Annuities

Annuities - If You Don't Want to Outlive Your Money

Annuities are insurance-like contracts. You give an insurance company some money. The company invests your money for the time you specify and then pays you, based on the principal in your account, for the rest of your life.

The two main types of annuities are deferred or immediate.

With a deferred annuity, either a lump sum or periodic deposits are allowed to grow, sometimes for decades. The longer the period, the more money your investment should earn and the bigger the payout will be when you start drawing your annuity down.

An immediate annuity starts paying out at the beginning of the next payment period. If you pick monthly payments, your first check comes in a month – if yearly, the check will arrive the next year.

Of course, an immediate annuity does not allow for much growth in your investment. The insurance company will use actuarial tables to determine how much your payments will be. If they guess wrong, they make up the loss on your contract by gains on contracts of those who died earlier than predicted.

[Many experts feel you should take a pass on immediate annuities.]

The payments you receive will be based on your life expectancy at the time the contract is prepared and will not be indexed for inflation.

Also the implied rate on most annuities is only 4 or 5%. You should be able to do better than that with a simple no-load index fund, while avoiding all the fees and expenses associated with an annuity.

The only advantage is that you won't outlive your money, as little as it may be worth 10 to 15 years from now.

An annuity can also be fixed or variable.

For a fixed annuity, the insurance company will guarantee a rate that you will receive for a certain period, at which point the rate will be recalculated. There is also a fixed annuity that is tied to a stock market index. Your returns will be governed by that index’s movements, although you are usually protected against loss if the market tanks.

Variable annuities allow you to pick you investments. You will be offered a choice of investments that resemble mutual funds – in some cases they will carry the same names as publicly traded funds – but which are only available to investors in that particular annuity.

You should have a wide choice of stock and bond funds with different objectives – growth, large cap, etc. The insurance company is placing the success of your investment on your shoulders.

If you are dealing with some of the better companies, the offerings, as I said before, might bear similar names to known, publicly traded funds. You will be able to get some idea of the track record of that particular fund.

If you’re offered the choice of investments that carry unrecognizable names, it may be more difficult to make the proper choice. In that case you have to rely on the statistics that the company provides.

There are some advantages to annuities: you can contribute to them without limit: your money grows tax free: your money is protected from creditors: and upon withdrawal you only pay taxes on the growth in the investment.

Deferred annuities carry a life insurance component, so that your heirs get back your investment if you die early – before the annuity stage starts.

When it comes time to pay, you can ask for payments for your lifetime, for your lifetime, plus the lifetime of another or for a fixed period. If you don’t want the insurance company to keep all your money if you die close to the inception of payments, the later are better choices for you.

Also, the IRS is more lenient with minimal withdrawals than they are with traditional IRA’s and 401K plans. Disadvantages of annuity include: high fees, which include sales charges, maintenance fees and insurance premiums. If you’re investing in a variable annuity, you are adding another layer of management fees to the costs of the “mutual funds” you pick.

With deferred annuities, there can also be long periods during which you will be penalized for withdrawing money or canceling the contract. Some contracts allow the insurance company not to credit you account with earnings until this period, which can last seven to ten years, is up.

There have been a lot of scandals, followed by class action lawsuits, against major insurers in this field, mainly having to do with the way this product is marketed and “flipping” by agents to generate fees.

An annuity is a helpful tool, especially if you worry that you will outlive your money. But it is expensive – maybe too expensive for most people. The flipping problem shows how a supposed safe investment could turn into a costly mistake.

Agents would convince their clients that a new annuity they were selling was much superior to the one they already owned. The agents would try to talk them into buying the new product, even if the client would be penalized for premature cancellation of the account. Usually the client was promised he would more than make up for the loss with the growth in the new annuity.

Many people saw years of earnings disappear, usually for the same or even an inferior product the agent was pushing. Some of the companies selling these annuities failed do to poor or dishonest management.

If you feel you want or need an annuity, shop carefully. This is usually easier said than done, because these products are sold by agents who want to close a deal, not provide information.

But you need to find a financially sound insurance company that is offering a product with reasonable fees and, hopefully, some guarantee of at least minimal growth, no matter what happens to the markets or interest rates. In this field I wouldn’t settle for some no-name company. Stick with names you know that carry the highest ratings – I would rather deal with Metropolitan or New York Life than some company I never heard of.

There are many bells and whistles that come with each annuity. You might have to compromise on some issues to get what you really want.

The language of insurance and annuities can be confusing and arcane. If you don’t have the desire or ability to plow through the turgid language, hire a fee-based Certified Financial Planner and let him or her translate everything into English for you.

Don’t allow yourself to be bullied by a high pressure sales job. There can be a lot of money at stake and you want to get the best deal possible.

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