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The Annuity Puzzle For Retirement Investing

Sunday, June 5, 2011 - 10:38 AM
A professor of economics in this New York Times article reviews why so many people dislike annuities. His focus is on the fixed immediate annuity (aka life annuity) which is the only annuity that Clark Howard says can be a reasonable deal.

One downside not mentioned by the NYT author is that buying one of these annuities today locks in the low interest rate for the buyer's lifetime. The fixed payouts won't look as appealing if inflation starts to shoot up. One suggestion in this Wall Street Journal article is to ladder annuities similar to CD ladders.
Ken TuminKen Tumin5,469 posts since
Nov 29, 2009
Rep Points: 125,077
1. Tuesday, June 7, 2011 - 7:46 PM
A single-premium life annuity is a simple insurance bargain (which is why they are sold by insurance companies). The interest component of the annual payout is zilch. The primary driver is the life-expectancy bargain. Assume you are 65 years old, male, with a typical life expectancy of 78 years. You hand me $100,000. I agree to pay you a fixed amount until you die. What would I pay you? It's really that simple. If I'm the insurance company, I assume I can spread the annuity risk over a huge population, so that the "average" longevities allow me to return to you $100,000/13 (a little less than $7700/year). The interest the insurance company receives on your money before they pay it to you is their profit. If the insurance company is generous (yah, right), it might share a tad of that interest with you by boosting the annual payment a smidge. It's easy to compare annuities if you know your average longevity, any special issues that might decrease same, and can do simple math. Don't be deceived by annuity salepersons that offer a "guaranteed 8% return." In my example above, for a 65 year-old male, that 8% merely represents the return of your own money, over your life expectancy, with a smidge of interest ($300 over 13 years). All the rest is company profit and sales commission. So, if you buy an annuity, accept the fact you're buying a life-insurance product. Live long, you prosper. It's a simple insurance gamble.
BozoBozo137 posts since
Feb 14, 2011
Rep Points: 937
2. Tuesday, June 7, 2011 - 10:22 PM
Many years ago when there were defined benefit plans with cash outs, people wanted low interest rates because with a  cashout you would get a lot more money in order to guarantee that monthly benefit. Usually you waited for rates to go up before purchasing an annuity.
Ally6770Ally6770914 posts since
Jan 16, 2010
Rep Points: 2,662