How to Determine If You Need an Annuity

How to Determine if You Need an Annuity
••• YinYang/Getty Images

Most people are familiar with annuities, and many have been pitched an annuity from an advisor, or on the internet. Before you start falling for any too good to be true sounding sales hype, answer this very basic, but critical question, “Do I even need an annuity?” How do you determine the answer to this question? Well, I have developed a method based on my belief that annuities are not investment products. If you want growth from an investment, you should be looking at products that are not annuities. Annuities are a type of insurance, not an investment tool. What is my method? 

The P.I.L.L. Strategy to Determine If You Need an Annuity

An annuity is not for everyone. They are not one size fits all panacea products, even though that’s how they are typically sold. Annuities are a transfer of risk products that solve for specific things. In my annuity world, annuities only solve for 4 specific goals:

  • Principal protection
  • Income for life
  • Legacy
  • Long term care

The easy to remember acronym is P.I.L.L.  Use this P.I.L.L. strategy to help you decide if an annuity can help you transfer some risk. What risk? The risk of outliving your income stream, the risk of losing money in the market, the risk of running out of money due to healthcare costs, or the risk of not having anything left to leave for your spouse or other beneficiaries. When I say “transfer of risk”, that means instead of you shouldering the risk to solve one of these problems, you are giving that responsibility in full to the insurance carrier. You will pay for the contractual guarantees to solve for these risks, and it may be worth it if it fits with your overall financial goals and your specific risk tolerance levels.

 A deeper dive into the strategy will clarify how annuities can appropriately be a part of a balanced portfolio. Generally, fixed annuities like SPIAs, DIAs, MYGAs, and QLACS work well to solve for these situations. They are relatively simple with low commission rates, usually with no ongoing yearly fees as well. Conversely, variable and indexed annuities are peddled like pancakes at a BoyScout breakfast. Often being sold as a great way to get great returns from the market without suffering any downsides. I hate to break it to everyone falling for this marketing fiasco, but annuities aren't some magical financial product that delivers amazing ROI. Let's keep it real, folks! Annuities are good at some things!

Principal Protection

Principal protection is pretty much self-explanatory. If you want to make sure you do not lose any money and want to defer taxes on gains in a non-IRA account, then a fixed rate type of annuity might be a good choice for you. 

Income for Life

When you are considering the purchase of an annuity, the primary transfer of risk many people want to solve for is lifetime income. This guaranteed income can start immediately using income now strategies, or income later strategies can help you prepare to receive income down the road at a specific date.


Legacy can be described as that which you leave to your heirs or beneficiaries. Some annuities can offer guaranteed growth amounts that can be used as a death benefit that goes to your heirs or beneficiaries as part of your legacy for them. Life insurance is still the best legacy product on the planet, but if you can’t qualify for that product, then annuities with an attached death benefit rider are good solutions. 

Long Term Care

Long Term Care is a concern of most baby boomers and seniors because of its expense and potential financial drain on family members. The traditional long-term care product (not an annuity) is definitely the best solution, but if you cannot qualify for that strategy, then Long Term Care annuities can address long-term care from a transfer of risk standpoint.

Annuities are Not Investment Products

I believe that annuities are not growth products, which is contrary to the view of most people who sell annuities. Unfortunately, the vast majority of annuities sold are variable and indexed annuities. Most are sold under the false assumption that market return dreams will be realized. That typically never occurs. 

Variable Annuities

Variable Annuities use what’s called separate accounts (aka mutual funds) for their growth component, but the average annual fee of a variable annuity is around 3% and is charged for the life of the policy. In addition, variable annuities have limited investment choices as well. The combination of high annual fees and limited investment choices does not equate into real market growth in my opinion. If you want market growth using mutual funds, then go buy mutual funds. You certainly don’t need a variable annuity to do that.

Indexed Annuities or Fixed Index Annuities

Indexed annuities are the hot product of the day, and what you will probably be pitched if you attend a bad chicken dinner seminar, or search for annuities on the internet. Agents will inappropriately call them “hybrids” to make you feel like you are getting something cutting edge (not!), and the dream sold is full downside protection with market upside. The reality of the product is that indexed annuities were designed to compete with CD returns, and that’s exactly what they have historically done. 

Again, if you want index type returns, then go buy an actual index mutual fund. Indexed annuities limit the upside, and you can only lock in gains (if any) one day per year. That, my friend, is not in the same category as an index mutual fund. The way that I use indexed annuities is with attached income riders for future or target date income planning, and only for the contractual guarantees. Indexed Annuities: The Good The Bad and The Truth will flesh out the burly truth about indexed annuities. Indexed annuities do have redeeming qualities if placed properly within a portfolio, in fact, indexed annuities were designed to compete with CD returns.