Annuities for the Ages

You are quickly approaching or even past acknowledged retirement age. You wonder what happened to the rich investment returns when you were younger. Bank accounts, money markets, and CDs are paying almost nothing. There are higher returns available, but the continuing financial turmoil makes the risks of investing in the stock market, junk bonds, and real estate at your stage of life unacceptable. Then your financial advisor tells you that he has just the answer for you — an OLD but NEW product! It is a safe annuity guaranteed by a mammoth insurance company. So that’s the answer, right? We need to talk.

Annuities come in two general flavors. There is an immediate annuity, so named since there is an immediate payout based on a sum certain paid in, and there is a deferred annuity that promises a stream of payments over some future time period.

What are the differences? Here is an example of an immediate annuity using fictitious numbers: you agree to pay to the big insurance company $500,000 for the promise of a stream of income of $2,000 per month for the rest of your life. Here you are playing roulette against the insurance company’s army of actuaries who have already figured out your statistical likelihood of beating the clock. Compare that to a deferred annuity where you pay a lump sum or monthly payments, and in return the Insurance company guarantees you fixed sum per month starting in ten years for the rest of your life.

You assume that this has to be safe. The promise comes from a billion or trillion dollar insurance company that has survived the recent financial turmoil. And the rates take you back to your youth. The insurance company promises initial rates at 5 or 6%. What could go wrong?

Plenty. Slow down and take a good, hard look. Many adults 65 and older are being pushed into annuities. Agents and brokers like them because the commissions and bonus levels can be significant. Insurance companies love annuities because they lock up your money for a defined period of time giving the insurance company the opportunity to invest that money and make a higher rate of return. And since it is an annuity contract and not a whole life policy, many insurance companies do not even have to maintain reserves on those funds. This means that they can invest the entire amount in order to make big returns for themselves.

The initial interest rate or teaser rate is exactly what the name says. The insurance company promises an initial rate of 5-6 % for a limited time period. There are significant penalties and surrender charges if you need to withdraw the principal. Sometimes those penalties, combined with the cancellation or surrender charges, are far more than just the teaser rate interest and can actually go into the principal. Thereafter, rates may drop during the remainder of the contract to as low as .01 % for the life of the annuity which can be 15-20 years down the road.

Why is this a bad investment for the 65 and older crowd? Unless you have a substantial free cash flow, you are locking up your cash for a long time with close to a zero rate of return. Your hands are tied if you need the money. And in order for you to “win”, you have to outlive the standard actuary tables by a large margin.

So, if it appears to be too good to be true then perhaps it is too good to be true. While annuities can be appropriate and suitable investments under the right circumstances, you should carefully consider the investment. And you should think about working with a fee-based advisor so that you know that you are getting objective advice and not advice from someone driven by the commissions from selling you certain products.

One final word of caution. Many states require that someone selling you any investment, annuities included, perform suitability or needs analysis to determine if the investment suits your financial goals and needs. Make sure you are getting that from the person selling you the annuity.

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