Annuities: All They’re Cracked Up to Be?
As the life expectancy of Americans continues to soar, more people are searching for ways to also extend the lifetime of their investments. One popular investment vehicle, used as a source of guaranteed lifetime income and a hedge against outliving assets, is the annuity. An annuity is a contract between you and an insurance company in which, in return for a lump sum payment or series of payments, you receive regular disbursements, beginning either immediately or at some point in the future.
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Before you rush out and starting buying annuities, however, it might be prudent to take a little time, do some research in order to understand the pitfalls of this particular investment vehicle. In his recent article: “Annuities vs. Bonds: Do the Math,” Elliot Kass at www.financial-planning.com questions whether annuities are indeed the best investment. He’s backed up in this regard by Brian Rezny, a fee-only financial planner at Rezny Wealth Management in Naperville, IL, who argues that annuities are not only inferior but expensive.
Why? First, Rezny points to a 3% or less return on a 25-year investment with no inflation protection. Then, he argues, while an annuity may offer an investor income for life, that income never increases. And given today’s levels of inflation, this means a return of less than 3%.
Another point by Rezny: the money a client does receive is generated from the money they used to initially purchase the annuity. Since it takes around 15 years for an investor to get their money back, this does not bode well for older clients. “If a client purchases the annuity at age 65, then he would be 80 years old before he actually begins seeing a return on his investment,” says Rezny. “Clients who live only to 81 or 82 would see almost no return at all.”
Then there are the fairly hefty costs of holding annuities, ranging between 3.5% and 5% a year and further diminishing the returns. A retiree whose annuity is earning between 5% and 7% (a fairly typical range, according to Rezny) is only receiving between 1.5% and 3% a year after expenses. Although they’re structured and sold a bit differently, both the expenses and the returns are similar for variable and hybrids. Most of his clients, says Rezny, would be better off simply buying U.S. Treasuries, which are far more secure and for which they would get a similar return without locking up their money for 20 years or having to pay surrender penalties.
At CAIM we agree that annuities pose a number of problems. Not the least of these are lack of transparency, lack of liquidity, high costs and a lack of protection against inflation.
