WHAT TO KNOW ABOUT TODAY'S MOST POPUAR ANNUITIES, They promise income ... at a price

[scotcfeld]

Regarding the article in the AARP Bulletin in the January / February edition: "WHAT TO KNOW ABOUT TODAY'S MOST POPULAR ANNUITIES, They promise income ... at a price" by Karen Hube my comment is as follows:

The biggest issue is only tangentially mentioned.  The conclusion of most annuities is the surrender of your money / investment when you die.  If you outlive your actuarial age, then you have nothing to lose, and would have profited from receiving more than your investment, at the expense of those who die earlier than their actuarial age which IS mentioned in the article.

But the comparison that is not mentioned is that you could conceivably, ON YOUR OWN or through a financial advisor, make investments that could mimic annuity returns.  The difference is that your own investment stays with your estate when your die.  If you have no heirs and don't care about family or generational estate planning then this is fine.  However, if you do care about family or generational estate planning then an annuity may be WRONG!!

Now it is true that you could buy an annuity and include the purchase of a life insurance policy FOR YOUR ANNUTIY INVESTMENT (not for you but for your annuity investment) for your heirs , but this is obviously, or should be obviously expensive.

Let me provide an example.  Today, you could buy 30 year US bonds - AT NO COST - directly from the government, today paying approximately 4.7% annually.  In 30 years, the bond matures and you get your investment, your money back.  Clearly no cost is better than some cost.  And if necessary, you have the option of early redemption if necessary. Early redemption would be adjusted for any change in interest rates when / if you decide to redeem early, so you could make money or loose money on early redemption. (I have used US Treasuries in this example. A 20 year GM bond is currently quoted at 6.75%, clearly not as safe as a US Treasury).

The difference is knowing this is possible and available which is where I fault the article. Clearly, for those without financial knowledge, an annuity is buying expertise at a SIGNIFICANT price, that a financial advisor could provide.  The difference is, even if the cost of the financial advisor is equal to the cost of the annuity, you retain YOUR MONEY when you die so your heirs can inherit it.

One additional pet peeve I have with annuity products is that they are legally allowed to provide somewhat MISLEADING information.  Typically, they don't mention that if you are guaranteed a 4.7% return / payment, that return implicitly includes the return of your investment.  So ... which is better:

4.7% US Treasury bond where you receive your investment back in 30 years, or

4.7% annuity, but when you die, you lose / surrender your investment?

If you want to take advantage of potential stock market gains, the average stock market gain has historically been far higher than any annuity.  However, certain annuities do provide a floor on stock market losses, WHICH IS THE ONE FEATURE only available with annuities.

Annuities are useful for people who want a simple lifetime solution and who don't have financial expertise - a broker, or don't avail themselves of financial expertise.  But there is a significant cost associated with annuities.

[Tonster521]

@scotcfeld, I understand your concept. However, you are comparing two different income streams which will not have the same results. Generally, a retired person buys an annuity for income and transfers the risks associated with obtaining that income to an insurance company. Many use an annuity because they do not have a monthly pension. For many folks, annuity payments are based on life expectancy which includes gender as opposed to a time based payout (i.e., 10 years, 20 years, etc.) For illustration, I obtained a quote for a Single Premium Immediate Annuity (SPIA) for $100,000 for a single male age 65 payable for Life with a Cash Refund. This annuity will provide $603/month or $7,236/yr after a 1 month waiting period. If that person dies before receiving $100,000, any remaining amount is paid to a beneficiary or estate. 

Based on the alternative that you provided (30 year Treasuries at 4.7%), one would receive only about $392/month or $4,700/year based on a $100,000 investment. That is about $211/month or $2,536/year less than the annuity. To equal the same income stream as the annuity ($7,236), you need to buy/investment $153,957 of 30 year Treasuries at 4.7% which will cost you $53,957 more than the annuity. If you keep your Treasury investment at $100,000, you will need to sell Treasury Bonds each year to obtain the difference ($2,536) between the income from the annuity and interest earned on the Treasury investment. Selling Treasuries will take on bond market risk which means you may be selling the Treasuries for a gain or loss. Selling at full value (which is almost impossible to do) will provide about a 22 year income stream before the Treasuries reach zero (all sold). 

In summary, you are comparing apples and oranges. Or, saying it differently, comparing two different income streams ( $7,236 for annuity vs $4,700 Treasury interest) or two different initial amounts ($100,000 for annuity vs $153,957 for 30 year treasuries). 

[RN362636]

There are several types of annuities available. Another type is a MYGA (multi year guaranteed annuity). They work much like a bank CD. You invest a specific amount of money and you are guaranteed a specific interest rate for the entire length of the contract which is most often 3,5,7, or 10 years. They are not lifetime contracts like many other annuities. Much like a bank CD, if you break the contract and want your original investment earlier than the stated contract there is a penalty. Many contracts offer interest to be paid annually or 10% of the contract amount. Tax is not owed until the interest is actually withdrawn; it gives one a way to control income and therefore when tax is due as well as avoiding possible IRMMA charges for Medicare. If you die you don't lose your investment. The full contract value as well as interest is paid to your named beneficiary. MYGA annuity rates in the past couple of years have been 6.5% but some have since decreased. MYGA annuity rates are almost always better than bank CD rates but similar in function. Every state has a State Guaranty Association which usually guarantees up to $250,000 which is similar to FDIC coverage at a bank CD. I wouldn't invest more than the amount covered by the Guaranty Association. If one invested $100,000 in a 10 year MYGA at 6.5% the interest earned would be $6,500 per year ($541 per month). The interest rate is guaranteed for the length of the contract which is not the case with other annuities such as an index annuity. At the end of a MYGA annuity contract you have a choice of getting your entire original investment returned to you, sign a new MYGA contract or turn the money into a lifetime contract which I would never do personally. A MGYA is the only annuity that I am aware of that doesn't have a high commission ( up to 9-10% of your investment amount). A 10% commission would mean that the salesperson would get 10% of your $100,000 investment ($10,000) as a commission right off the top. That is probably why most investment advisors will try to talk people out of a MYGA; it decreases their income! There is a small commission associated with a MYGA annuity, but it is paid by the insurance company, not you. Your entire investment is included in your contract. With a MYGA there is no associated bond market risk, gender or life expectancy associations for interest rates. They aren't a bad deal for someone who doesn't want to tie up their money for 30 years or a lifetime and wants some sort of guaranteed income for a set period of time.