Annuities come in many different shapes and sizes but at the foundation they are an insurance product that issues some sort of guarantee.

As many of you know, I am not a big fan of insurance products or the ways they are sold, but being a financial planner I cannot look past their utility in managing risk in a plan. When I first started in the business 13 years ago, annuities were a four letter word that you didn’t dare use, then the financial crisis hit in 2008 and everyone needed at least a piece of their net worth in an annuity. The truth is they are all unique products that with guarantees from the insurance company can help solve a problem within a financial plan. The two biggest problems that I believe annuities can help solve are: 1) an investor’s fear of market downturns and 2) the need for a guaranteed income source.

Every person has a varying level of risk tolerance and comfort with investing. Some don’t bat an eye when assets drop 30 – 40%, while others lose sleep if assets drop at all. An annuity can be the solution for people who lose sleep when assets drop in value. One possible product could be a fixed index annuity that lets you participate with market performance but won’t let you lose money. You don’t get to have your cake and eat it too though, because they cap the upside performance and will limit the liquidity with surrender fees if you take a withdrawal early.  If it is a suitable product and you’re nervous about markets, it may be a better solution than sticking your funds in cash.

The other way an annuity may be appropriate is if you need some of your income guaranteed. When you are no longer working and need income to live, most people in the private sector will only have social security for a guaranteed income source. The rest of the income may need to be pulled from your portfolio, and if this is a majority of your income then we put an extra strain on the portfolio to perform in order to have a successful plan. One way to determine if an annuity with income benefits is appropriate for you is to do an Income Needs Analysis. You will add up all of your guaranteed income sources, then divide them by your base expenses (typically your expenses excluding entertainment, travel, car purchases, etc.). We usually like to see this ratio above 60%. If it isn’t, an annuity can be used to fill that gap. This helps insure that the success of your plan is not determined by market performance and you push some of that risk onto the insurance company.

There are thousands of annuities with many nuances. Make sure the one you are considering is suitable to you and covers a need that you want to meet.