SECTION 6.2: Annuities
Historically, an annuity could be understood as a sort of reverse life insurance policy. In this context, “reverse” means that you get payments for a fixed period (or until you die) for paying into the annuity for many years. When their modern history began, annuities were almost always tied to life insurance policies. It sounded great; if I die, my family gets my life insurance money. If I live a long time, I’ll have steady money coming in to retire on. Today, annuities come in many different types, but in essence, they involve investing your money in a large corporation that agrees to make payments to you at some future date for a fixed period of time. Because an annuity is an agreement between you and a large financial institution, there is a contract. There are also several different contract periods that you need to understand.
The first contract period is known as the accumulation phase. During this period, your payments start and growth begins. Your payments will continue until the next phase where the money stream reverses course and the annuity starts paying you. The magic moment in time where your payments stop is often referred to (by insurance companies at least) as the annuitization phase. The payout phase usually begins when the investor retires. This phase can be really long or really short, depending on how much money was invested, how big the payments are, and how good a deal the investment was in the first place. It is worthy of note that all monies invested will continue to grow during all three phases of the process.
Payout Options
Straight life. This payout option means that you get your payment until you die. Period. Even if you exhaust all of the money you put in, you will still get your monthly check. This sounds like an awesome deal, but consider this: Insurance companies would not offer these plans if they were losing money. A few very lucky souls may outlive their annuity investment, but for the majority of cases, the insurance companies will win. They win if you die before you’ve exhausted your investment because they get to keep all of the remaining funds. I take the position that this is too big of a risk (and the insurance companies agree, or they wouldn’t sell these things). If you follow my advice and retire a millionaire, you can keep the bulk of your funds invested and never have to touch the principle. If that is the case, then you will never have to touch the principle and it will keep making you enough to live on even in poor performing investments like bonds. You can live to be 100 and still have a huge chunk of cash to leave your kids or your cat (or do something really awesome and endow a Chair of Criminal Justice). I view these insurance annuities as I do playing the lottery; it’s just a tax on the uneducated poor that are scared and don’t know any better.
Cash refund annuity. These work like straight life annuities, but if there is any money left over when you die your beneficiary receives any money left in your account. The downside is that your monthly payment is a lot less.
Joint Survivor Life. With this type of contract, two individuals are the annuitants, and the payments continue as long as one of the is alive. This breed is marketed to couples successfully because logic dictates that one spouse will almost always outlive the other.
These are just a few of the available types. Since these things are dreamed up by big companies and marketed to all types of people, the variety is essentially endless. There some advantages, especially if you make a lot of money and need a place to hide it, or if you want to hide money from bankruptcy, FAFSA, and other risks. For most people, especially those in the helping professions, these things are a bad idea. They are loaded down with fees, and most of your “profit” goes to the company that sold you the annuity. The money is tied up until you reach retirement age, and you can only get at it by paying some really expensive penalties. Because these are contract based, you cannot make an intelligent decision unless you understand the contract; these things are so complex an MBA would weep on reading it.
Not all annuities are bad, but most of them are. Some investment vehicles are called an annuity because of regulatory mumbo-jumbo and these can be quite good. When managing my retirement account, I invest in TIAAs Real Estate Account when I think the market is turning bearish. Right there on the cover of the prospectus, it says “annuity.” The prospectus is 286 pages long, but experience has taught me that this particular vehicle acts like a mutual fund with the equity backed by real estate rather than common stocks. TIAA puts all of its cards on the table; they provide financial statements just like any other investment. This fund has made 6.45% since inception. That says to me that it’s safer than stocks during a bear market, but I wouldn’t want to leave the bulk of my funds in there because of the low yield relative to other opportunities.
My parting advice on annuities is this: Don’t let anyone sell you an annuity. If you find an opportunity, do your homework, and you determine that it is a valuable investment, then you may be onto something. I’ve never found an annuity that I’d consider a good long-term investment, especially if you want to retire rich.
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