Do Retirement Annuities Really Make Sense?

The golden years

For many retirees today, the golden years may less than golden (photo: creativecommons.org)

A retired couple sells the farm and moves to town to enjoy an easier life. They plan to travel and spend their golden years doing what they love. But as fate would have it, the husband dies a month after they buy the house in town.

The retirement annuity

A few days later the life-insurance agent arrives at the door with the settlement check in hand. The widow has $300,000 left in the bank after selling the farm and buying the house. The agent asks her how she plans to get by once her money runs out. Naturally, she doesn’t know, so the agent says, “What would you say if I could guarantee a lifetime income for you, tax free?”

The grieving widow welcomes the idea. She hands over her $300,000 nest egg, and the agent sells her an annuity as a means to safeguard her money. Now she now lives on $2,000 a month, and will continue to do so until she dies.

Considering the market today, that may sound like a fair deal. Or does it? Let’s take a closer look.

Annuities defined

Annuities are financial products marketed by insurance companies to provide lifetime incomes for investment or retirement purposes. Unlike whole-life insurance, annuities begin to pay out immediately, if desired. According to the insurance companies, buying an annuity is a good way to liquidate your assets.

If you are of retirement age and have accumulated a large sum of money, you can put it all into an annuity and immediately begin receiving monthly payments. If you have several years to go before retirement, you can pay into the annuity over time. Agents will tell you that you can accrue wealth this way, while being guaranteed a lifetime income once you retire.

What you really get

Agents earn larger commissions on annuities than they do on other types of insurance products, and are therefore motivated to sell them.  That self-interest leads agents to embellish the truth just a bit. They’ll tell you the truth, but they’ll also twist it, leaving you confused and leading you to believe that they are acting only in your best interest.

Am I saying that agents will lie to sell you an annuity? Not really. But I am saying that you need to look behind the curtain and see what’s really going on. Even quick payday loans can’t help you once you’ve been conned by slick marketing tactics.

Marketing vs. reality

Insurance agents tend to stress the positive features of an annuity in order to make a sale. To be fair, insurance agents aren’t the only people who do this: All marketing emphasizes positive features while minimizing negative aspects. But buying a junk financial product is a much more serious mistake than buying the wrong designer perfume. In fact, your future may depend on not getting caught up in the marketing hype of the financial industry.

The marketing ploy of annuities is that you are guaranteed to receive a lifetime income on your investment. The reality is that when you die, the checks stop coming and your heirs get nothing. You can, of course, arrange to have your heirs receive money when you die, but only if you settle for lower monthly payments.

Where’s your money?

What happened to your money? Where’s the principal you invested?

When you purchase an annuity, the insurance company invests your money in stocks and bonds. The money that will give you a lifetime of income is really just the interest and dividends paid on the stocks and bonds the insurance company bought with your money.

Your payments are not taken from the principal you invested. Your principal is never touched. After your death, unless you accepted lower monthly payments in return for a post-mortem pay-out, the insurance company does not pay the principal to your heirs. In fact, the company keeps it. And that’s why insurance companies that sell annuities make the big bucks.

Be smart with your money

How are the companies that sell annuities able to promise a lifetime income from your money without touching the principal you invested? They do something that you can do on your own: They purchase stocks and bonds, just like any other investor. If you were to invest your money yourself, you would still receive a lifetime income and you’d keep the principal for yourself and your heirs. (My next article will explain how to do this.)

Do your own investing

An annuity is nothing but another insurance product designed to take more money from you. With their obscure policy language, it’s easy for insurance companies to do just that. Your best bet is to do exactly what the insurance companies do: Invest in stocks and bonds and buy term life insurance. Don’t leave your heirs to pay for your funeral expenses with quick payday loans. Do your own investing, and leave your loved ones a true legacy.