“Guaranteed lifetime income, such as in the form of annuities, is incredibly valuable for retirees,” said Jeffrey Brown, a professor at University of Illinois at Urbana-Champaign and a co-author of the paper, Framing Lifetime Income. “It is the single best way on a risk-adjusted basis to maximize one’s ability to spend in retirement without concerns about running out of resources. Every other strategy either exposes the individual to more risk, or reduces one’s ability to consume.”
It’s important to understand that annuities, with the important exception of the variable annuity, are not investments. They were not designed to compete with investments and they should not be compared to investments. They are safe money products with principal and income guarantees that no investment can provide. Investments, including variable annuities have market risk; fixed deferred annuities and fixed income annuities, do not.
Investments, including variable annuities, have the potential for high rates of return but they also have the potential, as many investors have learned, to suffer large losses. Fixed annuities have guaranteed minimum interest rates and some also have rates that are linked to an index such as the S&P 500. Linked rates give the owner the opportunity to earn a higher rate of interest without the risk of investment loss. For many people, especially retirees who may not have time to recover from investment losses, the principal and income guarantees provided by fixed annuities are far more important than the opportunity to make unusually large gains every few years.
Are annuities for everyone? Of course not! But for those who need to keep their money safe and are looking for a reasonable rate of return that is currently very attractive compared to CDs and other safe money products, they may be just what the doctor ordered.
So, the next time you read or hear someone saying that annuities are terrible investments you will know that they are either talking about variable annuities or misinformed. And you might ask what they have to gain by making such statements. There is a good chance that they have an axe to grind. For example, it should come as no surprise that many investment advisors who charge fees for managing investments, don’t like annuities. Why? Well, one reason might be that every dollar that goes into fixed and income annuities may be one less dollar that they will get paid to manage. That money is off the table and probably permanently. Is that the only reason? Maybe not, but it’s one that anyone who is considering an annuity should be aware of.
Most fixed and indexed annuities have early surrender charges that some reporters and analysts like to complain about. This is not the time or place to explain why surrender charges are necessary to protect the company and the remaining policyholders, but it is a good time to explain why surrender charges are certainly not the worst thing that can happen. If you put $100,000 into a simple fixed annuity that has a first year surrender charge of 10% you know exactly what will happen if you completely surrender the contract during the first year. If you have earned no interest and had no other adjustments or withdrawals, you would get back 90% of your money. Guaranteed! If you put the same $100,000 into any true investment product will you have a guarantee that you will always get at least 90% of your money back? Certainly not, but many investors would have been thrilled to get 90% of their money back just a few years ago; especially those who were relying on their investments for retirement income.
Surrender charges usually grow smaller over a period of several years (10 years is very common) and eventually disappear. And even during those years most companies allow penalty-free withdrawals each year of 5% to 10% of the accumulated value or premiums paid. Most companies allow these penalty-free withdrawals beginning in the second contract year. Anyone who anticipates drawing more than 10% per year probably shouldn't buy an annuity.
Some companies offer a Return of Premium guarantee which means that surrender charges cannot consume any of the premiums that were paid in. In that case, the minimum guaranteed withdrawal or surrender value is the premiums paid minus any previous withdrawals. In total, you cannot get back less than you paid in. That is the classic definition of liquidity; the ability to get your money back without loss.
Every individual and family should consider annuities and all other financial products in light of their own circumstances. We encourage everyone to seek professional advice before using any financial product or service.
Posted by C. Thomas Thames
About the Author: C. Thomas Thames is a Certified Financial Planner™ professional with offices in Folsom and Woodbridge, California. Tom specializes in retirement planning, tax reduction strategies and estate preservation.