I Hate Annuities – I Love Annuities

The financial world has seen an explosion in the annuity marketplace over the last 15 years. With the Baby Boomers coming into retirement at the rate of 10,000 per day the insurance companies have not missed the opportunity to design, market, and sell record amounts of annuities – both in contracts sold and premium dollars paid – during this timeframe.

The proposals that are coming out of Washington to enhance the scrutiny of the sales of annuities have been grabbing the attention of not only the financial and political media – but also the general media. The concerns stem from the sales of annuities to those that do not fully understand all the contract language – especially the terms related to lengthy and stiff penalties if a contract owner changes their mind and wants out.

Truth is that even for a 25 year veteran of the financial services industry the annuity model of today is very difficult to understand. The complexities of how interest is calculated makes even the most seasoned veteran pause. Therefore the chance that an average consumer – even one with superior intelligence – will understand all the nuances of the contract is slim. At the beginning of my career – in the late 1980’s – an annuity application was 2-3 pages. Today they are 30-50 pages!!

When you shift through all of the rhetoric surrounding the annuity designs of today – they still offer what no other investment can – the peace of mind that a guaranteed lifetime income stream can offer. The term annuity comes from Latin which meaning “per annum”. The first annuities were issued to Roman soldiers as a way to compensate them for their service to Rome. That is why no matter what the press or competitors say about annuities – “I Love Annuities” – as long as the purchaser understands that they are getting something very special in the security of the income payment but they are also paying a price for that security – proving the old adage that “there is no such thing as a free lunch”.

The challenge for the consumer is the only way to “beat the insurance company” and “get into their pockets” is to live a long time – well past your life expectancy. A typical annuity will take the balance in your annuity policy – factor in your life expectancy (or the life expectancy of two people in the case of a joint life annuity) – and offer you a payment that you cannot outlive. Let’s look at that a little deeper.

Take for example a couple that are both 73 years of age. Let’s assume that they give $150,000 of premium to an insurance company in exchange for a monthly income check that will last as long as they do. That monthly check will equate to about $850. If you assume that the insurance company will earn 3% on the funds that it holds on your behalf – it will take just over 19 years for that pot of money to deplete to zero. One of them will need to last until 92 years of age before the insurance company is “really on the hook”. If they both die prior to that – the insurance company wins. On the other hand if one of them lives to Age 100 – this annuity might have been a wise buy. This is why “I Hate Annuities”.

In the Safe Money investing world there are a host of options that can create safe, sustainable, monthly income without the need to give up control and access to the principal. This takes some discipline and prudence on the part of the investor – not to spend foolishly – this is what the allure is all about in the annuity world – it’s like “buy an annuity and we will protect you from yourself”. This definitely appeals to some consumers – especially those that are not savers and have some issues surrounding their spending habits.

In conclusion the decision of whether to purchase an annuity or not rests more on the habits and the longevity of the purchaser. There is no such thing as a perfect investment – one needs to give to get. In the equity markets you need to give the safety of your principal to get the opportunity for nice returns. With annuities one needs to give up some control and flexibility in order to get the security of principal and the potential to receive a “check” for the rest of one’s life.