Are annuities a good investment?
You’re probably not going to get rich from an annuity. They weren’t designed for that. What you get instead is the option of receiving a guaranteed stream of income for the life of your retirement, and other safety features.
With pensions offered by fewer companies, more and more people are responsible for a greater share of their retirement income. Because of this, outliving retirement income is one of the biggest fears of people about to retire or currently living in retirement. Annuities are about the only financial vehicle that can guarantee a lifetime stream of income.
Annuities can also help you avoid market downturns. People who retired shortly before the 2001 tech stock bubble or the 2008 financial crisis may have lost a significant portion of their retirement accounts if they were heavily invested in stock and mutual funds. Some of these individuals were forced to return to work because they no longer had enough saved to retire.
Even variable annuities have optional safety features
Even if you opt to buy a variable annuity, in which you invest your premium in mutual-fund like investments, there are features that can help you minimize your losses and help you guarantee a certain amount of income, regardless of how the underlying investments perform. Because of the added risk involved in a variable annuity, insurance companies have added several types of guaranteed benefits to these products in the last several years, including:
Guaranteed Minimum Accumulation Benefit Rider. This rider restores the annuity’s accumulation value to the amount of total premiums paid if, after a certain number of years, the accumulation value is less than the premiums paid, minus any withdrawals.
Guaranteed Minimum Withdrawal Benefit Rider. This rider guarantees you the ability to withdraw a set percentage from your annuity every year until the value of the original premium paid is withdrawn. This is essentially a money-back guarantee should your account decrease in value.
Guaranteed Minimum Income Benefit Rider. This rider offers a minimum income regardless of your actual accumulation value.
Let’s talk numbers
Because of their general lack of risk, annuities typically do not offer a high rate of return. The key to earning the best return on an annuity is deferring income as long as possible and receiving income as long as possible.
One annuity calculator shows that a 65-year-old man buying an immediate annuity for $100,000 will collect $6,790 in annual income. It would take just under 15 years for that individual to earn back his original principal. If the person lives to age 90, his total lifetime income would be $169,750 before taxes. That amounts to a total lifetime return of just under 70 percent, which divides about to just under a 3-percent annual return.
As a comparison, current five-year CD rates are averaging about 2.2 percent, while the 30-year Treasury is currently yielding 2.9 percent.
That same individual could take immediate income for just five years and collect $20,470. That would total $102,350 over the five years, a 2.35 percent increase over the original principal.
If the person defers income for five years on his $100,000 annuity, he could receive lifetime income of $9,984 annually. If he lives to 90, his total income would add up to $199,680, which means he would nearly double his original investment. The average annual return would be about 4 percent.
By the same token, if he defers for five years and receives income for five years, his annual income would be $24,070. That totals $120,350, which is about a 2 percent annual return.
In another example, a 50-year-old woman who defers income on a $100,000 annuity purchase until age 70 could collect annual lifetime income of $17,440. If she lives 10 years after beginning income, her total return would be just under 75 percent, or a 2.5 percent annual rate.
But if she lives 20 years, her total income would amount to $348,800, or nearly 3 1/2 times her original investment. The annual rate of return from her original investment would then be 8.75 percent.
Besides the guarantees offered by annuities, there are other upsides that make it a worthwhile investment for some people.
Tax deferral. Money deposited in a fixed annuity grows tax-deferred until you take distributions. You will not pay tax on the portion of your payments that is considered a return of your original premium. The taxable portion is what your annuity pays above and beyond what you put into it. For example, if the value of your annuity doubles what you deposited, then half of your income withdrawals will be taxed as regular income. The other half will be considered a return of your principal.
Unlimited contributions. Whereas 401(k)s and IRAs have caps on how much you can contribute annually, annuities allow almost unlimited contribution amounts. The only cap is what the insurance company places on its products. This means individuals can catch up significantly on retirement income if they have the funds available to put into an annuity.