Author Topic: Why you should never buy an annuity!  (Read 13899 times)

Mr Mark

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Why you should never buy an annuity!
« on: August 20, 2017, 01:30:42 AM »
In these uncertain times, with stock markets at 'record highs' and scare stories about the reliability of the '4% rule', you may be tempted by a beguiling offer* to buy an annuity. A basic immediate annuity is where an insurance company agrees to pay you a fixed amount annually until death for an initial lumpsum payment.

At the moment, $1,000,000 will buy a 60 year old male about $60,000 (6%) per year for as long as you live. [For a 40 year old it would be about $48,000]

Sounds great right? Especially for those concerned about running out of money in retirement, what's not to like? 6% sounds a lot better than 4%, and without all that risk of the stock market crashing! Sign me up!

The problem is that a basic annuity is NOT an 'investment'. If you die, the payments stop and there is no return of capital. EG if you died after the first year you would have lost $940,000. This has terrible implications for the effective rate of return (and for any heirs you might have had). At 6% it takes almost 17 years of payments before you even get your original $1 million back.

A 6% annuity, assuming a low 2% annual inflation, has a 30 year real rate of return of just 2.4%**, and your annual payment just before you die in year 30 will only be worth $33,400 in 2017 dollars because of inflation. Even if you live to be 110 years old the real IRR after those 50 years of collecting payments will be a meager 3.6% with an annual payment by the end of just $22,300. Meanwhile with the 4% rule your payments not only increase to keep pace with inflation but you will almost certainly still have a huge stash to pass on to your surviving heirs!

There are many more complex annuities available - ones with payments adjusted for CPI, or with minimum payout terms, or returns somehow linked to the SP500. But the basic math remains. This is why insurance companies pay such huge commissions to the people that sell them, and why those sales people* are so keen to get you to buy them.

Don't be fooled.


**Compounded real rate of return pretax, assuming 6% nominal payout and 2% inflation
  5 years: -31.2%
10 years: -9.9%
20 years:   0.0%
30 years: +2.4%
40 years: +3.3%
50 years: +3.6%


higher inflation of course makes these returns even worse!

[edited into original post] Disclaimer: I've seen 1 potential use for these instruments of financial destruction - related to medicaid long term care liabilities. If you're a couple on Medicare/SS with (a) a big 'stash and (b) one partner is not well (early onset Alzheimers/dementia combined with other health problems typically) and (c) likely to need expensive long term nursing home care before an early death, the couple can use annuities to transfer liquid assets above the medicaid cutoff into life long income for the surviving spouse to avoid the care costs draining the assets away before being eligible for medicaid (also depends on specific state law on asset claw backs).
« Last Edit: September 14, 2017, 02:04:10 AM by Mr Mark »
Mr. Mark

Miss Piggy

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Re: Why you should never buy an annuity!
« Reply #1 on: August 20, 2017, 09:57:50 AM »
A financial advisor I never trusted tried over and over again to sell me an annuity. It always felt like such a sales job...like he was trying to sell me the equivalent of a used car with no engine.

JustGettingStarted1980

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Re: Why you should never buy an annuity!
« Reply #2 on: August 20, 2017, 10:09:45 AM »
 I've heard some good arguments on Bogle heads that an annuity might be considered "floor" longevity insurance. But for triple M followers with relatively low yearly spending, Social security should very nicely serve that purpose already at a much lower cost, while also happening to adjust with inflation.

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JAYSLOL

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Re: Why you should never buy an annuity!
« Reply #3 on: August 20, 2017, 10:25:15 AM »
I've heard of annuities, and had a general idea of how they worked and figured they were probably not a great deal, but i didn't realize they were this bad!  Thats an awfully shitty return for the money.  In fact, it looks like most traditionally retirement-age people would be way better off sticking their $1M in cash under the mattress and spending $60k a year rather than this.  Good info, thank you for doing the math on this one for us, now i know what to say if someone brings them up

DavidAnnArbor

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Re: Why you should never buy an annuity!
« Reply #4 on: August 20, 2017, 08:16:17 PM »
Thank you for doing the math on that.

Mr Mark

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Re: Why you should never buy an annuity!
« Reply #5 on: August 20, 2017, 10:22:13 PM »
No worries. I like that sort of number crunching. :-)

To highlight the badness of these investments, a financial planner is being prosecuted for putting an old lady into an annuity. She bought it for ~$165,000 and the sellers commission was something like $9,600. No wonder they try to push people into these things.

Disclaimer: I've seen 1 potential use for these instruments of financial destruction - related to medicaid long term care liabilities. If you're a couple on Medicare/SS with (a) a big 'stash and (b) one partner is not well (early onset Alzheimers/dementia combined with other health problems typically) and (c) likely to need expensive long term nursing home care before an early death, the couple can use annuities to transfer liquid assets above the medicaid cutoff into life long income for the surviving spouse to avoid the care costs draining the assets away before being eligible for medicaid (also depends on specific state law on asset claw backs).
Mr. Mark

intellectsucks

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Re: Why you should never buy an annuity!
« Reply #6 on: August 21, 2017, 08:33:43 AM »
Boy what a bunch of horseshit.  Here’s a better piece of advice: NEVER listen to anyone who tells you to NEVER use a certain type of financial product.
Annuities serve a variety of purposes and are not limited to Single Premium Immediate Annuities (the type of annuity listed in the OP).  There are many different types of annuities that serve a variety of different purposes, all appropriate in different circumstances.  Fixed or indexed annuities can be used in place of Certificate of Deposits to give the extremely risk averse a better yield with zero risk of loss, variable annuities can offer ways to use market growth to increase future income without taking on market risk, annuities of all types give you tax deferred growth.
You reference the $9600 commission paid by the insurance company as evidence of how terrible they are, but haven’t given any context to that number.  Let’s make the absolutely nonsense assumption that an investment into VTSAX admiral shares of one million generates only enough growth to cover fees.  You will end up paying $9600 in fees over 24 years, probably about the average life expectancy of the retiree in your original example.  Your fees will be much higher if you end up living longer than that or if you live outside of fantasy land and end up getting dividends and growth.  Keep in mind that the insurance company is on the hook to guarantee your returns/income for the rest of your life no matter how long you live, and they never get to charge you any additional fees.
Lastly, you present the the “Life” payout option as if it is the only way to receive income from an annuity.  A six second google search yields this article that goes into detail for all of the different ways that you can receive income from annuities: http://www.investopedia.com/articles/retirement/05/071105.asp
A quick summary: life (guaranteed income for the rest of your life, no matter how long you live), joint life (guaranteed income for the rest of your life and the rest of your beneficiary’s life), period certain (guaranteed income for a certain number of years).  Almost every annuity also offers a return of principal option (no matter what happens, the company will guarantee that you receive back at least the full amount you put in).
I’m not an annuity shill, and certainly wouldn’t recommend them as the primary investment vehicle for the majority of people, but they have their time, place and purpose, just like any other investment vehicle.  This forum and its members are looking for more detail on how to succeed financially and don’t benefit from poorly researched and misleading bullshit.  Go peddle your clickbait elsewhere.

SnackDog

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Re: Why you should never buy an annuity!
« Reply #7 on: August 21, 2017, 09:22:04 AM »
Nothing wrong with buying a high quality annuity if you understand them well and get a good one which suits your needs.  People tend to buy them once they are pretty old in order to guarantee a simplified minimum level of income (a safe floor), regardless of the mental state of the recipient.  By waiting until you are old, your life expectancy is shorter so the payouts are better and inflation risks mitigated.  We all know people who have died and left behind a partner who can't manage investments or who lived long but lost their wits.  In some cases, these people lose their investments altogether and end up with nothing. An annuity is a good hedge against this.  It has another added benefit that if you lose a personal or civil liability lawsuit (the risk of this goes up every year), you can lose all your investments but probably not your annuity income.  There are downsides, like the insurance company going bankrupt or Venezuela-style inflation.   Overall, just another tool to consider as part of your planning.  I may get one if I live to 75 or so.  I think if enough people purchased them the terms would improve a lot.  There is no point in everyone saving enough money to die with leftovers in 95% of all scenarios - we should just pool the risk and spend more!
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Hargrove

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Re: Why you should never buy an annuity!
« Reply #8 on: August 21, 2017, 07:36:37 PM »
There are many different types of annuities that serve a variety of different purposes, all appropriate in different circumstances.  Fixed or indexed annuities can be used in place of Certificate of Deposits to give the extremely risk averse a better yield with zero risk of loss, variable annuities can offer ways to use market growth to increase future income without taking on market risk, annuities of all types give you tax deferred growth.

I get that different people have different preferences, but keeping a million bucks in a sock drawer is a bad retirement plan given the alternatives, and annuities are also a bad retirement plan, given the alternatives. Your argument seems to be "but some people like them," which doesn't address the substance of the OP at all.

You can make any poorly-scaled plan sound good if you ignore relevant comparisons. Why, you could cross the US in a motorized scooter, and it would be really fast when you consider how long it would take a flea to cover this same distance.

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Re: Why you should never buy an annuity!
« Reply #9 on: August 21, 2017, 07:49:54 PM »
First off, no, I won't be ever buying one.  My rule of thumb is, first and foremost, DON'T BUY WHAT YOU DO NOT COMPLETELY UNDERSTAND.  And I can assure you, even if I were to read the prospectus (is that what they're called when it's an annuity?) -- I would not fully understand it.

That said, there are certainly annuities out there that pay on death.  The original description is not fully true.  I know, as I've been the beneficiary.  In my case, the taxes sucked.  There was no basis step up like other inheritances.  But it paid out 100% of its value.
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Mr Mark

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Re: Why you should never buy an annuity!
« Reply #10 on: August 21, 2017, 10:52:47 PM »
Boy what a bunch of horseshit.  Here’s a better piece of advice: NEVER listen to anyone who tells you to NEVER use a certain type of financial product.
Annuities serve a variety of purposes and are not limited to Single Premium Immediate Annuities (the type of annuity listed in the OP).  There are many different types of annuities that serve a variety of different purposes, all appropriate in different circumstances.  Fixed or indexed annuities can be used in place of Certificate of Deposits to give the extremely risk averse a better yield with zero risk of loss, variable annuities can offer ways to use market growth to increase future income without taking on market risk, annuities of all types give you tax deferred growth.
You reference the $9600 commission paid by the insurance company as evidence of how terrible they are, but haven’t given any context to that number.  Let’s make the absolutely nonsense assumption that an investment into VTSAX admiral shares of one million generates only enough growth to cover fees.  You will end up paying $9600 in fees over 24 years, probably about the average life expectancy of the retiree in your original example.  Your fees will be much higher if you end up living longer than that or if you live outside of fantasy land and end up getting dividends and growth.  Keep in mind that the insurance company is on the hook to guarantee your returns/income for the rest of your life no matter how long you live, and they never get to charge you any additional fees.
Lastly, you present the the “Life” payout option as if it is the only way to receive income from an annuity.  A six second google search yields this article that goes into detail for all of the different ways that you can receive income from annuities: http://www.investopedia.com/articles/retirement/05/071105.asp
A quick summary: life (guaranteed income for the rest of your life, no matter how long you live), joint life (guaranteed income for the rest of your life and the rest of your beneficiary’s life), period certain (guaranteed income for a certain number of years).  Almost every annuity also offers a return of principal option (no matter what happens, the company will guarantee that you receive back at least the full amount you put in).
I’m not an annuity shill, and certainly wouldn’t recommend them as the primary investment vehicle for the majority of people, but they have their time, place and purpose, just like any other investment vehicle.  This forum and its members are looking for more detail on how to succeed financially and don’t benefit from poorly researched and misleading bullshit.  Go peddle your clickbait elsewhere.

Wow, tell us what you really think!

'poorly researched and misleading bullshit' is IMHO what your post represents. For example, the PV of fees on a VTSAX portfolio of $1,000,000 over 30 years would be $4,964. The likely commission on a basic $1,000,000 immediate annuity to a salesperson would be more like $50,000 (if you read the post the example I found in the court case, it refers to a $165,000 annuity, not $1 million).

You provide no economic analysis or specific examples to justify the rather inflamatory and ad hominem statements you make. Given the assumption that the company selling these things don't have a magic way of investing, these commissions and their profits come from 3 places: taking a massive premium up front, not having to make payments to people who die and from the fees they cream off the projected portfolio yield. This is one of the reasons why the real rate of return is so poor. Your 24 yr life expectancy (actually a lot more for the average 60 yr old male, but meh) as I described would represent a compounded return (with such an immediate annuity) of just 1.3% assuming 2% inflation. The annuities also have other disadvantages I didn't get around to mentioning: they are highly illiquid, and the annuity payments are taxed as ordinary income (unlike a Vanguard VTSAX for example).

Plus the insurance company does charge additional fees with the more complex annuities you mention. Remember these instruments are not investments but a type of insurance policy. Please provide the details of what you consider a worthwhile annuity deal including the details you claim are useful (such as guarenteed principal) as these all serve to reduce the annual payment significantly.

You certainly sound like an annuity shill to me. Have you (or a close relative) recently bought an annuity of some kind?

EDIT
Also Spork, I thought I was clear that I was decribing the numbers for a basic immediate annuity, and specifically mentioned that more complex ones (including ones that promise to repay nominal principal) can be obtained.
« Last Edit: August 21, 2017, 11:38:40 PM by Mr Mark »
Mr. Mark

Mighty-Dollar

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Re: Why you should never buy an annuity!
« Reply #11 on: August 22, 2017, 12:33:16 AM »
Here's the problem with immediate annuities... They leave you in poverty later in life! You get teased with an initial high rate of return that eventually gets surpassed by a very low risk mix of bond and stock index funds.

Also the 4% rule is a red herring. Just because it may fail doesn't mean that annuities are even close to being better. Even during the worst of times, when you have to reduce income below 4%, today's immediate annuities fail miserably by comparison.

And once you reach your life expectancy your heirs will get nothing!

And you lose your liquidity with these products. There's million reasons why you might need to get your money back.

This video says it all...
https://www.youtube.com/watch?v=QDUbQeZvJ9g

Quote
I've heard some good arguments on Bogle heads that an annuity might be considered "floor" longevity insurance.
Bogleheads is run by biased moderators who I believe are in the insurance industry. I actually got suspended for bad mouthing insurance agents. Bogleheads is a sham site.

There may be people in THIS forum who are actually insurance salesmen. intellectsucks is presenting typical insurance industry strawman arguments, anecdotes and statements of opinion instead of side by side comparison data (bond/stocks VS annuity) like in the video I referenced. intellectucks had the gall to attack the low cost index fund VTSAX using the strawman argument it has fees and annuities don't have fees. Annuities fees are BAKED INTO THE PRODUCT! Annuities are not "free". Instead of giving you a fixed 7% income rate, you get 6%. That IS the fee baked into the pathetic product!
intellectsucks also said that "the insurance company is on the hook to guarantee your returns/income for the rest of your life no matter how long you live". Again you are only guaranteed POVERTY later in life. And what do I need a guarantee in the FIRST PLACE if I'm investing in a low cost mix of a total bond market index fund and a total stock market index fund? I don't! In the last 22 years there has never been a down year where you lost more than 1% when heavily invested (72% in bonds). Again YOU DON'T NEED AN EXPENSIVE "GUARANTEE"! BTW annuity guarantees are not guaranteed in the first place. http://investingadvicewatchdog.com/images/28-72-year.jpg
« Last Edit: August 22, 2017, 12:49:58 AM by Mighty-Dollar »

gerardc

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Re: Why you should never buy an annuity!
« Reply #12 on: August 22, 2017, 02:41:01 AM »
I think annuities are a great concept in theory, the only problem is the insurance companies need to make a huge profit, so the actual numbers/offers you get suck. I could see it becoming more popular if low-fee annuities came to exist, e.g. with an owner structure like Vanguard. It's basically an insurance on your life time -- some people die sooner, some die later, and the "lucky" ones pay for the "unlucky" ones like with any insurance (here "lucky" means to die earlier, which costs less).

Laserjet3051

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Re: Why you should never buy an annuity!
« Reply #13 on: August 22, 2017, 02:12:15 PM »
Here's the problem with immediate annuities... They leave you in poverty later in life! You get teased with an initial high rate of return that eventually gets surpassed by a very low risk mix of bond and stock index funds.



Quote
I've heard some good arguments on Bogle heads that an annuity might be considered "floor" longevity insurance.
Bogleheads is run by biased moderators who I believe are in the insurance industry. I actually got suspended for bad mouthing insurance agents. Bogleheads is a sham site.



I was following this thread to hear both sides of the story on SPIAs, but as soon as you made the above claim (in bold red) you lost all credibility. ALL.

Mighty-Dollar

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Re: Why you should never buy an annuity!
« Reply #14 on: August 22, 2017, 07:11:29 PM »
Quote
I was following this thread to hear both sides of the story on SPIAs, but as soon as you made the above claim (in bold red) you lost all credibility. ALL.
Nice empty post. Because why?????????? Did you even read my entire post??? I actually got suspended for bad mouthing insurance agents. Translation: Bogleheads suppresses speech against annuities and the cons who sell them.

Hargrove

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Re: Why you should never buy an annuity!
« Reply #15 on: August 22, 2017, 07:34:04 PM »
Quote
I was following this thread to hear both sides of the story on SPIAs, but as soon as you made the above claim (in bold red) you lost all credibility. ALL.
Nice empty post. Because why?????????? Did you even read my entire post??? I actually got suspended for bad mouthing insurance agents. Translation: Bogleheads suppresses speech against annuities and the cons who sell them.

There is a bunch of context to a suspension we're not privy to, including your particular situation, and we wouldn't get anywhere debating it even if we knew what happened. This is also concerning a very large site which, from what I've read, is one of the big three FIRE sites (MMM, Bogleheads, and ERE) that people use as a wealth of resources, information, and inspiration. It's extremely unlikely that Bogleheads is "a sham site," and an anecdotal argument isn't very compelling proof. That's including if you were banned by a single moderator (even if that moderator was an insurance salesman), because Bogleheads is not just someone's blog or a single moderator's forum, it's an entire FIRE community.

Since we still don't have much support for annuities weighing in, I looked at
http://obliviousinvestor.com/single-premium-immediate-annuity/
and checked from there via a link from Vanguard at
https://www.incomesolutions.com/LifetimeIncomeEstimate.aspx#results-anchor
for 5k/month (60k annually) for a deposit quote.

The deposit quoted is 629,562.42 if I were 55 and buying for payments to begin at 65. The average stock return over 30yrs doesn't quite fit this 10yr napkin math, but let's say it does for the sake of averages and that we can guess that deposit invested would have grown to 1,259,124.84.

50,364.99 would be the 4% SWR on stocks invested to a long-term average after that window, coming slightly short (4,197/mo vs 5,000/mo) by 19%, but the stocks have significantly more upside if you died early or if you lived longer than 5 years.

If I were going to bet on an annuity, I suppose if the bull market continued two more years and I had just turned 55 and was utterly terrified of starting before a bear market began, and if also I did not expect to live to 75 for some reason (and didn't care about leaving money behind), OR worried about getting cleaned out from a debilitating disease's medical expenses (high rate of heart failure in the first case or perhaps Alzheimer's in the second, where I didn't think I could keep directing my investments?), then perhaps I could imagine a scenario where such a thing might seem appealing.

It still looks like the worst kind of market timing to base retirement planning on a bet on a bad deal pulling through on its rarest opportunity, but, well, I'm trying to bring us something here.

Mr Mark

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Re: Why you should never buy an annuity!
« Reply #16 on: August 22, 2017, 10:38:13 PM »
...

50,364.99 would be the 4% SWR on stocks invested to a long-term average after that window, coming slightly short (4,197/mo vs 5,000/mo) by 19%, but the stocks have significantly more upside if you died early or if you lived longer than 5 years.
...


Hargrove,
Remember the initial 4% withdrawal will be increased to keep pace with inflation while the annuity payment you got I assume is nominal(?) and thus slowly loses purchasing power.
Mr. Mark

Hargrove

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Re: Why you should never buy an annuity!
« Reply #17 on: August 23, 2017, 04:22:39 AM »
Yeah, that's why I added the life-expectancy scenarios.

GenXbiker

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Re: Why you should never buy an annuity!
« Reply #18 on: August 23, 2017, 06:32:22 AM »
The deposit quoted is 629,562.42 if I were 55 and buying for payments to begin at 65.

Remember the initial 4% withdrawal will be increased to keep pace with inflation while the annuity payment you got I assume is nominal(?) and thus slowly loses purchasing power.

Being deferred, that makes inflation an even bigger factor in devaluing the annuity.  And, even if you were to pay a lot extra for a deferred annuity that increases payments with inflation, that adjustment only starts once the payments begin but not increased for the inflation that occurred during the accumulation phase.
« Last Edit: August 23, 2017, 06:38:23 AM by GenXbiker »

Dicey

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Re: Why you should never buy an annuity!
« Reply #19 on: August 23, 2017, 10:29:10 AM »
Boy what a bunch of horseshit.  Here’s a better piece of advice: NEVER listen to anyone who tells you to NEVER use a certain type of financial product....Here's even better advice: Don't listen to anyone who believes intellect sucks.

Annuities serve a variety of purposes for a very limited subset of investers and are not limited to Single Premium Immediate Annuities (the type of annuity y investment vehicle for the majority of people, but they have their time, place and purpose, just like any other investment vehicle.  Ditto.

This forum and its members are looking for more detail on how to succeed financially and don’t benefit from poorly researched and misleading bullshit. This is true. Annuities are not a meaningful or cost-effective solution for the vast majority of mustachians. Go peddle your clickbait elsewhere. Oh, dear God, please take your own advice.
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uwp

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Re: Why you should never buy an annuity!
« Reply #20 on: August 23, 2017, 01:33:49 PM »
Annuities are like any other insurance product: not everyone needs/wants it, there are a lot of crappy versions of them out there, and usually the worst products pay the person selling them the most.

DISCLAIMER: I have recommended an annuity before and think they have their place sometimes.

Even Vanguard offers annuities (https://investor.vanguard.com/annuity/?lang=en).
So they can't be all bad... right?


EDIT: Another commonality with other insurance products: It is designed so that the insurance company makes money; they have a longer time horizon and rarely die.
« Last Edit: August 23, 2017, 01:53:20 PM by uwp »

Mighty-Dollar

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Re: Why you should never buy an annuity!
« Reply #21 on: August 23, 2017, 10:12:57 PM »
Annuities are like any other insurance product: not everyone needs/wants it, there are a lot of crappy versions of them out there, and usually the worst products pay the person selling them the most.

DISCLAIMER: I have recommended an annuity before and think they have their place sometimes.

Even Vanguard offers annuities (https://investor.vanguard.com/annuity/?lang=en).
So they can't be all bad... right?


EDIT: Another commonality with other insurance products: It is designed so that the insurance company makes money; they have a longer time horizon and rarely die.
Never mix insurance with investing.
ALL annuities are crappy products that return between 0 and 3% in best case scenarios. Even the so-called "good" annuities (SPIA's) leave you in poverty because those fixed income payments for life eventually are surpassed by bonds and stocks.
"Annuities have their place" is a phrase I hear insurance salesmen use all the time. It's nothing more than a statement of opinion that is not backed by data versus bonds and stocks.
Vanguard is simply cashing in on the opportunity. Vanguard's portfolio selector does not recommend annuities. In fact I don't know of one single robo advisor that includes annuities, and for good reason.
By the way this site is a SALES PITCH for annuities that does not even begin to cover the many negatives. http://obliviousinvestor.com/single-premium-immediate-annuity/
Here's a real critique of SPIAS http://investingadvicewatchdog.com/immediate-annuities.html
« Last Edit: August 23, 2017, 10:16:04 PM by Mighty-Dollar »

Finances_With_Purpose

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Re: Why you should never buy an annuity!
« Reply #22 on: August 24, 2017, 12:29:42 AM »
I'll add one other gaping issue with annuities that nobody seems to have mentioned: it's putting a huge chunk of your nest egg with one single insurance company.

It's far less likely the whole economy (read VTSAX) will go under.  Or even a few investment companies - Vanguard, Fidelity, so on - which you can spread your money around/between.  (Especially now that places like Fidelity offer more competitive options in order to compete with Vanguard.)

But what if your retirement plan was at AIG?  Oops. 

And what if low/negative interest rates drive insurers under?  Oops. 

Annuities carry far higher risk than they seem, for extremely poor returns (in my experience).  Not to mention the crazy commission they have to price in, too.  There's zero diversification, which makes them inherently risky. 

As one poster said, never mix insurance with investments.  (Dave Ramsey says that as well, so maybe the poster got it there.)  I've had to fend off extremely aggressive annuity salesmen - they especially like to pitch the elderly on them as they sign up for Medicare and so on (because so many of them don't know better).  It's shameful. 

gerardc

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Re: Why you should never buy an annuity!
« Reply #23 on: August 24, 2017, 12:55:04 AM »
Here's a real critique of SPIAS http://investingadvicewatchdog.com/immediate-annuities.html
That case is pretty convincing, pretty much seals this thread.

However, it only proves one thing: current annuity terms are scammy. Why couldn't a legit company sell low-fee annuities? It seems the same phenomenon as mutual funds in the 1970's, where fees were high because people were not educated about them, and salesmen had big commissions. If we could reduce commissions and overall bullshit with annuities, I think they have the potential to be a good product -- basically lifespan financial insurance. I don't see why insurance companies can't currently provide better terms... probably because of low demand / inefficient market. I'm confident it will get better in the future, especially with all those millenials retiring early!

Mr Mark

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Re: Why you should never buy an annuity!
« Reply #24 on: August 24, 2017, 01:31:00 AM »
^ Vanguard do this already (but not with a guaranteed payout) via their Vanguard Managed Payout Fund (VPGDX)  https://investor.vanguard.com/mutual-funds/managed-payout/#/mini/overview/1498

Interestingly they target a trinity study-esque 4% payout (yeah!), but charge a rather nasty 0.42% in fees (boo!). It's essentially a managed fund of funds that tries to provide an automatic  ~4% SWR and keep the fund growing to keep pace with inflation. They set the payout at the start of the year and then give it out as a monthly payment. For a lot of these people for whom some posters have suggested might actually want to consider an annuity (like 'old people' just about to get SS & medicare, or widows with zero clue about investing, both groups that annuity salespeople target) it looks like a far better alternative (but with the risk that returns will vary with the value of their diversified market returns).

But there's no free lunch. We Mustachians can get away with doing our own SWR using index funds with super low fees and quite a lot of financial nouse and effort (asset allocation, IRAs, roth conversions and CD ladders, tax gain/loss harvesting, etc). It's totally unreasonable to expect someone to pick this up when they might be very old and not financially literate, and so they will have to pay higher fees than we do for someone to do all this work for them.

I wish Vanguard & AARP would start a non-profit to give people financial advice and guidance on how to invest safely in Vanguard.

EDIT
Hey interesting site, thanks for the link gerardc. I really liked the list of the false arguments used by annuity salespeople http://investingadvicewatchdog.com/annuity-lies.html. Grandma wouldn't stand a chance.
« Last Edit: August 24, 2017, 02:01:08 AM by Mr Mark »
Mr. Mark

DavidAnnArbor

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Re: Why you should never buy an annuity!
« Reply #25 on: August 24, 2017, 05:49:36 PM »
^ Vanguard do this already (but not with a guaranteed payout) via their Vanguard Managed Payout Fund (VPGDX)  https://investor.vanguard.com/mutual-funds/managed-payout/#/mini/overview/1498

Interestingly they target a trinity study-esque 4% payout (yeah!), but charge a rather nasty 0.42% in fees (boo!). It's essentially a managed fund of funds that tries to provide an automatic  ~4% SWR and keep the fund growing to keep pace with inflation. They set the payout at the start of the year and then give it out as a monthly payment.

So it looked like I would receive 3.62% when I used the calculator on the managed payout fund webpage. I assume the .38% I wouldn't receive is the fee I would be paying Vanguard to handle the payout.

Mighty-Dollar

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Re: Why you should never buy an annuity!
« Reply #26 on: August 25, 2017, 01:18:34 AM »
Here's a real critique of SPIAS http://investingadvicewatchdog.com/immediate-annuities.html
That case is pretty convincing, pretty much seals this thread.

However, it only proves one thing: current annuity terms are scammy. Why couldn't a legit company sell low-fee annuities? It seems the same phenomenon as mutual funds in the 1970's, where fees were high because people were not educated about them, and salesmen had big commissions. If we could reduce commissions and overall bullshit with annuities, I think they have the potential to be a good product -- basically lifespan financial insurance. I don't see why insurance companies can't currently provide better terms... probably because of low demand / inefficient market. I'm confident it will get better in the future, especially with all those millenials retiring early!
Retail SPIA's generally pay advisors between 3 and 4%. Vanguard pays no commissions to any advisors and Vanguard sells immediate annuities. But the costs of annuities only tells part of the story. Insurance companies are still for profit companies and they invest at least 70% in bonds (by law). Their portfolios only earn about 3% right now. If they paid out more than what a bond heavy portfolio earns then they would go out of business. So fees or no fees, you're not going to get better returns than if you were to invest on your own.

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Re: Why you should never buy an annuity!
« Reply #27 on: August 25, 2017, 07:28:23 AM »
But the costs of annuities only tells part of the story. Insurance companies are still for profit companies and they invest at least 70% in bonds (by law). Their portfolios only earn about 3% right now. If they paid out more than what a bond heavy portfolio earns then they would go out of business. So fees or no fees, you're not going to get better returns than if you were to invest on your own.

Right, except that the companies that sell annuities are essentially collecting a lot of money on dead bodies. Many folks pass away before they hit any kind of "break even" point.

Annuities to me just feel creepy for this reason. Kinda like life insurance, only different.

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Re: Why you should never buy an annuity!
« Reply #28 on: August 25, 2017, 08:47:12 AM »
PTF

intellectsucks

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Re: Why you should never buy an annuity!
« Reply #29 on: August 28, 2017, 11:01:35 AM »
Let me clarify my stance a little, since it seems like my post has been misinterpreted.
No one should EVER put all or the majority of their funds into ANY type of annuity, no matter the type of payout.
There is absolutely no denying that other investment types will offer a much higher rate of return over time, for a much lower cost.
 The benefit of annuities vs other investment types that offer higher returns and lower costs is that they offer GUARANTEES that are not included in other investment types.  Those guarantees have a value, maybe not to you or to me, but certainly to some people.  Hence making a blanket statement like “never buy an annuity” is not useful information.
The value of that guarantee is what really can’t be overstated in annuities favor.  Two considerations in favor of those guarantees. 
Risk tolerance is something that absolutely must be considered in evaluating your portfolio.  Unfortunately risk tolerance is very often an emotional consideration.  2008 was the last year that the S&P 500 had a negative returns.  There are people who are accumulating their staches who have literally NEVER SEEN a bear market.  What will happen to those people if there is another huge loss like in 2008 or (God forbid) multiple years in a row of large losses like the early 2000’s?  Lots of them will be panic selling and moving to cash; lots of them are ALREADY doing it trying to time the market which is another disastrous move.  My experience is that people have a much higher tolerance for risk when they know a portion of their assets are guaranteed.  Having money in an annuity is a much better option than having money sitting in cash, either because it was pulled out in the midst of a crash or because it was sitting on the sidelines waiting for the “Trump dump”.
If you or your spouse need nursing home care or its equivalent, how long will your stache last to provide that ultra-safe 4% SWR?  Costs vary, but a fairly conservative estimate will be around $10k/mo.  Average stay is a little over 2 years.  Once the patient receiving the care dies, perhaps the surviving spouse will be mentally capable of adjusting the financial plan to account for the reduced assets, perhaps not.  Or, perhaps you or your spouse will end up with costs that far exceed average and you end up impoverishing yourselves.  Having a source of guaranteed income that neither spouse can outlive certainly looks a little more attractive than at the start of this thread doesn’t it?
Here’s an example: The CNNMoney annuity calculator puts a single life annuity payment for a 45 year old male in Pennsylvania at $1681/mo for an initial premium of $400,000.  That number comes REALLY close to the MMM family’s bare bones minimum expenses for the year, and is 25% higher than a 4% SWR on the same amount.  If you instead opt for a joint life payout, you’ll probably be in the range of $1100/mo, a pretty fair bit lower than the MMM family’s bare bones budget and around 18% less than a 4% SWR on the same amount.  If you have a stache of $1 million, that leaves you with $600k to invest in VTSAX or any other mix of investments to provide higher rates of return and inflation protection.  Since you already have a guaranteed source of income, you could probably get away with a lower SWR on your remaining $600k, making your odds of growing your stache during drawdown even more likely.
Will this example provide the same level of income as a more traditional stock/bond mix?  Almost certainly not.  Will it take a big portion of your stache and make it illiquid (similar to a real estate investment)?  Yes.  However, that guaranteed income can help offset the risk of retiring in market conditions similar to 1999 where the next three years saw average losses of 14%.
To summarize my opinion: annuities are fine for some people to put a portion of their money, but terrible for others.
People who would benefit from annuities:
The extremely risk averse
People who manage their assets and have spouses who are clueless about managing those assets
People who are concerned about their income producing assets being eaten up by nursing home or other large medical costs.
People for whom annuities are not a great idea
People who are risk tolerant
Couples where both spouses are confident in their current and future ability to manage assets effectively
People who are unconcerned about future nursing home or medical costs

uwp

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Re: Why you should never buy an annuity!
« Reply #30 on: August 28, 2017, 02:51:18 PM »
Let me clarify my stance a little, since it seems like my post has been misinterpreted.

We are arguing against the crowd here.  Obviously everyone is an investing robot and doesn't mind the market going down because they know deep down in their circuit board that it always comes back up and will return a nice round 10% going forward into eternity.

Sometimes people prefer the guarantee that an annuity provides, and are willing to pay for it (through lower returns compared to 60/40).

This isn't even getting into the weeds of arguments like using annuities as bond replacements allowing you to take more risk with the rest of your portfolio.
« Last Edit: August 28, 2017, 02:57:13 PM by uwp »

Hargrove

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Re: Why you should never buy an annuity!
« Reply #31 on: August 28, 2017, 04:27:05 PM »
Considering that the principal is lost, guaranteed, so an early death probably means a loss and a late death means competing against the mighty market returns, the snide commentary is really not necessary. It's hard to make an argument for something stick if your talking points are "clueless demographics" and "catastrophic and prolonged economic downturn that the annuity company survives."

The market has always come back up. It's not a guarantee of future returns. However, for over 100 years, it's been the best operating advice to work with. If you want to bash the wisdom of generations on anything - investing, Shakespeare, how to scramble eggs... it should probably be with a well-thought argument.

Or, I guess, you could just complain that everyone is a robot.

I can't really accept the "extremely risk averse" argument because an annuity IS an absolutely massive risk of principal that will PROBABLY lose. It's not an easy, ultra-low-risk option for the risk averse; it's a lower-payout, significant-risk option for those terrified of risk who don't know much about finances.

I'd even love to hear a counterargument FROM an annuity salesperson - you would think they have some scenarios where the annuity wins if it weren't just cultivating fear and calling detractors names.

DoubleDown

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Re: Why you should never buy an annuity!
« Reply #32 on: August 28, 2017, 05:06:40 PM »
Annuities have their place, they can make sense in a variety of situations. I certainly would not put my entire portfolio into an annuity, but I do think it makes great sense to put in a sufficient amount to cover bare-bones expenses for life if those aren't covered by other income streams. In the OP's example, if you have $1M and need $20k/year to cover basic necessities (food, shelter, health care), then I would definitely consider buying an annuity at that payout for $333k. You can leave the other $667k invested to cover all other expenses beyond basic necessities (travel, eating out, transportation, etc.), and likely having plenty left over to pass down to heirs.

Having your basic expenses covered no matter what can provide a real healthy peace of mind for those who would otherwise worry about market crashes or other shocks to your net worth. You'll know that no matter what, you'll at least have a roof over your head and be able to eat. This can also help you feel more comfortable about regular spending and giving yourself a raise every year with inflation, since you won't have to worry about market ups and downs affecting your ability to survive.

Other forms of income can already fill the place of an annuity to cover basic life expenses -- pensions, Social Security, and the like. If you expect sufficient income from those, then an annuity is likely overkill.
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uwp

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Re: Why you should never buy an annuity!
« Reply #33 on: August 28, 2017, 05:50:28 PM »
People appreciate the assurance that annuity income provides.  That has a value - especially to folks who are already retired. I don't know why you keep dismissing that. Also, annuities are generally insured by the state, so you can be protected in your prolonged economic downturn scenario where the insurance company went bankrupt. 

bobechs

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Re: Why you should never buy an annuity!
« Reply #34 on: August 28, 2017, 06:13:04 PM »
At least the payout on a SPIA should shut up the only-feel-(somewhat)-safe-with-a-2%/1.5%/1%-withdrawal-rate-and-the-rest-of-you-are-suckers contingent around here.

Except that nothing will ever shut them up.

Free Forever

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Re: Why you should never buy an annuity!
« Reply #35 on: August 28, 2017, 06:13:09 PM »
I'd invest some of my savings in an annuity if the terms were good enough. Like if it paid me in the ball park of inflation + 4-5% at my age (37). So never say never but it's unlikely any insurance company will offer a deal like that unless you're quite a bit older than me.

Many, but not all, of the investment oriented products offered by insurance companies can be roughly replicated using stocks , bonds and options , usually at a much lower cost, if you have the discipline and know how to do it (probably <.5% of all investors). There's always going to be a legitimate market for these products, mainly people who are risk averse, will never be competent at DIY and/or lack the discipline to stick to an investing strategy.
« Last Edit: August 28, 2017, 06:15:51 PM by Free Forever »

DoubleDown

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Re: Why you should never buy an annuity!
« Reply #36 on: August 28, 2017, 10:07:59 PM »
Many, but not all, of the investment oriented products offered by insurance companies can be roughly replicated using stocks , bonds and options , usually at a much lower cost, if you have the discipline and know how to do it (probably <.5% of all investors).

This is not true. Insurance companies can provide guarantees for payouts that you cannot achieve on your own because insurance companies pool risk across large populations. Your individual portfolio will be far more volatile than an entire insurance company's assets whose payouts have been determined through extremely sophisticated actuarial work (unless you are invested with no risk, in which case your returns will be very sub-optimal compared to an annuity).

There's always going to be a legitimate market for these products, mainly people who are risk averse, will never be competent at DIY and/or lack the discipline to stick to an investing strategy.

While there's a hint of truth there (since some people jump into annuities without understanding them), it also discounts very legitimate reasons for buying annuities that have nothing to do with being incompetent or lacking discipline. Respectfully I'd suggest studying the issue a bit more. There are some very smart people here on this board and elsewhere who understand that annuities can have a very legitimate place in a smart investor's plan. We haven't even touched on tax and withdrawal implications, which are other advantages of annuities. The fact that you think an individual investor can DIY an annuity suggests some further learning would be helpful.
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Paul der Krake

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Re: Why you should never buy an annuity!
« Reply #37 on: August 28, 2017, 11:16:33 PM »
Annuities protect against two things:
- making disastrous decisions in your old age
- living significantly longer than expected

That's it. You don't get extra points for dying with the highest return on your investments.

That being said, buyer beware. It's an industry ripe with snake oil.

GenXbiker

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Re: Why you should never buy an annuity!
« Reply #38 on: August 29, 2017, 04:20:28 AM »

I don't even have kids that would be left out, and I still can't see a situation that I would ever want to buy an annuity.

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Re: Why you should never buy an annuity!
« Reply #39 on: August 29, 2017, 05:00:20 AM »
It can be great longevity insurance.  If you are a 70 year old male, Vanguard will give you a guaranteed 7.7% payout for life.  At age 70, unless inflation is absolutely raging, it is a pretty good proposition for at least a portion of your money.  It is almost double the 4% SWR.  You can turn $1 million into $77,000 per year.
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shawndoggy

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Re: Why you should never buy an annuity!
« Reply #40 on: August 29, 2017, 06:34:56 AM »
I suck at math, so maybe you guys can help.  My wife is a public employee and has the opportunity to buy up to an extra five years into her public retirement system.  Each year presently costs 28500 (at age 46) and will net approximately 200 per month (2400/yr) in retirement income at age 60.  We are considering buying the five years now.  When combined with her existing service credit and expected additional service credit at retirement, this should result in approximately $3000 / mo in guaranteed income.  The benefit is subject to cola increases after three years and there is a spousal benefit as well. 

Thoughts?

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Re: Why you should never buy an annuity!
« Reply #41 on: August 29, 2017, 07:42:07 AM »
I don't even have kids that would be left out, and I still can't see a situation that I would ever want to buy an annuity.
That's what's so very odd about this thread. Sure, annuities might be good in a few very specific circumstances. You could say the same for Whole Life insurance or a full service broker. It's just that none of those options is particularly mustachian. In fact, they're all solidly anti-mustachian.  One must wonder why the OP is promoting them so fervently here, in the land of DIY investment portfolios. Sheesh, look at the flak an Edward Jones account generates. Annuities are an order of magnitude worse for all but a tiny subset of the population.

Most, if not all, mustachians can achieve their goals without ever knowing a thing about annuities. Well, except one: annuities are very expensive for the buyer and very, very lucrative for the seller.
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DavidAnnArbor

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Re: Why you should never buy an annuity!
« Reply #42 on: August 29, 2017, 07:43:14 AM »
I suck at math, so maybe you guys can help.  My wife is a public employee and has the opportunity to buy up to an extra five years into her public retirement system.  Each year presently costs 28500 (at age 46) and will net approximately 200 per month (2400/yr) in retirement income at age 60.  We are considering buying the five years now.  When combined with her existing service credit and expected additional service credit at retirement, this should result in approximately $3000 / mo in guaranteed income.  The benefit is subject to cola increases after three years and there is a spousal benefit as well. 

Thoughts?

Whenever I have a question like this, I like to use the Present Value function on an Excel Spreadsheet.
For example, I would want to compare how the 28500 times five years would have grown by age 60 and then what the 4% safe withdrawal rate would be at that point versus the guaranteed payout of the present value of $2400 times five would be worth.

DavidAnnArbor

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Re: Why you should never buy an annuity!
« Reply #43 on: August 29, 2017, 07:53:52 AM »

That's what's so very odd about this thread. Sure, annuities might be good in a few very specific circumstances. You could say the same for Whole Life insurance or a full service broker. It's just that none of those options is particularly mustachian. In fact, they're all solidly anti-mustachian.  One must wonder why the OP is promoting them so fervently here, in the land of DIY investment portfolios. Sheesh, look at the flak an Edward Jones account generates. Annuities are an order of magnitude worse for all but a tiny subset of the population.

Most, if not all, mustachians can achieve their goals without ever knowing a thing about annuities. Well, except one: annuities are very expensive for the buyer and very, very lucrative for the seller.

It can be great longevity insurance.  If you are a 70 year old male, Vanguard will give you a guaranteed 7.7% payout for life.  At age 70, unless inflation is absolutely raging, it is a pretty good proposition for at least a portion of your money.  It is almost double the 4% SWR.  You can turn $1 million into $77,000 per year.

I agree with both opinions above.
Still SnackDog raises a good point about perhaps using annuities as longevity insurance since if I were 75 years old I could get a great payout from the annuity. I might use a portion of my stash at that point to buy an immediate annuity.

I'd like to know what happened to those customers of AIG who bought annuities ?  Did they lose their money during AIG's bankruptcy ? A government bailout helped AIG stay afloat and recover.
Annuities are protected by state insurance commissioners. However, if it's anything like what happens to pensions in bankruptcy, then the insurance company is going to be allowed to reduce the payout to the annuity customers. Some states have insurance commissioners and/or laws that favor the insurance company over the policyholder.
Why do annuity contracts have to hundreds of pages in legalese?

I have a nephew who just recently got a job with New York Life Insurance company, and the pay is strictly by commission, there's not even a base salary. Sad!

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Re: Why you should never buy an annuity!
« Reply #44 on: August 29, 2017, 08:23:53 AM »

Still SnackDog raises a good point about perhaps using annuities as longevity insurance
since if I were 75 years old I could get a great payout from the annuity. I might use a portion
of my stash at that point to buy an immediate annuity.

If you're a US citizen and your area of concern is longevity insurance, your best bet is to
defer social security benefits until age 70. 

https://www.kitces.com/blog/how-delaying-social-security-can-be-the-best-long-term-investment-or-annuity-money-can-buy/

There's nothing preventing you from considering an annuity at age 75, but most likely
your stash will be so large by then that you won't need it.

Paul der Krake

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Re: Why you should never buy an annuity!
« Reply #45 on: August 29, 2017, 08:27:21 AM »
I'd like to know what happened to those customers of AIG who bought annuities ?  Did they lose their money during AIG's bankruptcy ? A government bailout helped AIG stay afloat and recover.
Annuities are protected by state insurance commissioners. However, if it's anything like what happens to pensions in bankruptcy, then the insurance company is going to be allowed to reduce the payout to the annuity customers. Some states have insurance commissioners and/or laws that favor the insurance company over the policyholder.
Good summary of what happens to policy holders:
http://www.kiplinger.com/article/insurance/T003-C001-S001-what-the-aig-bailout-means-for-you.html

For AIG specifically, AFAICT all claims have been and continue to be paid.

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Re: Why you should never buy an annuity!
« Reply #46 on: August 29, 2017, 08:51:41 AM »
Whenever I have a question like this, I like to use the Present Value function on an Excel Spreadsheet.
For example, I would want to compare how the 28500 times five years would have grown by age 60 and then what the 4% safe withdrawal rate would be at that point versus the guaranteed payout of the present value of $2400 times five would be worth.

Right.  So I get that to get $12K a year, I need $300000. 

Right now I can buy that $12K a year stream (starting in 14 years) for 142500.  It looks like 142500 turns into approximately 300k with a 5.4% rate of return.

So I guess the question is whether a guaranteed 5.4% rate of return makes sense for a portion of the portfolio to generate some guaranteed income?

The additional factor here is that my wife's retirement comp is based on her highest 3 years of salary.  In the unlikely event she could bump her salary up from its current rate between now and age 60, the income stream would also increase (i.e. in the extreme, if she doubled her state salary, she'd also double her retirement, and the 12k a year would turn into 24k a year for the same 142500 investment).  Realistically she's close to being topped out, but cola and step increases should bump her salary by 2-3% per year between now and retirement too.


caracarn

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Re: Why you should never buy an annuity!
« Reply #47 on: August 29, 2017, 08:55:20 AM »

Still SnackDog raises a good point about perhaps using annuities as longevity insurance
since if I were 75 years old I could get a great payout from the annuity. I might use a portion
of my stash at that point to buy an immediate annuity.

If you're a US citizen and your area of concern is longevity insurance, your best bet is to
defer social security benefits until age 70. 

https://www.kitces.com/blog/how-delaying-social-security-can-be-the-best-long-term-investment-or-annuity-money-can-buy/

There's nothing preventing you from considering an annuity at age 75, but most likely
your stash will be so large by then that you won't need it.
A very interesting analysis.  I have felt delaying SS payments was a solid strategy unless you had a family history of death before 70.  Takes a little longer to get a true benefit but the survivorship analysis was helpful too.  With my wife being several years younger than I this becomes something we should certainly discuss as the time nears to decide when to pull the lever and release the SS funding.

intellectsucks

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Re: Why you should never buy an annuity!
« Reply #48 on: August 29, 2017, 09:09:23 AM »
@Hargrove-Losing the principal due to early death in an annuity only applies when choosing the “single life” payout option.  As I’ve pointed out multiple times, there are other payout options, including ones that offer return of principal guarantees.  As for the rest of your points, I guess we’re just going to have to agree to disagree.  I do not believe that risk averse people (even if they are “mustachians”) will be more comfortable with market risk than with inflation risk.  You do.
Regarding the “catastrophic and prolonged economic downturn that the annuity company survives”, it doesn’t have to be catastrophic, or especially prolonged.  Sequence of returns risk is very real and requires planning to mitigate.  In my mind, using an annuity as a portion of your stache to provide a set minimum level of income is a perfectly reasonable way to lessen or eliminate that risk.  It certainly isn’t the only way to mitigate that risk, and there’s nothing wrong with mitigating it another way or even with choosing to ignore your risk if you’re comfortable changing your plan later on.
@DoubleDown-The peace of mind factor is so huge.  Great reply.

DavidAnnArbor

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Re: Why you should never buy an annuity!
« Reply #49 on: August 29, 2017, 09:26:09 AM »
With interest rates this low, and since these insurance companies are required to invest 70% in bonds, buying an annuity right now means you are at one of the lowest yield rates on an annuity.
There's anticipation that interest rates will gradually rise. So if I were an insurance company, I would really want to sell annuities like crazy right now, talking them up in message boards, etc., because if interest rates eventually do go up, and yield on bonds rise, then the insurance company will make a lot of money having to give only low payouts to policy holders who were unlucky enough to buy policies during low interest rate environments.