Insurance products can be suitable in many different circumstances. Annuities are commonly used to 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 useful for retirement planning, but it can also create a trade-off for the owner’s family and/or beneficiaries. Consider a life annuity: what if the contract has significant value at annuitization, and the owner dies shortly afterward? With a life annuity, the insurance company keeps the remaining value (minus any payments already made). That outcome can be a major concern for someone who wants to leave annuity assets to a spouse, children, or other beneficiaries. For that reason, this type of annuitization is 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 increases 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 part or all of the separate account to common stock investments, which tend to outpace inflation over long periods of time.
This creates the main “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 fewer fees.
Annuities are generally best suited for someone looking to supplement retirement savings. For example, suppose a 30-year-old investor has access to a 401(k) at work and also has 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, it may be suitable to contribute those funds to an annuity.
When choosing between fixed and variable annuities, the key suitability factor is risk tolerance:
Life insurance is most appropriate for someone whose death would create a financial loss for others. 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 seeking low-cost life insurance for a specific period. A common suitable profile is a young couple in a low tax bracket with a newborn child. The 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 seeking coverage for their entire life. In recommendation-based questions, you’ll typically be given the client’s priorities. Match those priorities to the policy characteristics:
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