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Are Annuities a Scam? Here's What the Numbers Say...

Everyone wants financial stability in retirement, especially after a brutal year like 2022. One specific financial product, an annuity, promises exactly that – but is it worth what you pay? Let’s run the numbers…

Annuities Promise Financial Stability, but At What Price?
"Sure, I can explain annuities to you. But you'd better sit down first..." Photo by Kaleidico

From Peter Reagan at Birch Gold Group

When economic times are tumultuous, like they are now, older Americans generally start looking for more financial security in retirement. One of the investment vehicles suggested by many financial advisors is an annuity.

But despite promises of “guaranteed monthly income,” like any form of investing, there are risks and drawbacks to consider before deciding whether an annuity is right for you.

What is an annuity?

The Money Guy Show spent an entire episode discussing this issue:

Since I’m more of a writer than a talker, I’ll stick to text. Here’s a standard description of annuities:

An annuity is a financial contract that you enter into with an insurance company. You purchase the contract for a specific amount of money, either through a lump sum or periodic payments. In exchange, the insurer agrees to pay you a set amount on a recurring basis.

Depending on the type of annuity you buy, you may begin receiving payments immediately or defer them to a later date. Typically, annuity benefits are payable until your death, but some plans only allow you to receive payments for a fixed amount of time.

The basic points are:

  • You buy an annuity (usually all at once)
  • You receive recurring payments (usually for the rest of your life)

For an individual, it’s easy to see some benefits to this trade-off! After all, we’re all looking for financial stability. Especially if your retirement savings haven't been growing as well as you hope.

Why not yank all your savings out of volatile assets and use what you have left to buy yourself a stream of fixed income?

There’s always high interest in fixed-income types of investments during times of economic uncertainty. And rising interest rates can make them even more appealing. As Sri Reddy, senior vice president of retirement and income solutions at Principal Financial Group in Des Moines, recently told U.S. News:

Given the rise in interest rates in the past year, annuity consumers can generate the same level of guaranteed income with less savings. While annuities always provide lifetime income protection, the amount of income varies based upon where interest rates are when you purchase the annuity. For example, with today’s environment, a 65-year-old male retirement saver can generate nearly $7,000 per month for $1 million in savings.

I ran the numbers – $7,000 monthly on $1 million in savings is the equivalent of an 8.4% yield on your principal. That’s impressive!

If you’re a regular reader (especially of our Scam Watch columns), you’re probably thinking, This sounds too good to be true. What’s the catch?

Let’s dig a little deeper…

Are annuities a good retirement vehicle?

First off, there’s no such thing as a plain-vanilla annuity.

Just scratch the surface and you’ll discover an absolutely bewildering variety of annuity types, laden with jargon like:

  • Cash refund
  • Certain
  • “Death benefit” (it’s really, really hard for me to type those two words side-by-side)
  • Fixed or variable
  • Indexed
  • Value adjustment
  • Single life only

In fact, this annuity website’s glossary page lists nearly 100 items!

Now, just because something’s complex doesn’t necessarily mean it’s a bad idea. Although personally I tend to be extremely hesitant to invest in anything I don’t fully understand, that's just me. You may be perfectly comfortable owning assets you know little or nothing about. Maybe I'm too skeptical! Maybe the finance industry really is doing their best to offer me a good deal!

Here's the thing: annuities are a jungle.

Just take a look at this “at a glance” graphic:

Annuities defy simplification

Image via SmartAsset

That's NINE different characteristics for FIVE different types of annuities. A total of 45 different profiles and that's not everything! That's the simple version!

What does all this jargon remind you of? It makes me think of whole life insurance, possibly the most infamous of all the “investment” products relentlessly pitched by both insurance companies and their legions of commissions-hungry sales teams.

Now, I don’t know for a fact that annuities are as profitable for insurance companies as whole life insurance. (I simply suspect they are.)

And I’m deeply skeptical of any investment that prohibits your access to your own principal investment and takes away your control over your own money.

The deeper you look into estimates of annuity payments, the more you’ll realize those disclaimers you see in tiny text at the bottom of the websites, stuff like “results not typical” and “there are no guarantees” starts to make sense.

This article, for example, sets out to answer a very simple question:

How much will a $200,000 annuity pay me per month?

Unfortunately, there’s no simple answer…

Age Type 1 annuity Type 2 annuity Type 3 annuity Type 4 annuity
85 $2,586 $1,809 $1,203 $1,836
80 $1,945 $1,632 $1,197 $1,542
75 $1,551 $1,345 $1,173 $1,335
70 $1,294 $1,254 $1,118 $1,179
65 $1,132 $1,116 $1,045 $1,067

That’s right – your payment will vary by as much as 150% based on your age and the various options you select!

The same article cites two major drawbacks that could be enough to make you think again:

High fees: Unfortunately, most annuities have high fees involved. If you want to avoid fees, choosing another investment is the way to go.

No access to the principal: Once you sign up for an annuity, you won’t be able to pull out your funds. So, if a major expense comes up, this principal is inaccessible.

What if the annuity's seller goes out of business? Well, the good news is there are "guaranty associations" in all 50 states that cover at least $250,000 in annuity benefits for customers. (Sort of like FDIC insurance on bank deposits, and limited exactly like FDIC insurance.)

Uncle Sam always gets his share too. That means annuity payments have tax liabilities just like any other investment, and might even be riskier if you want to try to save on taxes:

Generally, your earnings become taxable at your regular rate once you start making qualified withdrawals. That means you don’t get the added benefit of being able to apply the lower capital gains tax rate. If you start receiving payments before age 59.5, you’ll also get hit with an additional 10% early withdrawal penalty.

I ran some numbers using the Schwab annuity calculator – what if a 65-year-old California man had $1 million to spend on an annuity to bring some financial stability to his retirement? What would that get him?

Look, there’s no sugar-coating this: this looks like a bad deal.

Maybe that’s why personal finance guru Dave Ramsey reacted like this when a caller told him she’d bought an annuity:

If our hypothetical 65-year-old had an average lifespan and purchased the “single life only” annuity, he’d be paying $1 million and getting, in exchange, $834,048. That’s not a typo!

Now there are obviously some scenarios in which our hypothetical annuity could become worth more than he paid (only one of the four scenarios outlined above – which requires our annuity holder to celebrate his 85th birthday).

Annuities promise financial security in retirement by providing a stream of fixed income payments. Based on the numbers, though, it looks like annuities could be the most expensive form of financial stability.

Another way to enhance financial stability during retirement?

If you’re wondering how to add financial security to your retirement plan, well, annuities are an option. They do not look like a smart option to me. However, like all the other decisions you make about your retirement savings, the choice (and the responsibility) is yours. Maybe the absolute certainty of regular monthly income that’s worth less than you paid for it has non-tangible benefits. Like peace of mind. Certainty. Relief from the stress of checking your balances day in, day out.

If I’m right about how annuities are “sold rather than bought,” you might have heard about them from your financial advisor.

There are other ways to enhance your financial stability during retirement. Diversifying with physical precious metals can not only provide stability, they can help lower the volatility of your savings. "Lower volatility” is finance jargon we can translate as “fewer stomach-churning drops.”

What’s better, in my mind, is that physical gold and silver are easy to understand! You don’t need to study a glossary or wade through hundreds of pages of contracts with dozens of riders and clauses.

That simplicity appeals to me. So much of our lives is enormously complicated already, don’t you think?

Whether you’ve been considering an annuity or just looking for some peace of mind, here’s what a financial advisor won’t tell you about gold and silver. And of course if you’re interested, here’s where you can learn more about the benefits of a gold IRA.

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