You Shouldn't Be Dying to Buy Annuities

Every few months Barron's publishes a feature article telling readers about The Best Annuities. Should you be interested in buying a product that can provide lifetime income without stock market risk? For almost everybody the simple answer is, No. Why then are annuities one of the most purchased products from financial advisers? The easy answer? Commissions on their sales are about the highest paying thing advisers can foist on their clients. A typical annuity pays 6% of the principal as an upfront payment to the salesperson. When you spring for a $200,000 annuity, the commission can be $12,000. On a million dollar buy that jumps to $60,000. No wonder they are so motivated to recommend them. The first thing to know when considering these products is that nobody lives forever. Our Social Security department says a 65-year man will likely live an additional 19.3 years, to 84.3 years old. A woman of 65 can expect to average an additional 21.6 years. Annuities are sold in a very deceptive manner. Most salespeople like to compare the percentage income you can make in risk-free investments like treasury bonds or bank CDs vs. what their annuity products will pay you. What they fail to mention is that, in most cases, neither you, nor your heirs, will ever see your principal again. That's not the case when you buy treasuries or CDs. The following graphics, detailing the best annuities Barron's could find, are useful in illustrating my points. Barron's highlights the guaranteed income for life feature of a $200,000 immediate annuity bought by a 70-year old man or woman on just their own life (not based on second to die). You'll be told that if a man simply bought a 2% CD, his annual income on $200,000 would be just $4,000. They'll then ask, Wouldn't you rather have $13,500 or so of spending money each year? At first blush that seems like a no-brainer, right? Remember, though, with a CD you'd still have $200,000 in principal due you on expiration day. With the annuity you won't get anything back at the end -- nor will your heirs. Keep that in mind as I explain the alternative to buying that annuity. If you simply withdrew about $13,500 each month of your starting $200,000, you'd owe no tax on that money, as it is not income. If you never earned one penny of interest, you could have the same lifestyle as the annuity buyer for at least 14 to 15 years. Assume even modest earnings on the money not yet withdrawn and that time frame would extend more than 20-years, to beyond age 90. Half the men would statistically have expired before collecting 100% of their money back from the bank or the insurance company. Few can expect to live beyond 90. In the unlucky case where the annuity buyer died relatively young, his family would be deprived of all future income from that annuity, as well as whatever might have been left of the principal not spent. Ouch. If a realistic return of 5% to 7% was achieved on the original $200,000, it's very likely that at least some of the money would have lasted longer than the man. Deferred annuities are another widely sold product. With these you put in a lump sum, but wait to start collecting until years into the future. It's a similar concept to deferring social security payments from 62 or 66 to age 70. By foregoing years of income now, you'll qualify for more per year later, but for a reduced period of time. Barron's examples show the same $200,000 initial investment sitting untouched, from purchase at age 60, to when monthly payments begin at age 70. The annual income for life numbers might seem tempting until you understand what you could have done without tying your catch up in that product. Simply investing at 4%, 6% or 8% annualized, well below what stocks have provided over the long run, your $200,000 would have grown to between $297,773 and $441,608 by age 70. Total annual available cash, including drawing on what is still your principal, would be generally higher, starting withdrawals at age 70, than the annuity payments would be. Plus, whenever the annuitant dies, that money can be passed along to heirs, rather than forfeited to some insurance company. Barron's also covered a third type of annuity, which it called personal pensions or longevity insurance. These plans involve buying annuities many years before finally beginning to take income staring at an advanced age, like 80. Keep in mind, the average male will only live four or five more years beyond 80. Taking in $40,000 to $45,000 annually sounds like a lot until you realize you might not collect it for very many years. What could that cash have been worth simply by investing it employing the DYI method? The amount of $200,000, left alone for 20 years, would grow to between $443,343 and $975,088, depending on rates of returns of just 4%, 6% or 8%. At that point the money would be throwing off substantial income while still growing over time. Annual draw downs from those account values would outdistance what the annuities offer while preserving your principal for heirs or charity. Remember, too, that Barron's showed only the best paying annuity choices. Many companies offer much worse terms than showed. There's a reason annuity issuers pay such high fees to salespeople. Getting your money and feasting off the meager promised returns (to buyers) is a huge money maker for them. When you see the ads for Crash-Proof Retirement on CNBC ask yourself, How can they offer risk-free returns of 4% to 9% annualized in a zero interest rate policy world? That firm is probably among the very worst offenders in terms of offering what no longer exists in nature. Yet the consumer protection bureau does nothing to stop their deceptive advertising. You have a 99% chance of doing better on your own than you do by purchasing annuities. Don't get fooled by the sales pitches and hard sell techniques. I was insurance-licensed back in the 1980s and 1990s, but I never sold any annuities.

You Shouldn't Be Dying to Buy Annuities

Here's some investing advice you can live with: You have a 99% chance of doing better on your own than you do by purchasing this misleading product.

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