Is an Annuity a Good Investment?

Annuities Have Risks TooAnnuities Have Risks TooBy: Kevin R. Worthley, CFP®

As a Certified Financial Planner™, I've been privy to a higher-than-normal amount of discussion and advertising about insurance annuities lately. Marketing materials and wholesaler calls have increased at my office and even the venerable financial news-magazine, Barron's, chose to make annuities their featured article in a recent issue. It seems there is a lot of interest on all sides to give annuities a closer look these days.

What's the Attraction of Annuities?

Annuities have many features to consider in constructing a retirement plan. These may include tax-deferral, more stable returns, and interest rates that exceed other options. In times such as these when financial markets are volatile and other product interest rates are paltry, annuities may look particularly attractive. Today's financial fears may be driving consumers to annuities and these fears are utilized very creatively by insurance companies and their agents to push sales.

Thinking Long-Term


As with any other financial decision, purchasers of annuity products need to keep the longer-term perspective in mind. Specifically, though interest rates are very low now, they may not always be so. When the economy eventually recovers, interest rates may rise and generally, bank CD rates and bond rates follow suit. What is not being discussed very much is the underlying (low) interest rate or "rate of return" a current purchaser may be locking themselves into.

For example, if (as described by Barron's), an investor were to purchase a 10-year immediate-payout annuity with $200,000 from one of five well-rated insurance companies, he might receive a guaranteed monthly income of about $1,843 for the next 10 years and could realize a total 10-year income of over $221,000. Guaranteed by the insurance company, no worries about market volatility. Sounds good, right? That is until someone does a quick calculation and shows the annuity investor that over those 10 years, their $200,000 may only generate an internal rate of return of less than 2.3 percent.

Or how about the fixed lifetime immediate annuity for a 60 year old purchaser to age 85? The monthly income offered by an annuity in Barron's was listed as $1,124 for 25 years, which works out to a rate of return of 4.6 percent over 25 years. Sounds fine now, but you might recall that general interest rates for bank CDs were well above 5 percent just five years ago. So, over 10 or 25 years, do you think that interest rates might rise again to these levels, once the economy improves? Being locked into an annuity with a 2.3 percent return or even a 4.6 percent return may not look so comparatively appealing then.

Gambling with Interest Rates


I want to be clear; I am not trashing annuities. They are certainly viable and worthwhile financial products when utilized in a retirement plan where the purchaser's interests are the focus of the recommendation. What has to be realized is the consequence or trade-off of committing one's money to a long-term and/or irrevocable investment decision at today's ultra-low interest rates. Insurance companies are all too happy to enter into this bargain; if rates rise during the contract period, the company has the principal to invest in other venues that may earn the company a higher 'spread' over what's committed to the policy-holder.

If you are considering an annuity purchase, make sure you understand all the implications and alternatives available to you before committing to the decision. Even then, you might be better off selecting shorter-term contracts or not committing too much of your savings in these unusual times. At the very least, don't be pressured to commit until you are truly ready and comfortable with the decision.

Kevin Worthley is a Certified Financial Planner™ professional licensed with a registered investment adviser that provides personal financial advice online for a fee. He enjoys fly fishing, other outdoor activities and is a dedicated yoga practitioner.

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