In the world of financial services, an annuity is about as boring as it gets. You invest money with an insurance company then get a steady stream of income until you die.
For many, it has the appeal of a defined benefit pension, which in today’s world has gone the way of the dodo bird. For seniors worried about having their money last through retirement, safe from market gyrations, annuities have started to look pretty attractive.
Here’s how most annuities work: a number of people buy the product from an insurance company, which sends them a monthly check until they die. Some people will die sooner than others. You’re betting you’ll live longer while the insurance company, which is an expert in the actuarial tables, is taking the other side of that bet.
While most financial planners will point out that the return on an annuities is quite a bit less than other financial instruments, many retirees frankly don’t care. After the 2008 financial crisis, they are looking for guarantees – at least as much of a guarantee that the financial services industry can offer. According to an insurance newsletter, sales of most annuity product types enjoyed double-digit growth rates in 2013.
Consider the source
Before buying an annuity it is important ask and answer a few questions. For starters, where are you getting your information about the annuity you are considering? If it is from the insurance company selling it, it’s best to look for a second opinion.
Annuities are very profitable products for insurance companies. Not that there’s anything wrong with that, but you should understand the person trying to selling you this product has a very strong incentive to get you to sign on the dotted line.
If you have a spouse you will probably consider an annuity with survivor benefits. That means if you die first, you spouse will continue to receive income for the rest of his or her life.
Not without risk
Doing so, however, entails some risk. An annuity with survivor benefits will pay less income each month than one without these benefits. The insurance company must plan for payments until two people die, not one, so the monthly payout is less.
And what happens if your designated survivor dies first? You continue to receive the reduced monthly payout from the annuity, but as John Grobe, a financial consultant specializing in federal government retirees, points out, the money withheld to care for your beneficiary was essentially wasted.
In addition to an annuity with survivor benefits, there are immediate annuities, fixed annuities, variable annuities and equity indexed annuities. An immediate annuity, in which you pay in a lump sum of cash in return for a monthly check, is about the simplest, and according to Certified Financial Planner (CFP) Tim Maurer, probably the best for the largest number of people.
Best of the bunch?
“For Americans who will not be retiring with a meaningful stream of pension income, immediate annuities offer that potential,” Maurer wrote in an article for CNBC.com. “Because an immediate annuity is purposefully consuming both interest and principal to create an income stream, the individual distributions are likely to be higher than anyone could justify taking from a balanced portfolio of investments, where maintenance of the principal balance is often the goal.”
Maurer is least impressed with the equity indexed annuity, which he says is tied in to the rise in the stock market but somehow, without the downside risk. He’s not alone in his skepticism.
Wes Moss, a CFP who writes for the Atlanta Journal-Constitution, cautions consumers these products are being sold with commercials describing them as “can’t lose” investments. What you should know, he writes, is that you’re locking your money up for 10 to 15 years while receiving a rather anemic return – in the neighborhood of 2.5%.
“If those annuity owners had invested wisely and consistently in a balanced S&P 500 and government bond market blend, exposing themselves to some risk, their potential upside for that 25-year period was considerably higher, ranging from 6.5 to 7 percent per year,” he writes.
All this may be true, but it is also clear that for many consumers approaching and entering retirement, economic turbulence in recent years has virtually eliminated their appetite for risk. However, before making any financial decision that commits you long-term, it’s a good idea to talk with a trusted and objective financial advisor.
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