When it comes to financial products, annuities would seem to be the perfect vehicle for retirees. The concept behind them is simple enough: you trade in a lump-sum of cash that you’ve built up over the years for a stream of monthly checks for the rest of your life. But few things about annuities are simple.
The first problem: there are more types of annuities than flavors at Baskin-Robbins. Your choices range from plain-vanilla Immediate Fixed Annuities to the equivalent of Jamoca Almond Fudge: Advance Life Deferred Annuities (sometimes referred to as "longevity insurance"). Each one is intended to meet a different financial need, so it helps to be a financial planner to fully understand them.
Then with annuities, as with everything else, you seldom get something for nothing. As Thomas Idzorek of Ibbotson Associates, a Morningstar Company notes: "There is no free lunch with investment products. None of the vast number of products magically engineer additional money. Investors pay by either taking on risk or paying fees to mitigate risk."
That’s why you have to watch out for costs--especially when it comes to variable annuities. As Steve Weisman, author of The Truth About Buying Annuities puts it: "Variable annuities have been described as being mutual funds wrapped in life insurance." To this definition, he adds, "and covered with fees.'"
But even the basic immediate annuities require some caution. Even they generally carry penalties for cashing in early (known as "surrender fees"). And if you add on any extra features--such as inflation protection or a death benefit--be prepared to pay extra.
With all of these potential pitfalls, it’s easy to dismiss annuities as not worth the trouble. But another leading expert on personal finance, Dr. Lewis Mandell, is a fan of immediate annuities. He says if you worry about outliving your income, you really should look into an immediate annuity that begins at retirement or at some years after you retire.
The bottom line: it's worth taking the time to educate yourself about annuities before you buy one. And to do that…start by watching the "Get Your Finances Ready for Retirement" segments airing on NBR on January 5 and January 12.
Comments
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The guy that creates the income stream is the one who makes the extra buck. Make your own stream and pay yourself. Annuities are a poor choice due to high fee's period.
My compliments on an excellent overview of annuities. It is only appropriate to add two points. While variable annuities are investment contracts, it is incorrect to compare fixed annuities to investments, because they are guaranteed insurance contracts with no investment risk. Also, the most important point missed is that fixed annuities are guaranteed to protect, preserve and return the principal within the contract. This is an important and valued benefit during these uncertain financial times. www.bobmaconbusiness.com
I’m so happy to see NBR do a segment on fixed immediate annuity contracts. But, there is just so much more to these simple and elegant financial arrangements then portrayed on shows such as yours that you barely do them justice. We live in such a fast paced world with relatively “high tech” and correspondingly, very complicated financial products. It’s easy to forget that “old fashion” fixed immediate annuity contracts have been a part of the rich financial tapestry of various societies for thousands of years.
And there is a good reason for their historic and wild popularity, very little of which, has to do with lifetime income and “longevity insurance”. Their historic popularity, unlike all “modern” financial products and or arrangements, stems from the fact that; these contracts are extremely safe. But this safety isn’t simply derived from the fact that fixed immediate annuity contracts are backed by life insurance companies, their safety is derived from the uniqueness of the terms and conditions of the annuity payments themselves.
Annuity contracts that pay future income predicated on an individual or two individuals expectation of living to the next payment date are, for all practical purposes, only valuable exclusively to him or her. And, this is the great difference and why these contracts are safe. Third party interests, for the most part, see no value as benefiting themselves in such annuity arrangements.
And as the decades of retirement or even pre-retirement stretch before us, and as individuals, it’s easy to forget that there is much that lies in the path of our financial success besides the whims of stock markets. There are just every day occurrences, disastrous events, with horrible financial implications that affect all of us. Modern financial products, with the exception of Social Security and defined benefit pension plans are not designed to protect consumers.
For the average person, a financial crisis is a very common event and one that necessarily can’t be planned for in advance. It’s that moment in time, an instant, when one’s life changes for the worse. And this time is always just a moment away, It’s a slip and fall, automobile accident, illness, marital property claim (divorce), casualty loss (think hurricane Katrina, or Ca. Northridge earthquake), adverse litigation, creditor action, business failure, significant and swift asset loss (the Madoff effect), etc., instances that work to decimate savings accounts, stock portfolios, mutual funds, deferred annuities, U.S. Savings Bonds, IRAs and 401(k) plans, etc. And older individuals may never financially recover form such events.
It’s a tremendously bad assumption; to just assume consumers will live uneventful lives to leisurely draw upon their savings in order to finance their retirement. Mr. Greenberg, the first blog poster, with the $1,000,000 stock portfolio might think differently about a simple but humble fixed immediate annuity if he should be compelled to turn his stock portfolio over to his adult child or nare-do-well sibling after suffering a cognitive impairment due to an illness, car accident or a simple slip and fall. Or perhaps he remains in good health and an ex-spouse or soon to be ex-spouse or ex-business partner comes looking for the portfolio. At that point, who is to say what will become of it. Of course, at this time, it will be too late for the fixed immediate annuity choice.
Or how about the gentleman, who remarries late in life to a much younger wife, a wife that has grown frail, but most likely will still survive him. This gentleman can’t depend on his adult children by his first wife to take care of wife #2 and watch out for her interests after he is gone. They probably hate her guts. But a joint husband and wife annuity works so well because wife #2 will just inherent the payment regardless of what is going on with the rest of the family after he is gone.
Or consider the terminally ill, age 40, lung cancer patient who, has been told she has 12 months to get her affairs in order. She is desperately attempting to pass her last remaining asset, an IRA or 401(k), to her minor child. This is her last remaining asset as her marriage dissolved following bankruptcy due to the financial and physical strains of the illness because she had no medical health insurance and her house was foreclosed on. The child is 12 and the ex-husband and surviving family are predatory. An IRA fixed immediate annuity payment provides her some income over her remaining life and then to the remaining life of her child. The surviving family will not able to dissipate her child’s inheritance because of the annuity’s structure.
If you think I’m just making these cases up, I assure you, they are very real. And, anyone who believes that these things just can’t happen to them because they have somehow, acquired a “special standing” with God, are self-delusional.
The clients of Bernard Madoff, individuals much brighter and infinitely more intelligent than you or I, or any financial planner I know, surrounded by the most highly paid financial advisors in the country and hundreds of computer geeks stilled learned the hard way that bad things can and do unexpectedly happen to good people.
Fixed immediate annuity contracts aren’t just about, a “guaranteed income stream” planning, or inflation unadjusted payments or “investment” choice option competitiveness or high returns vs. low returns, fixed immediate annuity contracts are the only financial product available to retail consumers that are designed to “preserve” the family or the family unit. The family is preserved via the “wealth” of the future income the contracts provide. That’s what fixed immediate annuity contracts do. They preserve the fabric of the family.
There is a group of people out there who can give upwards of 50 billion reasons why they would today favor the security of an annuity contract over trying to make their own stream of income.
Annuities work for the overwhelming majority of retirees who have social security as their only form of defined benefit. Lump sum payouts in the hands of the average person tend to disappear on things unrelated to retirement. Our DB plan does not allow lump sum payouts. We don't want people to work for 20+ years and within a couple of years, have only social security because they blew their retirement nest egg.
I was disappointed in your story on annunities. My husband and I are in our early 70's and have been urged to buy an annuity. Your report did not say much about what happens if an insurance company fails or the percentage of fees payed over the life of an annuity. The reporter said to check the ratings of the companies, but certainly over the last year we have learned that sometimes rating don' mean very much.
Last year I earned $83,000 in dividends on about $1,000,000 in investments. This year, my investment portfolio is about half the size of last year, yet I still earned about $83,000 in dividends.
Why would I give up all control of my investments and potential future gains so that I could earn about 60% of what I can do on my own? I seem to
have done pretty well making my own guaranteed stream of income.