Annuities: A Great "Guarantee?"

Here is another article about annuities.  Does the word "GUARANTEE?"  make you feel safe?  Jeremy Burri urges you to take a closer look.  To read more about annuities, just click the link at the bottom of this post.

Annuities have enjoyed a profound resurgence over the last 15 years as the average investor’s portfolio has been whipsawed back and forth.

Essentially a life insurance product that insures against outliving income, annuities have brought the investor a sense of safety through their advertised “guarantees.” An investment designed to provide a "guaranteed income" is not new. A hundred years ago you could have purchased what is now called an “immediate annuity,” and you still can purchase one today. A new feature in many annuities offers “guaranteed income for life” while keeping your money invested in the market. Does this sound familiar to you?

Assume you are a 55 year old who plans on using an annuity for retirement income at age 65. You could buy a deferred annuity, with special riders, today and in 10 years (at age 65) have guaranteed income for life. Or you could wait until age 65, buy an immediate annuity, and get that same income for life (again, assuming you are only considering annuities.) Both options can give you what you want at age 65. So how do these options differ? Which is better? Further, what is the insurer actually guaranteeing you, since the stated guarantees on the deferred annuity do not relate to the cash value (like a CD guarantees a rate of return)? How do you translate these guarantees into an actual number you can relate to?

Let’s say you chose option one, and at age 55 you purchased a deferred annuity with riders that guarantee that your “income base” (the amount of money you put in) will grow at 5% a year and that you can receive a 5% income benefit each year, no matter what happens to your contract or to the market. If you start with a $100,000 investment, by age 65 your income base will grow to $162,890. (Remember, this is not cash value, and you cannot withdraw it.)  Based on that income base, you can receive $8,144 per year (5% of $162,890) for the rest of your life.

You could also have chosen option two, waiting 10 years to buy an immediate annuity to provide yourself with the same $8,144 for life at age 65. However, if you only have $100,000 now at age 55, it will need to grow some in order to provide you with the same amount of income in 10 years. How much growth is “enough?” If you wait, you run the risk that in the meantime your investments will not earn enough, or worse yet, decline in value.

Let’s do the math. In order for the immediate annuity to be the better option, over the ten year wait your $100,000 must earn only 3.1% per year. Do you believe that is an attainable goal? If so, then you would be better off not paying for the guarantees of the deferred annuity. These costs, seldom discussed in detail, are very high and have significant impact.  Furthermore, many times once these extras are selected on the contract, they cannot be dropped.

But this is not to say that the immediate annuity is the investment of choice. We believe there are even better, more cost-effective, non-annuity options. If you would like to learn more about annuities and other investments, please give me a call at 920-893-5262 or email me at jburri@veritasinvesting.com to learn more.