March 9, 2022
Sid Roy
Last month we talked about a very interesting topic – annuities. That session was super informative, but annuities are a deep topic, and we had a lot of ground to cover. So, we followed up with another session this month on annuities covering various aspects.
The first question we talked about is – who should consider annuities. As we learned last month, annuities are akin to your own personal pension. At the high level, annuities provide a guaranteed sum of money for the rest of your life like a public pension would. Therefore, folks who might find annuities useful – are those who face the risk of running out of money if they live longer than a certain age. Committing a portion of the retirement savings to a lifelong income ensures that the amount is available evenly throughout the retirement irrespective of how long the retiree lives. The assured earning under all circumstances is an additional degree of safety and peace of mind for some folks.
It is also not uncommon to see people wanting to simplify the management of finances during retirement. Annuities provide a potentially simple path to a guaranteed income, without the headache of managing investment portfolio to generate cash.
The third reason for exploring annuities is for diversifying sources of income, especially those with surplus retirement assets. Multiple sources of cash-flow – social security, workplace pension, rental properties, annuities, stock dividends, interests, etc., can create a consistent cash flow that can weather a variety of adverse market conditions.
On the other hand, annuity isn’t quite a remedy for under savers. If your nest egg isn’t large enough to sustain a reasonable retirement lifestyle, it’s unlikely that annuities would solve that problem. Similarly, if you’d want to spend down your nest egg and pass on the leftover assets to your successors, annuities won’t make sense.
The second question we talked about – the considerations before purchasing a specific annuity. We discussed that the annuities should be evaluated based on two primary considerations – price and transparency. To assess the price of an annuity, one should be on the lookout for an array of fees. The most common ones are the mortality premium, administrative costs, sales commission, etc. There are additional costs for Indexed or Variable annuities. The active management fees for the investment funds tend to be steep. Before buying an annuity, you should be very familiar with the different fees and understand the bottom-line cost. You should also understand the penalty you’d pay in form of surrender charges and early withdrawal tax hits if you change your mind and try to get out of it.
Then comes the question of transparency on financial state of the insurance company behind the annuity. Is the issuer healthy and resilient enough? It is not common, but issuers can go bankrupt. So, the more transparent the issuer is in providing information, the better.
Annuities get a bad rap but if there is a reasonably priced annuity, and the issuer is transparent, it can be a good option for some. After all, what’s not to like in a reliable pension plan if it doesn’t cost a leg and arm?
Happy Investing.