Why I’m not a fan of Annuities

While perusing finance articles I came across one from MarketWatch called “Why don’t retirees like annuities?“. The article touched on the most common issues that annuities are not flexible, can be complicated to understand and laden with excessive fees. Without a doubt these are serious concerns for investors but the article did not address an additional concern I have with the total actual payouts.

Annuity salespeople are extremely pushy. Besides sidestepping any disclosure about commissions and fees they also dodge the question of how much money will actually be paid out over a lifetime. Instead they redirect you to a % that your money will return and how great it is because you can’t get a guaranteed income at that rate anywhere. But who exactly is it great for? You, the Salesperson, or the Insurance Company?

To answer this question lets look at an example where I have $100,000 I would like to invest into an immediate annuity. I head to my local annuity store and they provide me the following table:

Depending on which age I chose the annuity, my $100K investment will pay out a guaranteed rate of 5% to 6% for rest of my life. Sounds pretty good but the key words here are “for the rest of my life” and exactly how long is that?

I’m going to be generous and use pre-covid U.S. Life expectancies of 76.61 for males and 81.65 for females. We can also look at the region with the longest life expectancy (Hong Kong) with 82.38 for males and 88.17 for females. We can now compare these to the highest payouts for each annuity age bracket.

Life Expectancy Age76.6181.6582.3888.17
Immediate Annuity at 60$83,116$108,337$111,990$140,963
Immediate Annuity at 65$66,734$95,704$99,900$133,181
Immediate Annuity at 70$39,977$70,459$74,874$109,892
Table: Anticipated Lifetime Annuity Payouts for a $100K Immediate Annuity

In most scenarios you do not even get back your base investment. Assuming you are extremely lucky and get to age 88 the largest payout is ~$141K and that amount is over 28 years which equates to a growth rate of just 1.25% per year on the initial $100K investment.

Unless there is a medical breakthrough that allows us to live well beyond the age of 100 it appears the only person that benefits from this deal is the insurance company and it shouldn’t come as a surprise. First they are a business an need to make profit, second they employ actuaries that analyze your life expectancy risk and adjust your payouts to that risk.

Recently the House of Representatives passed the Secure 2.0 act which will allow annuity offerings in 401(k) plans. One of the bill sponsors,  Richard Neal, D-Mass., spoke on the House Floor on March 29, 2022 stating the act “…is protecting Americans and their retirement accounts.” Of course the question is protecting us from whom? Not the insurance companies that’s for sure. As a note, I am not railing against the good U.S. Representative Richard Neal, for the most part I thought the act introduced some welcome changes to the 401K system (like auto-enrollment). However you can see insurance lobbying influence with the annuity aspect.

One might argue that annuities benefit those who have little financial knowledge or financial self-control. This is a pretty good argument as many of us know quite a few financially irresponsible or illiterate people but there are other alternatives. The mutual fund industry has what is referred to as managed payout funds that solves the issue of figuring out how to do drawdown and sends you a monthly check but still allows you access to your investment.

The problem with managed payout funds is they were introduced during the worst time of the financial crisis (circa 2008) and it was for a market (baby boomers) who had yet to begin retiring. As such they have not really gained traction over the years and are not offered in 401K plans. My biggest issue with these is they are modeled on old outdated portfolio allocations of bonds with some equities all based on their other mutual fund offerings. There are so many more income sources they could employ (REITS, utilities, dividend growth, or covered calls to name a few). If the mutual fund industry adjusted their portfolio mix to include some higher yielding or dividend growth components it might be the best solution today. But alas there is little to nothing out there that fits this bill so I will continue to manage my own assets to generate income as annuities are a benefit to only the insurance company.

2 thoughts on “Why I’m not a fan of Annuities

  1. Interesting perspective. Please see comments:

    “Annuity salespeople are extremely pushy.”
    Not all sales people are created equal. An annuity should be offered by an experienced qualified professional. Annuities are a serious matter and an optimal solution, especially for financially illiterate folks – most of the population. Avoid the snake oil salesmen, but maybe try to keep an open mind about annuities. They are one of the few products/solutions scholars and academics actually agree on.

    “In most scenarios you do not even get back your base investment…”
    Rates of return are easy to calibrate when an end date is a known variable. Date and time of death are unpredictable. Hence, if you plan to live 5 years, you can pay yourself 20% of your nest egg (plus a bit of interest). Live 10 years? Pay yourself 10%. Live 20 years? Pay yourself 5%. Live 30 years?3.33%. And, if you’re wrong…? Then what? Re-enter the workforce? I’m not sure anyone on their death bed decries “not having got back their investment.”

    Re: Life expectancies…
    These figures are a “moving target” and are often misinterpreted. It’s why an experienced professional should be consulted. “Life expectancy” represents averages at a certain age/time. Real life numbers can and do vary. Sometimes drastically. In fact, “life expectancy” increases as you get older (i.e. b/c members of a population who did not survive brought down the average).

    Single life predictions are impossible. However, actuaries can predict the annual mortality rate of a given population (i.e. 1,000 or more) fairly accurately. Participants benefit from “risk pooling.”

    “…the only person that benefits from this deal is the insurance company, they are a business and need to make profit…”
    Bad things happen when financial institutions fail. Profit is not evil (in America). More importantly, the insurance company will pool those funds, invest them long term and likely obtain a better long term risk adjusted rate than an individual.

    A couple of other things. As people age, cognitive abilities decline. It simply gets tougher to make decisions – especially about things like money, administration capital allocation, etc. While this is happening, confidence increases. That leads to the last comment.

    One in five seniors will fall victim to a fraud by a stranger. That does NOT include family members, friends, neighbours, etc. Large sums are often targeted. There’s a greater reward for the perp, but the victim is left penniless and without resources or faculties to seek remedies or recourse. An annuity helps to safeguard a person’s capital – regardless of their mental and legal capacity.

    Finally, an annuity should be a part of a retirement solution, not the solution. For seniors 65 and older, I would suggest exchanging annuities for any long term fixed income exposure (why would you opt for minimal interest income or wait decades to get your principle back?) By combining 25% – 40% of their nest egg with dividend paying equities, a retiree may have years of worry free retirement income – some of it guaranteed.

    p.s. I’m NOT licensed to sell annuities in any state and I’m NOT trying to sell you anything. I think it’s in your interest (and your reader’s interest) not to discount the benefits of annuities and there utility as a vehicle for guaranteed retirement income. Best wishes.

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    • Thanks for commenting and agree with some of your points especially with declining cognitive abilities as well as elderly abuse. These are two good examples of the benefits of an annuity.

      Also agree not all salesman are the same however there are enough to give the industry a bad rep and personally know people who have been taken advantage of.

      In regards to profit I never stated it was evil, that was something you construed. I wholeheartedly agree profit is essential for a capital economy to function. My only point to that statement is that an insurance company is a business and needs to make a profit to exist, going bankrupt would be bad for everyone. I also do not blame them for assuming the least amount of risk to achieve that as I would do the same. But it would be misleading to assume an Insurance company is always acting in your best interest.

      Liked by 1 person

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