all depends on which type of annuity and which options are selected.

Mostly At Or Near Retirement Age
It’s difficult to categorize exactly who buys annuities. Most customers are at or near retirement age, though some reports suggest the average is trending younger and younger. As measured by the LIMRA Secure Retirement Institute, most annuity buyers are between 58 and 67.

“Annuities can be for anyone,” says David Hanzlik, vice president of annuity and retirement solutions at CUNA Mutual Group in Madison, Wis. “While all annuities provide annuitization options that allow you to turn your assets into an income stream to protect against longevity risk, there are also numerous other risks annuities can help protect against, such as protection against market risk.”

Married With Children?
Lalla says the majority of his clients are married; only about a quarter of them have children living in the household. If a client has dependents, it can influence the type of annuity he or she buys.

“For example, consumers without dependents might prefer an annuity with the highest level of income but a less advantageous death benefit, such as a single premium immediate annuity,” says Lalla. “Those with dependents may be looking for an annuity that allows them to pass on some of their assets. Variable annuities with a guaranteed lifetime withdrawal benefit offer the potential for a greater death benefit and greater flexibility for the owner.” That flexibility is primarily due to the fact that variable annuities offer a variety of mutual-fund-like subaccounts to invest in.

Stolz stresses that annuitants come in all shapes and sizes. “Annuities may be more attractive to those with dependents, simply because they’ll want to make sure an income continues if they predecease their spouse,” he says. “But an annuity can work equally well for people with or without dependents.”

Ensuring Financial Security
While inheritance may figure into the annuity decision, it’s not typically the primary consideration. “Purchasing an annuity is about ensuring a guaranteed source of income to help provide certainty and cover costs throughout retirement,” says Perlin. “People concerned with leaving assets to their heirs are often also concerned with ensuring their own financial security during their lifetime—which is where annuities come into play.”

Clients concerned specifically about leaving a legacy to heirs will typically focus more on products like life insurance, she says, though an annuity can be an appropriate tool if, say, the client cannot get life insurance because of a pre-existing health condition. Such clients “can use a death benefit on an annuity to provide a legacy for their heirs,” Perlin says.

Effect On One’s Estate
Nevertheless, clients can shrink the size of their estate by funding an annuity. “Buying an annuity to fill an income gap in retirement typically means that person will have less money to leave to heirs,” Stolz says. “There is a cost to providing a guaranteed income for life.”

On the other hand, having that guaranteed income stream also means you’re less likely to become a financial burden on loved ones, and more likely to preserve other assets in your estate. “When it comes to annuities, it’s not an all-or-nothing decision,” says Craig Hawley, head of Nationwide’s annuity distribution unit in Louisville, Ky. Clients who have a guaranteed income, he says, enjoy “the flexibility to invest the rest [of their assets] more aggressively, whether it’s for greater growth, for greater liquidity or to pass along to heirs.”

Part Of A Holistic Plan
To Hawley, it’s important to realize that annuities are—or should be—a piece of an overall financial scheme. “The decision to invest in an annuity needs to be part of a strategic and holistic plan so clients can protect their income in retirement and ensure that they don’t outlive their savings,” he says. “It starts with knowing the client’s needs and priorities—accumulation, generating income [or] leaving a legacy. Second, it’s important to consider how annuities will fit with other sources of income such as Social Security; qualified retirement accounts; and other investments such as stocks, bonds and mutual funds.”

Stolz might agree. “One must separate those buying an annuity for the accumulation of wealth from those buying for an income,” he says.

Many Purposes
To be sure, annuities can fulfill many purposes. Those who have maximized their retirement contributions might set aside additional money in an annuity for tax-deferred accumulation. “Since annuities still carry a 10% additional tax, like IRAs, for withdrawals prior to 59 and a half, this has to be money that clients don’t anticipate needing in the near future,” Stolz says. “Those that buy an annuity to turn into income have typically calculated the amount they will need in retirement and will not receive enough money from Social Security and their pension—if they are lucky enough to have one—to fill the income gap. Essentially, they are creating their own pension.”

Put that way, it becomes clear that an annuity is truly just another type of insurance product. “An annuity is one of the only solutions that can protect a client’s future by providing guaranteed income for life,” Hawley says. “That’s a compelling proposition now that many clients face a retirement that could last 20 to 30 years or more. You insure your home, your car—why not insure your financial future?”