Income annuities—those that pay a lifetime income—are becoming very popular among retirees. Investing in one is a move that requires considerable deliberation. After all, it is a nearly irreversible decision.
Here’s what you should know before purchasing an income annuity.
Income Annuities Are Hot
Income annuities have received lots of attention in recent years, primarily because of losses sustained during the three-year bear market from 2000- 2002 and once again in 2008. Stories about people near or in retirement losing substantial portions of their nest eggs during those awful periods have given new credence to the relative safety of income annuities.
An income annuity is in essence a personal pension plan. Since a declining number of workers enjoy traditional, employer-sponsored pension plans, income annuities may become particularly favorable for younger workers. Certainly, it is reasonable to expect that annuities will play an increasing role in investment planning both for pre-retirees and retirees.
Is it better to self-manage your retirement money or to take an annuity? The answer is anything but simple, the ramifications can be huge, and the decision is made even more perplexing by the conflicting and often biased advice on the subject.
Despite their increasing popularity, there are some nagging drawbacks to these annuity arrangements.
Drawback Number 1: Your early demise. This is the income annuity horror story. Someone signs up for an annuity, receives a couple of monthly payments, and then has the audacity to die. And the winner is: the insurance company. But before heaping scorn on the insurance industry, remember that in order for the insurance company to meet its obligations to those who live way beyond their life expectancy, a few have to, in the words of Shakespeare, “shuffle off this mortal coil” much sooner. We'll leave it to the actuaries to figure all that out.
Possible solution. If you are concerned about sacrificing a sizable ration of your annuity payment on the insurance company’s altar, consider an annuity that guarantees payments for at least a set number of years. Then if you die before that set number of years, there will be something left for your survivors. Of course, those devilish actuaries have figured out your game and will reduce payments somewhat to account for the possibility that if you exit before the end of the minimum time period, they’re still stuck with making payments.
Another possible solution for a premature death is to buy an annuity that will pay out over a fixed period of time, say 10 or 20 years. If you live beyond that limit, the payments cease. Finally, some variable income annuities will, in exchange for a higher annual fee, return the unused portion of your annuity at your demise.
Drawback Number 2: The annuitant predeceases some other needful soul. If you’re looking for the biggest lifetime annuity bang for the buck, you’ll choose a single life annuity. As long as you live, you’ll receive payments. But it’s all over, in more ways than one, when you’re gone. When you die, the single life payments stop. If you have someone who would suffer financially (as well as, we would think, emotionally) if you’re first in line for the grim reaper, a single life annuity is probably a bad idea.