My adviser recommended an annuity. Is it the right move in this market environment?

By Alessandra Malito

'I haven't committed to the strategy yet and would appreciate some independent perspectives'

"The annuity was recently offering a 5.75% rate on a jumbo contract with a five-year term and no fees. The three-year option offers a slightly lower rate." (Photo subject is a model.)

Dear Help Me Retire,

I'm preparing to retire, and my fixed expenses are covered by Social Security. The majority of my retirement savings is in an IRA managed by a large brokerage firm, and my current portfolio allocation is 60% stocks and 40% bonds.

My portfolio manager, a CFP professional and fiduciary with the firm, has recommended moving a portion of the bond allocation into a deferred fixed annuity offered by a highly rated, unaffiliated insurance company.

We discussed interest rates, bond yields and how rising yields can affect bond-fund values as investors move money in search of better returns. I believe I understand the concern with remaining heavily invested in bond funds in the current environment, but I'd appreciate other perspectives.

The annuity was recently offering a 5.75% rate on a jumbo contract with a five-year term and no fees. The three-year option offers a slightly lower rate. I would have the option to withdraw up to 10% annually if needed, although I don't anticipate doing so. At the end of the term, the plan would be to move the funds back into my managed IRA account. The remaining portfolio would then be reallocated to a 70/30 stock/bond mix.

I haven't committed to the strategy yet and would appreciate some independent perspectives.

What am I potentially overlooking? Are there downsides to this approach, particularly regarding liquidity, inflation, insurer risk, taxes or the opportunity cost of locking in a fixed rate for five years? Does this seem like a reasonable strategy for someone in my position, given that Social Security covers my fixed expenses?

I'd be interested in hearing from anyone who has considered or used a similar strategy, as well as from those who see potential drawbacks I should discuss with my adviser before making a decision.

Sincerely,

Second-guessing Annuity

Dear Second-guessing,

Annuity recommendations on their own are not red flags - though these investment products have had a bad reputation in the past, because of sales tactics around them or inappropriate recommendations for individual and personal client circumstances.

Annuities can actually be a great source of guaranteed income for retirees, since they mimic the regularly scheduled paychecks that workers received when they were on the job. Some folks prefer that type of retirement income because it takes the guesswork out of portfolio withdrawals, and feels like the steady income they're used to receiving.

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"In the current rate environment, a five-year fixed annuity paying 5.75% from a strong insurer is a good place to park conservative money, especially when the goal is principal protection and a known return," said Patrick Huey, a certified financial planner and owner of Victory Independent Planning. "For the right client, that can be an attractive alternative to sitting in cash or taking more market risk than they can really tolerate. It sounds fairly plain vanilla, which is usually a good thing in annuity land."

Still, it doesn't hurt to do a bit more questioning before handing your money over, he noted. Know exactly what the purpose of this annuity is for your personal needs.

"Is this money truly meant to be protected for the next five years? Is the client nervous about market volatility and looking for a sleep-better-at-night option? Or is this being used because the rate sounds good? A product can be fine on its own terms and still be the wrong tool if it does not match the job," Huey said.

You vs. the market

Never try to time the market, but do understand your relationship - and your investments' relationship - to it. For example, know early on whether you'll be panicking about losses during a downturn, or if you can stomach volatility well into your retirement years. Also understand how the timing of withdrawing investments can impact your overall balance, such as if you're taking a distribution in a bear market when it will take longer for your portfolio to recover.

The characteristics of the annuity you mentioned - the 5.75% rate, the ability to withdraw up to 10% of the base value and no penalty after five years - "might just be a good idea based on the somewhat shaky market prospects in the near term," said John Power, a certified financial planner and principal at Power Plans.

"I'm not sure about the 70/30 mix once the assets are rolled over at the end of five years," he said. "But it could be OK if the client isn't relying on this asset as the primary source of retirement income and their risk tolerance will support that level of equity exposure."

More questions to ask yourself - and your adviser

When you chat with your adviser next, ask why this particular annuity model makes sense. For example, David Haas, a certified financial planner and owner of Cereus Financial Advisors, asked why you would put money in a fixed-rate annuity, which is good for someone with a low risk tolerance, when it will then be moved to a 70/30 portfolio, which is suitable for someone with a higher risk tolerance.

Haas also suggested running the numbers on the 5.75% rate with other tools, like 5-year CDs or term bonds. "My other complaint is that 5.75% seems a bit low for the loss of liquidity," he said. "I bet you could get pretty close to that rate or maybe even exceed it and be able to take your money out any time."

Annuities are good for guaranteed income, but they do have their disadvantages, Haas added. "You can pretty much always reproduce their investment returns without liquidity reduction or poor tax features - not an issue for a qualified account, which this appears to be," he said.

And of course, if you don't already know how your adviser is compensated, now is the time to do that.

"An annuity advertised as having no fees can still pay a commission to the adviser who sells it," said James Mayo, a certified financial planner and principal of IronFjord Wealth Management. "That doesn't automatically make it a bad recommendation, but it's a potential conflict of interest worth investigating."

Also look into any surrender charges if you need more than 10%, and see for yourself how reliable the insurer offering the annuity is, experts said.

Before you proceed with any recommendation - be it this annuity or anything else that comes up in the future - make sure you understand what it is and why it's for you. Start with the "why," not the rate, said Eileen Olson, a certified financial planner and founder of Emerald Wealth, and be so clear on what the product is that you can explain it to a friend over coffee.

"Listen to your gut," she said. "If something feels rushed or unclear, pause. A good adviser welcomes questions and can explain a recommendation so clearly, you could explain it yourself. Getting a second opinion isn't distrust. It's good practice."

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Have a question about your own retirement savings? Email us at HelpMeRetire@marketwatch.com.

-Alessandra Malito

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