To Annuitize or Not to AnnuitizeSubmitted by Concierge Financial Planning, LLC on March 11th, 2015
“What do you think of these annuities?” Mel asked. “An insurance guy I know is advising us to transfer all of our remaining IRAs into these two investments, and I’m not confident it’s the right approach for us.” Since these annuities didn’t look appropriate for Mel and Ginny, I figured the annuity salesman’s rationale was the big commissions he would earn on the sales.
Mel was right to be suspicious. At 70 and 72, he and Ginny had limited resources and mounting medical bills. They’re retired and Ginny suffers from MS.
Like many clients, Ginny and Mel came to me for objective advice. They didn’t fully trust guidance from anyone who was trying to sell them products. The suggested two annuities ended up being wrong for Ginny and Mel for several reasons:
- Investing both Ginny and Mel’s IRAs in annuities does not allow for the liquidity or flexibility that they may need for care or medical expenses. In fact, most insurance companies won’t allow a client to annuitize more than 50% of their liquid assets, and they were way over this threshold.
- The annuity that was suggested for Ginny was an immediate annuity based on her life expectancy only. These investments require the investment of a lump sum in exchange for monthly income for life and are designed and priced for people who are worried about living too long. With MS, Ginny has a shorter than average life expectancy.
- The agent recommended an expensive variable annuity with lots of bells and whistles for Mel. This involved investment of a lump sum, which could then be allocated to different balanced investment accounts. While the variable annuity allowed for growth, it also guaranteed that Mel would never lose more than his initial investment. While the product sounded attractive, it was also expensive. Excessive fees would eat into his returns. What’s more the annuity guarantee was on the nominal value of the initial investment not the real value. In other words, if Mel invested $100,000, he was guaranteed at least $100,000 no matter what the market did. Don’t be fooled here, in fifteen years at 3% inflation that $100,000 will only be worth $64,000! That’s right, invest $100,000 and get a $64,000 guarantee. Who wants to pay for that? Mel will have lost money in real (includes inflation) terms. And he would definitely feel the pinch.
What was right for Ginny and Mel? It turns out that an annuity was a good solution—just not the ones being sold to them. An immediate annuity on their joint lives using Mel’s IRAs would work well. The payout was higher than the payout on the proposed variable annuity and Mel and Ginny would be locking in an income stream that they could not outlive. The immediate annuity provided them with a minimum level of guaranteed income in addition to Social Security. The downside of this type of annuity is that, in addition to lack of flexibility, there is no opportunity for growth. However, investing Ginny’s IRAs in an appropriately balanced portfolio of low-cost ETFs solved these issues.
The insurance salesman would have made a bundle had Mel and Ginny bought into his plan. Unfortunately, it wouldn’t have been a win-win situation. The combination of annuities was certainly not in Mel and Ginny’s best interest. Unfortunately, annuities are still an area with opaque, often high fees and they can be sold by people who aren’t required to have a high degree of sophistication or experience dealing with complex financial products. As a result, people are often sold not only expensive products, but ones that don’t meet their needs at any price. This does not mean that annuities can’t be good tools, however. You just have to do your homework, understand what you are buying, get independent advice, and, above all, be an aware buyer.