Insurance products can be suitable in many different situations. Annuities are commonly used to help create retirement income, while life insurance pays a death benefit when an insured person dies. This chapter highlights key suitability considerations for each product.
Both fixed and variable annuities can provide income for life. Once a contract is annuitized, payments continue until the owner dies.
That lifetime income feature can be a strong fit for someone who wants retirement income they can’t outlive. At the same time, it can create a trade-off for the owner’s family and/or beneficiaries. For example, consider a life annuity: if the contract is annuitized and the owner dies shortly afterward, the insurance company keeps the remaining value (minus any payments already made). That outcome can leave little or nothing for a surviving spouse or children. Because of this, a life annuity payout is generally most appropriate for someone who does not intend to leave annuity assets to beneficiaries.
Fixed annuities provide consistent payments upon annuitization, and those payments grow annually at a fixed rate. Like bonds, fixed annuities are subject to inflation risk. For example, suppose an annuity holder’s payments increase by 3% per year. If inflation rises to 5%, the cost of goods and services is increasing faster than the annuity payments. The result is a loss of purchasing power.
Variable annuities also provide payments upon annuitization, but the payment level fluctuates based on the performance of the separate account. If the separate account performs well, payments can increase; if it performs poorly, payments can decrease. The annuity holder may allocate some or all of the separate account to common stock investments, which tend to outpace inflation over long periods of time.
This creates a clear trade-off:
Most financial advisers do not recommend using any type of annuity as a person’s primary retirement plan. Other accounts, such as a 401(k), 403(b), or individual retirement account (IRA), often provide better tax benefits, more investment flexibility, and fewer fees.
Annuities are typically best suited for investors who want to supplement retirement savings. For example, suppose a 30-year-old investor has access to a 401(k) at work and an IRA. If possible, they should maximize contributions to those accounts, especially if the employer matches 401(k) contributions. If the investor still has additional money to save for retirement, contributing those funds to an annuity may be suitable.
Life insurance is most appropriate when someone would face financial harm if another person dies. For example, suppose a working mother provides all the income for her family, including her husband and two children. If she dies without life insurance, the surviving family members may not have the income needed to cover living expenses.
In situations where a “breadwinner” supports others (for example, one family member earns most or all of the household income), life insurance can be a crucial part of the family’s financial plan.
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