If you’re looking for lifelong income, you can bet the annuity industry has your number. The pitch is easy – plunk down your hard earned cash and we’ll give you an income stream for as long as you live. Of course, you do realize that a big chunk of that income stream that you will be receiving is actually your own money and the guaranteed payments are based on a formula that pays out just a little more than you would received from a government bond.
Worse, most annuities come with a restricted period during which you cannot liquidate your annuity if you wanted to get out of it, without paying a serious penalty. That serious penalty is the commission that you handed over to the broker that sold you the annuity.
Now, back when interest rates were higher, things worked in your favor. You got nice returns – enough to cover the serious upfront commissions and then some. There are two types of annuities, Fixed and Variable. Fixed Annuity payments are made to you based on three factors. How much you put in, how long you’re expected to live and the market rate of interest.
So, if interest rates are high when you sign up, you got the benefit of higher payments combined with your own principal. Over the past decade, rates have crashed and stayed low and so have the returns from annuities. In a low interest rate environment you DON’T want to even thing about an annuity, as your monthly payment will be lower. You’re better off putting your cash in a highly rated income fund knowing that you will receive payments and whatever is left over will go to your heirs or if the need arises, you have the flexibility of pulling money out. Of course, the annuity pitch men will tell you that your money is at risk in the market and that is why you should opt for their meager paying guaranteed annuity. Truth is that you are paying dearly for that guarantee with a lower standard of living.
Then there’s the Variable Annuity, which allows you to invest your funds in a mutual fund type product with a thin insurance component. Basically you are guaranteed a monthly payment plus whatever the return might be from the income generated form your portfolio based on how the insurance/annuity company invests your money. Your guaranteed minimum payment comes from your own money you put into your annuity and the additional funds, well, if your investment manager stinks, so will your chance for any significant additional income. Remember, these managers need to invest in a risk averse manner so as not to lose the principal amount and that means they are not going to be providing the types of gains you see in the market and hopefully not the types of losses either. What you will pay for this “service” of returning your own money to you is a fat commission of around 7% or more at the outset plus whatever management fees are deducted by the fund managers.
A better idea would be to invest the cash your self in a highly rated mutual fund or an Exchange Traded Fund with a low expense fee and save yourself the commission. If you want to have guaranteed money left for your spouse or children, buy a low cost term insurance policy along the way. You can replicate the results or even better the results that annuity companies promise you…and without having to pay for the privilege!
To your wealth,