Annuities Have Real Value
The value that annuities can provide to retirees may not be obvious, but it is real.
Annuities are also becoming increasingly valuable as fewer people have that traditional source of reliable retirement income: an employer pension.
Insurance company annuities, like pensions, pay out a monthly income no matter how long you live. These payments come from three sources: 1) the initial amount invested to purchase the policy; 2) the interest earned on the amount that’s invested before it is paid out; and 3) “mortality credits.”
These mortality credits are the essential element that protects retirees from outliving their savings. As a retiree moves through her 80s, a growing share of the other people in the annuity pool die. The funds they leave behind in the pool are used to continue making monthly payments to those who are still living.
This is the starting point for a new summary of academic research on annuities by the Center for Retirement Research at Boston College, which supports this blog. To fully understand the individual studies, it’s necessary to read the report. But here are some takeaways:
- Rivaling annuities in complexity is knowing how much to withdraw year after year from retirement savings invested in stocks and bonds that fluctuate in value. These fluctuations affect how much can safely be withdrawn from savings for living expenses over an indeterminate lifespan. Unexpected reductions in how much retirees can withdraw are especially painful if the reductions are deep enough to threaten their standard of living. Annuities protect them from this risk by providing a guaranteed income.
- Insurance company annuities become quite attractive for retirees who hold only half of their “wealth” in the form of employer pensions and Social Security benefits (which are other forms of annuities), according to various studies.
- Old age brings on the doctor bills. New retirees, sensing this, often hold on to their savings to pay anticipated medical expenses. But medical expenses typically rise sharply in advanced old age, and an annuity that continues to make payments is an effective way to handle these late-life expenses.
- A deferred annuity purchased at, say, age 65 that starts making monthly payments at age 85 provides a substantial share of the value of an annuity that starts paying immediately at 65. But deferred annuities are much less expensive to buy.
A deep vein of behavioral research explores why only a slim minority of older Americans buy annuities. One reason could be that they’re leery of a complex financial product whose benefits are not self-evident. A second reason could be that an annuity requires buyers to give up their cash.
Until these impediments can be overcome, expect only a small subset of retirees to continue to realize the value annuities offer in a 401(k) world.
The research reported herein was performed pursuant to a grant from the U.S. Social Security Administration (SSA) funded as part of the Retirement Research Consortium. The opinions and conclusions expressed are solely those of the author(s) and do not represent the opinions or policy of SSA or any agency of the federal government. Neither the United States Government nor any agency thereof, nor any of their employees, makes any warranty, express or implied, or assumes any legal liability or responsibility for the accuracy, completeness, or usefulness of the contents of this report. Reference herein to any specific commercial product, process or service by trade name, trademark, manufacturer, or otherwise does not necessarily constitute or imply endorsement, recommendation or favoring by the United States Government or any agency thereof.
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Sometimes it's good to replace uncertainty (which exists with any investment) with something predictable, even if it is more costly. The problem with the world of annuities is that there are many that are overpriced and that complexity keeps people from making a decision. They don't know how to evaluate an annuity and so they don't even consider it.
Trouble is annuities are only guaranteed by the company selling them. If they're mismanaged, and go belly up, your money is gone. And as history has shown, this can even happen with large companies.
Per an NAIC study the recovery rate in insolvencies (in essence the amount applied to contract obligations) is 94.7% of liabilities, and NOLHGA guarantees also apply. However it is still important to select a high quality insurer !!
Your viewpoint on insurance company failure is common, though misplaced. The facts are very few people have ever failed to collect on their contracts for life insurance or annuities going back the last 100 years.Backstopping these contracts, besides insurer reserves, are the powers of state insurance commissioners, along with the many state guarantee funds. When an insurer is in trouble, most often a "marriage" is made and those contracts are assumed (without change) by a stronger carrier. Absent this, state commissioners can require carriers operating in their states to assume part of the liability of a failed insurer. The final backstop is your state's guarantee fund. In my state (Maryland) the fund guarantees on any one life (not per contract)up to $250,000 of annuity present value; up to $300,000 of life insurance death benefits; up to $100,000 in life insurance cash surrender values.To me, the bigger risk of annuities is the future value of the dollar itself! Govt. official policy is inflation, just another way of saying erosion of the purchasing power of your hard-earned dollars. Since annuities are priced in dollars there is no escaping this. Worse, Fed policy gives no indication of reversing it's cheap money policy anytime soon. Fixed annuities including "Indexed" versions are particularly vulnerable to purchasing power risk. Record low interest rates on deposits and bonds are what is choking the insurance industry along with the average saver. Some even call this a "war on savers." It is all driven by misguided Fed. rate setting instead of letting markets clear and find the actual rate of interest that should be paid to those who defer consumption (i.e. savers).You are still right to be concerned about the long-term impacts of buying a deferred annuity now to draw benefits 20-years in the future. It is a gamble as you point out, but for a much different reason. The bigger risk is systemic and beyond the concerns of whether any one carrier will fail or not.
Freddy L has raised a real problem. I believe that most (all?) states have annuity guarantee funds (somewhat like Federal Deposit Insurance). Many of the state guarantees, however, are for relatively low amounts, and I do not know how well funded and operated these state guarantee funds are. How do they apply to people who move from one state to another? If national policy is to encourage annuity purchases, we must first be sure that the guarantees (state or federal) are adequate in amount, administration, and funding.
Should an insurance company become unable to pay benefits the healthy insurers take over those liabilities. Mutual Benefit Life comes to mind.
Insurance is a state-regulated industry. States with Guaranty plans fund them through assessments on the insurance companies who sell policies in their state. If you move, the state where you reside would be your source of Guaranty funds if your insurer operates in that state. If not, the state Guaranty fund where you purchased your policy would be your source of guarantee.The amounts protected in my state are not trivial, but likewise are not intended to protect large accounts. These limits are: - To $250,000 present value of annuities; - To $300,000 in life insurance policies; - To $100,000 in life insurance cash surrender values. Limits are per covered person, not per contract.If a policyholder's loss was not covered in full by their state's fund, they could file claim for remaining proceeds from the Estate of the liquidating insurer.One of the biggest insurer failures was Executive Life of New York. They were liquidated and contracts taken over by the Guaranty Association Benefit Company (GABC), formed in 2012 by the various state life and health guaranty associations.See: www.mdlifega.org for Maryland fund website. www.gabenefitsco.com for GABC website.I hope this is helpful to you.
Annuities are complex financial instruments and not suitable for every senior. An unsuitable annuity can shatter a senior’s financial wellbeing. Recent California legislation was promulgated to protect senior consumers from insurance agents selling unsuitable annuities. In California, it is illegal to sell annuities to seniors for the purpose of qualifying them for veterans’ benefits and in most instances, to qualify for Medi-Cal (Medicaid). There are also strict suitability requirements to ensure that insurance companies preview annuity sales to ensure that the annuity offered to the prospective senior is in his or her best interest. Other states should follow California’s lead.
Thank you for this useful information Squared Away commenters! It adds important insights to this blog. Kim (blog writer)
An insurance annuity would be great if their rates were competitive to those of public defined benefit plans. Let's compare.Metropolitan Life Insurance Company sports a Single Life Option, at age 65, of $.0624 per dollar of premium while the New York City Employees Retirement System guarantees $.10654 per dollar.
I am 75 with a cancer history. I can't buy life insurance because of my increased risk of death, but the same insurance company won't consider this if I want to but an annuity (I dont get a lower price for the same benefit). I guess everyone with an annuity is healthy.
Thanks to the above comments for reinforcing my distancing myself from annuities. Waiting for government regulations to protect consumers from dangerous financial products does not seem to be forthcoming in my lifetime. I can never get the salespersons to make them understandable. My rule-of-thumb is: If someone is trying to SELL me a financial product it is for their benefit, not mine. Part of the solution is to require ANYONE dealing with someone else money to be a Registered Fiduciary. It would not hurt to also make all elected officials to do the same.
I love all the comments about annuities. Thanks to Dave G for being thorough about guarantee funds and insurance company history.I purchased an income annuity when I retired in 2011. It is a refund annuity that will pay out any balance to my spouse if I die before 2025. As long as I live after 2025 they still send me monthly income.I did a direct rollover of about 30% of my IRA mutual find account to the insurance company. My IRA has continued to grow and has more than replaced the amount I used for the annuity. I am considering an annuity ladder and will buy another one before year end. Although it is taxable income, it will reduce the balance of IRA on 12/31 and reduce MRD for 2017.
Trouble is annuities are only guaranteed by the company selling them. If they’re mismanaged, and go belly up, your money is gone. And as history has shown, this can even happen with large companies.