Insurance products can be suitable in many different situations. Annuities are commonly used to create retirement income, while life insurance pays a death benefit when the insured person dies. This chapter highlights key suitability considerations for both products.
Both fixed and variable annuities can provide income for life. After a contract is annuitized, payments continue until the death of the owner. That lifetime income feature can be a strong fit for someone who wants retirement income they can’t outlive.
At the same time, lifetime payments can create a trade-off for the owner’s family and/or beneficiaries. Consider what happens if a life annuity is annuitized and the owner dies shortly afterward. With a life annuity, the insurance company keeps the remaining value of the contract (minus any payments already made). That can leave little or nothing for a surviving spouse or children. Because of this, life annuitization is generally most appropriate for someone who does not intend to leave annuity assets to beneficiaries.
Fixed annuities provide consistent payments upon annuitization that 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 consistent payments upon annuitization, but the payment level fluctuates based on the returns of the separate account. If the separate account performs well, payments increase; if it performs poorly, payments decrease. The annuity holder may allocate part or all of the separate account to common stock investments, which tend to outpace inflation over long periods of time.
This creates a clear “push and pull” between fixed and variable annuities:
Most financial advisers do not recommend using any type of annuity as a person’s primary retirement plan. Accounts such as a 401(k), 403(b), or individual retirement account (IRA) often provide better tax benefits, more investment flexibility, and lower 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 contributions to the 401(k). 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 a financial loss 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 resources to support themselves.
Term life insurance is most suitable for someone who wants low-cost coverage for a specific period. A common suitable profile is a young couple in a low tax bracket with a newborn child. A low tax bracket suggests the family has limited income and may not be able to afford large premiums. If either parent dies during the term, the policy pays a death benefit.
All other types of life insurance are generally suitable for someone who wants coverage for their entire life. In recommendation-based questions, you’ll usually be given the client’s priorities. Match the product type to the priority:
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