In the late 1700s, the Royal Government of France became insolvent. One big reason why is because of selling annuities to the wealthy with actuarial tables, which underestimated the longevity of the annuitants. Such sloppy work compelled the treasury to pay out far more than they took in.

The Royal government tried imposing a heavy tax on citizens to compensate for this loss. No parliament existed; hence the citizens had no voice in the government. The high-handed imposition of the tax enraged them and set off the French Revolution of 1789. Annuities got a bad name, but that is all forgotten now.

When Are You Going to Die?

Actuaries at life insurance companies can predict at what age people will die. But they can’t predict when a particular person is going to die. If they could, it would make buying an annuity much easier. So, you have to calculate your life span. An easy way to figure this out is to use the calculator on the Social Security website here: ssa.gov/population/longevity

Eliminate Fear of Running Out of Money Before You Die

Many people fear running out of money before they die. They can eliminate this fear by purchasing an annuity “for life certain.” Couples often purchase “second-to-die annuities.” Annuities are extremely complicated, are notorious for high fees, and come with more bells and whistles than a fire engine. You get charged for all the additional features.

Three types of Annuities:

1. Fixed. As part of an overall retirement portfolio, a fixed annuity provides the security most clients seek in retirement. You can think of it as a hedge against living too long. The life insurance company guarantees the rate of return and the payout. Fixed annuities are most suitable for senior clients who want a specific monthly income and plan to annuitize immediately.

2. Variable. Variable annuities offer investment options similar to mutual funds. Your rate of return will vary with your asset allocation. I lean toward choosing an indexed annuity over a variable annuity because you are taking many risks—which is what most people try to avoid in an annuity. [1] The SEC has a 28-page guide to variable annuities here: sec-guide-to-variable-annuities

3. Indexed. “…these have characteristics of both fixed and variable annuities. Indexed annuities typically offer a minimum guaranteed interest rate combined with an interest rate linked to a market index… Indexed annuities expose you to more risk (but more potential return) than a fixed annuity but less risk (and less potential return) than a variable annuity.” [2] I think these are a far better choice than a variable annuity. SEC explanation here: sec.gov/indexedannuities

To sweeten the pot, many annuities offer life insurance to return the remaining principal to your heirs if you die a year or more after purchasing an annuity. But there is an additional fee, so don’t fall for this. It’s just an expensive way to buy life insurance. Again, let me stress that an annuity should only be part of a client’s retirement assets.

Resources:

[1] https://www.iii.org/fact-statistic/facts-statistics-annuities

[2] https://www.finra.org/investors/investing/investment-products/annuities#types

Contributing Writer: Subject Matter Expert Charles McCain

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