When we think of Annuities, we think of a stream of payments that begins after retirement and generally continues for “X” number of years this is called an “Annuity Certain” . In a “Life Annuity” you pay a fixed amount up front and receive a series of payments for the rest of your life no matter how long that may be. However, the technical definition of an annuity is any stream of regular payments so actually a mortgage is actually an annuity certain except rather than being the recipient you are the “issuer” and the bank or mortgage company is the “annuitant”.
The thing that makes a typical Life Annuity unique is that the issuer does not know how long the payments will continue, since it all depends upon the date of death of the annuitant. At this point the contract terminates and the remainder of the funds are forfeited although provisions can be included in the contract for other annuitants or beneficiaries. Although that will generally reduce the monthly payments that the annuitant will receive. Thus a life annuity is actually a form of longevity insurance, where the risk of providing income over a long lifespan is transferred from the individual to the insurer. This is the reverse of a typical life insurance policy which is actually “death insurance” since you are hedging against an early death. Through both of these contracts however, the issuer reduces its own uncertainty by spreading the risk over many clients. With enough clients actuarial tables can provide an accurate estimate of the risk. Annuities can be purchased to provide an income during retirement, or may originate from a structured settlement of a personal injury lawsuit.
The problem with both Life insurance and Annuities is that they are sold by commission based salespeople. So they tend to push the products that will earn them the highest commissions… which in most cases is not the product that is in your best interest. In today’s article Dennis Miller gives us a bit of insight into Annuities and Life insurance and how to get the deal that is best for you rather than for your insurance agent. ~Tim McMahon, editor
Annuities and Life Insurance
By Dennis Miller
In recent articles for my regular weekly newsletter we’ve covered a lot of ground regarding annuities. Of course, this just has readers even more interested. In today’s article we’ll take a look at the “package deal” many insurance agents will likely put in front of you when you ask about either an insurance policy or annuity product. Many readers asked if the package deal a good deal? Let’s see.
Shopping for Life Insurance
A few years back, I decided to purchase some additional life insurance. In the process I learned of a trick up the insurance company’s sleeve – the packaged deal savings and insurance policy. I knew a likeable fellow who happened to sell insurance and I phoned him for help. I told him how much insurance I needed and he immediately began to tell me about this great new universal life policy with 6% guaranteed income.
I told him I keep my investments and insurance separate and just wanted a quote on term insurance with a fixed premium for 20 years. That is just pure insurance; if I die my beneficiaries get paid, and if I live the insurance company benefits from the premiums I paid. After much discussion, he reluctantly agreed to bring me a quote for both his universal life policy and the term policy I was interested in.
He showed up at the appointed time and predictably started his pitch about the wonderful 6% guaranteed income included in the universal life policy. I listened patiently; he even showed me the 6% written in the policy. So I asked him how much the annual premium was. As I recall it was about $1,500. Then I asked him what the policy’s cash value would be in five years and ten years, and he gave me those numbers.
Divide and Conquer
After that I asked what the premium on the straight term policy would be. It was about $900. He immediately pointed out there was no cash value build up, which I understood. Then I subtracted the $900 for the term policy from the $1,500 for his universal life policy and said to him: “If I understand this, I can buy the pure insurance for $900, so the extra $600 I pay in premium each year will be saved and invested for me?” He nodded his head and said: “That is correct.”
Let me pause here to say that what I just did came directly from one of our nine tips on shopping for annuities: split up the features of the product so you can understand each individual part.
Alright, now back to our comparison shopping. Then I took the numbers he gave me for 5-year and 10-year cash values and compared them to the $600 per year the insurance company would supposedly invest for me – the return was around 3%.
I said: “You told me it was 6% guaranteed.” He then showed me where the policy guaranteed 6% once again. I pointed out that if I could buy the insurance for $900, then the extra $600 in premium should be what’s invested. The numbers just didn’t add up.
I concluded that while they put 6% in the contract, they must charge way too much for the insurance; the numbers bore that out. A 6% payout coupled with an expensive insurance premium was a horrible deal at the time.
The agent became angry and told me I needed to look at insurance as an investment product. He was trying to guide me in the exact direction our friend Stan the Annuity Man warned us not to go.
Universal Life is a Poor Investment
I told him I did and it was a poor investment because the company over charges big time for the insurance coverage. I will confess I was also aware that the agent’s commission on the universal life policy was substantially higher than the term policy. The price of straight term insurance policies is easily compared from company to company. So, insurance companies keep their premiums and commissions on these products much lower to remain competitive. Thankfully I could see through the BS regarding the universal life policy by splitting apart the features.
Breaking Down Annuities
Whether you are buying life insurance or annuities the concept is the same. The analogy to term insurance in the annuity industry is a single fixed premium, guaranteed lifetime annuity. [You pay a lump sum and the next month you begin getting regular monthly payments for the rest of your life. There are no extras or frills. Payments may continue for 1 month or 50 years, depending on how long you live. ~editor] With each additional feature a prudent buyer needs to understand how to “run the numbers” and determine the true cost and benefit to the insured. While the policy may have some fancy language, it may not always be such a good deal as we discovered with the insurance quotes our agent gave us.
Some insurance policies are nothing more than insurance, and some combine insurance with investments. The first step in comparing the two is to determine what the real insurance costs. Then you can look at the investment portion. Many salespeople will push for the latter type of policy because they get paid a much higher commission.
As I mentioned earlier, I like to keep my insurance and investment products separate. This way I can get a better deal and more transparency into the costs and expected benefits. If you’re considering an annuity or you’re just curious, you might want to take a look at our new free report, Annuities De-Mystified. In it you’ll find the 8-point checklist to figure out if an annuity is even right for you and our 9-point plan showing you what to look for when buying an annuity. The report also includes an important overview of the risks associated with annuities – risks that agents won’t often voluntarily tell you about. Here’s the link for a copy of the report.
See Also:
- Term vs. Whole Life Insurance – What Should You Choose?
- The Differences Between Term and Whole-Life Insurance
- Annuities for Retirement
- Planning Your Estate: 6 Things To Remember
Resources
“Insurance – be careful how you define it” by Alan Cleaver