Friday, January 18, 2013

Annuities - Caveat Emptor


Pension industry posts suggest that annuities are a new gold mine for people in the insurance industry. One writer suggests that annuities are a great opportunity to expand one's income. The writer is referring to the income of sellers of insurance products.

The arguments advanced for why consumers should buy annuities are:
- stability
- safety
- diversification

In principle, economists like annuities because they seem to match the need for people to have income until they die with a product that does it. Even President Obama is quoted as favoring annuities in a retirement strategy.

So yes, in some situations an annuity might make sense - let's say you don't know what to do with Lottery winnings, An annuity might be a good way to make sure the money lasts as long as you do.

But buyers of annuities need to be very careful or they will be throwing money away:
- Their risks go up because they are giving up control of their money. If there is a sudden need for capital, all they are getting is the regular return. This is a huge loss of access. This is inherently desirable only when the annuity is being sold to someone who cannot make financial decisions rationally and for whom the capital is tempting to spend.
- Insurance companies love annuities because they get to invest the money - so they pay their agents well to sell them. I have heard as much as 12 percent of the purchase price can go to the agent. Someone is going to pay for this, namely buyers in the returns they get.
- In the current interest-rate climate interest rates are bound to be on the conservative side. We have had a zero-bound environment for four years. Who says this environment is going to change soon? (I have said elsewhere that we are in a zero-bound purgatory that will last until we figure out why we are in it and why it is not heaven. No sign we are there yet.)

If what you have is a 401k or an IRA, it is crazy to roll them over into an annuity. Far better to maintain control of them and when you get to be 70.5 years old, take the Minimum Required Distribution. For no fee, just the cost of the transaction, with no 12% load, the mutual fund or broker will figure out the MRD and pay it out like an annuity. Yet you still have control of the underlying assets and in an emergency you have access to them. You also don't pay taxes on the income until you take it out.

In my view it should be against the law to roll a retirement fund over into an annuity. Just saying.