By: Bill Fay
When people ask about annuities, there are two things you can almost always count on:
- They are at or near retirement age.
- They are afraid they’re going to outlive their retirement savings.
These are legitimate concerns for the Baby Boomer generation plowing through the retirement gates for the next 15 years, but anyone else investing in an annuity needs to keep researching the product before throwing money in the pot.
Annuities are a safe, dependable way to assure yourself an income for a specified time, preferably the remainder of your life. They can provide you a guaranteed income and remove the fear that your money is being won or lost on the whims of Wall Street trading floors.
Record-Low Interest Rates
However, because the return on most annuities is tied to interest rates, they haven’t made sense for anyone other than retirees for a long time. Interest rates are at record lows, so if you invest money in an annuity today, you’re going to get the corresponding record-low return.
The average return on immediate annuities, for example, is around 5%, which would be the low-end expectation if you were to invest money in the stock market for 10 years.
Workers younger than 50 have the luxury of time to wade through the ups and downs of the market for 10 years. They should expect to see something close to the expected return of around 10% for stocks and mutual funds.
From Bad to Worse
A recent survey says 66% of those at or near retirement age don’t feel financially prepared for that phase of their life—and justifiably so. A lot of them watched their retirement accounts nearly disappear during the Great Recession.
The Dow Jones index plunged 7,657 points from October 2007 to March 2009, shredding a lot of 401(k) plans in the process. The real estate market also stepped off a cliff, turning homes that were once valuable assets into unaffordable liabilities.
The Social Security Administration also weighed in with news that caught the attention of the Boomer generation. The SSA says that women turning 65 today are expected to live to 86. A 65-year-old man can expect to live until he is 84. About one-third of healthy men and 44% of healthy women retiring this year will live past 90.
So Boomers found out their badly-bruised retirement accounts needed to last an average of 20, and in some cases 30 years, while not reducing their standard of life. Suddenly, guaranteed income from an annuity for the rest of your life didn’t sound like a bad idea.
Annuities: Good and Bad
That’s probably why annuity sales peaked at $265 billion in 2008—the middle of the stock market plunge. Sales have slowed the last three years, as the market and real estate gradually regained part or all of their lost value, but the cumulative impact made many Boomers reconsider their retirement savings strategy. Annuities, all but abandoned when the stock market was booming, are being mentioned as part of retirees’ investment portfolio.
The positives about annuities are easy:
- The income is guaranteed, in most cases for as long you live, so you can’t outlive your money. If you make it to 80, you get paid. If you’re still around at 90, you’ll get paid. The longer you live, the better the deal you’ve made.
- The transaction is relatively simple in investment terms: You give an insurance company a lump-sum amount and they tell you how much you will get back in monthly payments, based on your age, gender, and amount invested. Women usually get a little less than men each month for the same investment amount because women tend to live longer.
- Annuities are great from a tax perspective. They grow tax-free until you start withdrawing the money.
- You can buy a plan with time guarantees so that when you die, your spouse or another beneficiary receives your monthly payments for a specified amount of time. For example, if you bought a 10-year guarantee and died before the 10 years was up, your beneficiary would receive monthly payments until the 10 years was up.
- If you buy an immediate fixed annuity, your investment worries are over. The monthly payments are guaranteed, regardless of market performance. No more deciding whether to sell or buy.
The downsides of annuities are just as obvious:
- You’re essentially paying yourself with your own money. A 65-year-old man who invests $100,000 in an immediate annuity, would get $591 a month for life. He would have to live 14 years just to get back the initial $100,000 investment, which means a zero percent return for 14 years. If he lived until he was 84, he would have received a total of $134,748, which gives him an annual return of 7 percent.
- Inflation eats up annuities. You get the same check every month, forever, but the price of rent, food, transportation, medicine, etc., goes up. The $591 monthly check that paid for food and electricity 10 years ago barely covers the food in 2013. That’s inflation. Costs go up, and your check stays the same.
- Annuities offer no flexibility. Once you’re in, the penalties for getting out are severe. You’re tying up a lot of money with no escape hatch if your situation changes.
- Beware of fees. There could be a lot of them, especially with variable annuities. There is a surrender penalty if you decide to cash in early. There are administrative fees, mortality and expense fees, optional benefits fees, and the list goes on. You would be wise to read your agreement closely and understand how much you’re paying every year to own an annuity.
Most retirees already receive an annuity. It’s called Social Security. It’s a guaranteed income stream that comes every month and is adjusted for inflation with no fees involved. If you want to double up on that sort of security, annuities are the way to go.
If you want your money to continue working for you while you’re retired, you may want to look in other directions.
Bill Fay is a writer for Annuity.org. He spent 21 years in the newspaper business and eight more in television and radio dealing with college and professional sports; then seven forgettable years writing speeches and marketing materials for a government agency.