Annuities have been determined by President Obama’s Middle Class Task Force as a viable alternative to going broke in retirement. At least for some.
Before we delve into the reasons why, we should discuss some of the nuances of this part insurance/part investment plan. Annuities have long been considered a costly alternative to both insurance and investments. A product slathered with fees and penalties, annuities offer the buyer of such products not only coverage but a consistent paycheck each month. They are purchased in one lump sum with cash and depending on what age you purchased them, you can count on a steady stream of income.
The Middle Class Task Force believes that this knowledge would help the average person determine not only how much they can expect – in addition to other benefits such as Social Security – but also whether what they receive will be enough to live on. One of the pitfalls that this task force is grappling with is the idea that many retirees will run out of money before they die.
Annuities are often a choice for retirees who are expected to take a lump sum payout from their company. Despite the fact that only one percent of the employees offered such a product take it (about 20% of your employers will offer you this option), this sort of endorsement might send those numbers skyrocketing in the coming years. This will not make the product any better and often, your fears at buying into such a plan are well founded.
Those fears, usually based on what happens to the money should I die before you actually spend down the balance are well grounded. Insurance companies use actuarial tables to determine how long you will live. In other words, like all insurance products, they are essentially making a bet that they will not lose money on the deal. Most folks shy away thinking that if they die before they reach the age when the annuity deposit is used up completely (for a 65 year old male with $100,000 to lump sum, that would be around age 78) the money is lost. This means nothing is given to your heirs.
While those fears of dying before the ink is dry are realistic, the money you receive as a lump sum still must stave off the effects of inflation. While inflation is more or less benign now – except if you live in the real world that calculates the rising cost of food, taxes, and fuel – it can be expected to increase as you get older, driving the real worth of that monthly check (based on the gentleman above, around $632 a month; females would receive much less – about $591 – with the same deposited money) lower as you age. This sort of annuity is referred to as Single Life Income with No Payments to Beneficiaries or in insurance lingo, an SL.
Understanding those fears, as insurance companies do so well, you can add riders to the policy to protect your heirs in the event you do not live to see your investment begin to pay off. For about $60 less per month, you can ensure that your beneficiaries receive the regular monthly payment for twenty years – should you die. Die the day following the purchase, and your beneficiary will continue to receive the monthly payments. Should they live for another twenty years, they will have received not only the $100,000 back but an additional $27,ooo.
Other products offer you a guaranteed income which will be paid to your beneficiary until the policy expires. For instance, a Guaranteed policy would pay a monthly premium of $604 for twenty years with no lump sum payment at the end of that period.
The other fear: will the insurance company pass away before you do? This is a distinct possibility and one to consider. While some businesses have lasted decades, consolidation and economic missteps can leave you with a worthless policy and no way to recover the lost money.
While the Task Force is still working out the details of these problems (tax incentives for the first $10,000 paid out or allowing folks a trial period to try out the product have been discussed) these products still face hurdles.
One is the wealth illusion. Seeing what you have worked so hard of reduced to a single payment each month is always difficult. The second is your estimation of your health. If you are not doing well while you are working, the chances of outliving the annuity are reduced. The last: most folks are not expected to retire with a large enough lump sum to purchase one of these products.
The alternatives are also somewhat scary. If you roll the money into an IRA, you will have to determine the distribution on your own, taking into account taxes, inflation and market performance. This is no easy task.
The Obama Task Force should consider a fixed lifetime tax on all retirement income up to a certain amount. They have discussed this for the first $10,000 of annuity income but they could also extend this incentive to IRAs as well. If the retiree (or future retiree) could determine how much of a bite taxes would take, they could better estimate how much they will actually get when they retire. Currently, the assumption is that retirees will earn less and therefore be taxed at a lower rate. Guaranteeing that rate will enable folks to project better.
You would still have to contend with market forces – a serious downturn while you are depleting the account could shave years off of that income potential. There is no dodging risk but annuities may be too costly an alternative for peace of mind.