Annuities are a way of investing your money so that you are guaranteed to receive a set income for the rest of your life. Many financial experts champion these financial products as a realistic portion of your retirement plan.
However, many people who should be buying them aren’t opting to do so. Less than $200 billion of annuities were sold in 2012, as opposed to the trillions of dollars that are invested into 401(k) plans. In years past, people had pensions from big companies like the “Generals” i.e. General Motors and General Electric. Under these pensions the company set aside money and was under contractual obligation to provide an income for the retiree for the rest of his life (and often for the rest of his wife’s life as well). But times have changed. With the advent of Individual Retirement Accounts the “individual” became more responsible for his (or her) investments and the guaranteed income became a dinosaur. Thus individuals were subject to the whims of the market.
The Risks of Living Longer
Annuities are basically a type of insurance plan for seniors who might otherwise out live their savings. This concept is known as “longevity risk” —we all want to think that we’re going to live a long time, but the danger is that this long life could end in poverty if we live too long.
The number of centenarians (people living to over 100) is rising drastically and nearly 20% of people who make it into their 60s are now expected to live into their 90s. This means that planning to not outlive your savings is growing in importance. If you happen to become one of those venerable centenarians, then you could be retired for more years than you actually worked!
Annuities Can Be Complex
One of the main reasons that seniors aren’t buying annuities is because they don’t understand them. Although the concept is simple, individual annuity products can be complex because of the many variations and “riders” that can be added. It seems that each company offering annuities has their own variation, so it is difficult to compare one product with another.
Therefore, it’s probably in people’s best interest to talk to a financial adviser about annuities when considering your retirement options.
Stocks are an Attractive Alternative
One of the basic rules of investing is that risk is generally proportional to returns. In other words, people require greater returns in order to be willing to take bigger risks. Annuities are very low risk so the guaranteed return on them is typically fairly small. That is why people looking for larger returns often look elsewhere. But because of the low risk and guaranteed lifetime income, annuities can be the perfect investment in certain situations.
If invested wisely, playing the stock market can yield more than your typical annuity while also leaving cash for your children (or your children’s children) when you pass on. However, as many people learned in 2008, rolling the dice on the stock market means you have to deal with the often-volatile market, where your fortune can also be lost just as easily as it can be won. Do you want to take that risk?
If you are looking for a safe way to ensure that you have a guaranteed income for life, an annuity might be just what you are looking for. Plus some annuities can allow for growth based on how much is earned in the stock market by professional investment advisers. So you don’t have to give up all of the possible appreciation and you can have professionals managing your investments as well.
The whole point of retirement planning is to distribute your risk in such a way that you get some stability in your old age. If you risk all your money in the stock market, though, you’re gambling with your future.
Annuities Don’t Look Great for Women & Couples
At first glance, women get smaller payments than men would. This is because women live longer, on average, than men do, so although the checks are smaller they generally get them for three (or more) years longer than men do. So in the long run it balances out. Married couples get lower payments for a similar reason — statistically speaking, one of the two members of the couple will live to 90 years old. And by virtue of being part of a couple, they’re statistically likely to live even longer. Typically for couples; “joint life” annuity payments are set up so that payments will continue as long as either spouse lives. But you might want to discuss the option of dividing the initial investment into two parts and getting separate annuities for each partner rather than purchasing a single annuity “joint life” annuity. The payment on each half will be larger but if one partner dies their annuity payments will stop. So you need to run the numbers to see which would suit your situation better.
Nothing Gets Left for the Kids
One definite downside of annuities is that the payments stop coming when you pass on. Therefore, if all your money is tied up in annuities, you’ll be leaving zilch for your heirs. With a little thoughtful planning, though, this can be avoided. You can annuitize a portion of your assets and leave the rest in bonds or CD’s or the stock market so it can either be used for emergency purposes or for inheritance. There are also certain types of annuities (called “period certain” annuities) that will continue to pay for a fixed period even after the purchaser’s death. Or an Annuity combined with a separate lifetime insurance policy can provide the best of both worlds completely guaranteed, the annuity provides the income and the life insurance provides the inheritance. Also there are annuities these days that have “riders” that allow you to withdraw a fixed percentage every year without touching the principal, so you can even pass on the principal and spend the income.
Post-Retirement Poverty isn’t a Fun Topic
The point of annuities is to create a guaranteed cushion against post-retirement poverty. Unfortunately, this isn’t a concept that most people consider or really even want to entertain; ignorance ostensibly is bliss, after all. However, this is a very real possibility, and the less someone fails to consider it, the more likely it is to happen. Poverty rates skyrocket after a certain age, no doubt augmented by the incredibly high costs of medical care.
Therefore, it might be prudent to give the whole annuity concept another thought. Have you started planning for retirement? If so, are annuities part of the game plan, or have you decided to invest your hard-earned cash elsewhere?
See Also:
- Life Insurance and Annuities: The Secret is the Bottom Line
- Organizing For Your Retirement
- How to Choose a Financial Advisor
- The Truth About Annuities
Image via Flickr by MrHicks46
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