MONEY
No Good Thing Lasts Forever …
Except, Perhaps, Immediate Annuities
By Don Conrad and Hammid Firoozeh
Most people will agree that nothing lasts forever, but a careful look at various investment options might yield an exception or two. Rising health-care costs, inflation, and consumer prices are just a few of the variables that cause people to struggle to make ends meet these days. Unusually low interest rates only exacerbate the problem, forcing countless retirees to tighten their belts. If this outlook matches what you’re currently facing, don’t abandon hope; an immediate annuity might be the solution for you.
Recently, we were asked for advice by an 86-year-old former executive assistant who we’ll call Jacqueline. She came to one of our seminars at a local library. Afterward, Jackie approached us and started to talk about her situation. She never married and has no children. She’s been retired for about 20 years, and recently sold her home so she could move into a comfortable assisted-living residence. Jackie’s primary concern was to have enough income to supplement her Social Security and pension benefits so as to maintain the standard of living to which she had become accustomed – factoring in inflation, rising housing costs, personal health-care costs, and taxes. Her will would donate the remainder of her estate to a few charities of her choice.
To meet these goals, Jackie needed more income than her principal would allow under traditional conservative investments. Like many of her contemporaries, she did not have the physical stamina to re-enter the work force. This meant that she could not afford risks associated with the stock market. What she wanted, in her own words, was a guaranteed, preferably tax-favored income stream for the rest of her life, an income that would remain perfectly stable despite fluctuations in the stock market. After a thorough investigation of many options and detailed conversations with Jackie’s accountant and attorney, we narrowed the possibilities to one investment vehicle: the single-premium immediate annuity.
An annuity is a tax-deferred investment vehicle that gives you a fixed or variable annual income. The amount of that income is based on the initial value of the principal and the type of annuity the owner chooses to invest in. There are many different types of annuities, all of which are designed to meet various needs. Annuities can be fixed, variable, immediate, deferred, medically underwritten, etc. As with any purchase, investors must weigh the benefits that an annuity offers against the costs, management fees, liquidity, and the price of added benefits. Remember that annuities come in all sorts of sizes, shapes, and colors; there are literally hundreds of different ways they can be purchased. When looking to buy, you should always evaluate how the benefits match up with your own needs. It is for this reason that we always recommend a meeting between the investor, his or her accountant and/or attorney, and the person who is selling the annuity.
Although New York State is a highly regulated market that keeps a close watch on products that are sold to investors, you should always research whatever products you’re dealing with. Often, certain types of annuities pay a high commission to the people who sell them. Consequently, it is not uncommon for the seller to place his or her interests above those of the (typically less savvy) investor. Contrary to popular belief, annuities are not only sold by insurance agents, but also by brokers, CPAs, CFPs, tax preparers, local banks, and a host of other people and institutions. So it’s important to know whom you are dealing with, and to ask a lot of questions.
The type of annuity Jackie purchased was an immediate annuity, which requires the investor or investors (ownership can be single-life or joint-life) to put up an initial principal in exchange for a stream of payments. An insurance company is typically the seller of the annuity and will be the one that sends you the monthly, quarterly, semi-annual, or annual checks. Why would an insurance company be willing to take on this tremendous responsibility of lifetime payouts? It is all based on life-expectancy statistics, which are derived from actuarial tables.
Immediate annuities have various payout options. Some of the more common are lifetime income-only, lifetime period-certain, lifetime income-with-cash (lump sum) refund, lifetime income-with-installment refund, and period-certain. Simply said, you have several choices about how you receive your money. Keep in mind, however, that different types of annuities are sold through different insurance companies, with various credit ratings. Because so many factors play into a decision about which type of annuity to purchase, it is essential to consult a financial professional before making your final decision.
The payout amount of an immediate annuity is determined strictly by age and gender, unless it is a medically underwritten policy, in which case the health status of the annuity owner also plays an important role. (The insurance company will often pay more when your life expectancy is altered because of poor health.) What made this investment appropriate for Jackie was largely the fact that she had no heirs, because when you set up an immediate annuity you forfeit all rights to ownership of your initial investment principal. If you have heirs who are dependent on an inheritance they assume they’ll receive, a conversation about the consequences of going through with this kind of an investment should definitely occur. Still, the benefits associated with an immediate annuity are impressive; the insurance company will guarantee your income payments for the remainder of your life, even if you live to be 120.
Jackie’s Social Security, pensions, and bond income did not generate enough cash to meet her high monthly expenses, which meant that she had no choice but to dip into her principal every year. Had she stayed on that path, Jackie’s entire principal would have been depleted in about six years. We were tempted to recommended tax-free municipal bonds because of their liquidity, income security, and tax-free status. But current interest rates and Jackie’s high income needs would again have forced her to invade and ultimately deplete her principal within those same six years. Knowing that the national life-expectancy average of a woman Jackie’s age is currently around six years, and taking into consideration her superb health and strong genetic background, investing in municipal bonds created a risk we did not feel at all comfortable with.
In Jackie’s case, we chose a lifetime income-only annuity because the alternatives were too risky, and also because not being able to afford to live where she wants, with the people she cares about, was unacceptable to her. If, like Jackie, you are looking for consistency, guarantees, or just peace of mind that you won’t run out of money during the final stage of your life, an immediate annuity could be the solution for you.
