Tuesday, May 3, 2011

Why buying an annuity may NOT be a good idea, right now.

With 8,000 baby boomers turning 65 every day this year, it seems fitting to take a look at annuities as one option for guaranteeing a life-time income stream in retirement. Annuities can be especially helpful to women who typically outlive their spouses, who may have less retirement savings and lower Social Security benefits, and who may end up on their own living into their 90s.
An article this week written by Wall Street Journal personal finance writer Brett Arends caught my attention. I like Arends because he digs deep, backs up his assertions with lots of data and presents the materia in a clear and readable way.
With banks paying nothing on "safe" CDs and savings accounts, with bonds looking more risky if interest rates go up and stock market investing always a worry, many turn to annuities. These policies basically mean giving an insurance company a chunk of your money to invest. In return, the insurance company promises to pay you a monthly amount for the rest of your life.
First there are many variations of this concept with lots of moving pieces. Basically the insurance company is betting that you will die before they have to pay you more than they can earn on your money. If you die they (usually) keep the rest of the money with no residual going to your heirs. And there's typically an upfront 5 percent or so commission to the broker who sells you the policy.
Annuities have some appeal: Someone else manages the investment and pays you a regular fixed amount...no muss, no fuss. Twenty years ago, according to Arends, annuities were a good deal.
Right now, may not.
Here's why. Annuity payout rates "have slumped," he says.
If inflation picks up (and it's just a matter of time) the "fixed" income from an annuity is not going to keep up with cost of living increases.
Arends uses the example of a retired 65-year-old woman who invests $100,000 in a fixed annuity today.
"According to http://www.immediateannuities.com/, a comparison Web site, that will buy her an income of $590 a month, or about $7,000 a year," he writes. "Ten years ago, she would have gotten nearly $9,000."
Today's annuity rates are "artificially" depressed, Arends says. That's because the Federal Reserve has taken extraordinary action to keep long-term interest rates low.
The inflation factor
Inflationary cost of living increases have averaged 3 percent a year for the past 30 years. So if inflation picks up to say 2.5 percent a year, the buying power of a $100,000 annuity will fall from $590 a month to $360. If inflation ramps up to 5 percent, the "buying power will fall to $220" a month, Arends reports.
It turns out that inflation is not the only issue. "The insurance companies," Arends says, "that provide annuities typically have high costs, from administration to marketing. Sales staff often pocket the first 5 percent of your investment as commission. Those costs mean your returns are lower than they would be otherwise. And as payout ratios fall, these costs have become more important in relative terms, not less," he said.
So what to do? Again, there are no easy options. Here's what the experts say:
Option No. 1: Wait until interest rates get better before buying an annuity.
Option No. 2: Trust the S&P 500 to go up over the long term like it has been. Put your money there, take out less than the investment earns.
Option No. 3: Keep working. That means you collect a bigger monthly amount from Social Security when you do retire up to age 70.
Arends talked to investment advisers who suggest "limiting your annuity purchase or staggering with multiple buys over several years in case rates rise."
What questions should you ask before buying an annuity. Here are 7 questions to ask from http://thewisebuck.com/.
No. 1. Is the annuity agent independent?
No. 2. Have you done some comparison shopping and considered all of your options?
No. 3. Does the rate on a fixed annuity look too good to be true? You want a competitive interest rate at renewal time.
No. 4. What are the annuity’s surrender fees and how long are they in place?
No. 5. What is the track record of the funding options offered in a variable annuity? Don’t be swayed by last month’s top performer. Look for strong returns over a three-to-five-year period or more.
No. 6. Does a variable annuity offer multiple funding options in case you change your investment strategy a few years down the road?
No. 7. What is the insurance company’s rating? Is it financially secure with a good claims paying record?
Just remember that insurance companies and their agents have a vested interest in selling you an annuity. It may not be in your best interest, especially right now. In my personal experience, the worst example is when my mother was sold a variable annuity when she was in her mid-80s. Since then the payout value of the policy has been cut from $50,000 to $40,000 at her death and the value of the money left in the policy is down to $13,000. She invested $50,000. Now at 96, she's gained nothing from this policy and may soon have to pay into it to preserve the death benefit. Sigh.
Here's what the federal Securities and Exchange Commission says about annuities, click here.

No comments:

Post a Comment