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GOOGLE THE WORD “annuity” and you’ll receive 97 million and one results. Is there anything left to be said?
Yes, I think there is.
About 11 years ago, my 89-year-old mother asked me if she should invest more money in her Knights of Columbus annuity. Unbeknownst to me, she and my father had purchased it many years earlier. It earned a guaranteed 3.5% annual interest rate, which was better than every savings account or certificate of deposit available, plus it was tax-deferred.
As I had previously answered her vital questions—“can I get my hair done every other week?” (she could) and “should I give the front desk lady $20 for Christmas?” (she should)—she expected immediate and salient financial advice from her favorite son.
I told her I wasn’t sure if she should invest more as my knowledge of annuities was limited. I knew that variable annuities were bad, and that immediate fixed annuities had their uses and that their present value could be easily explained by PV = PMT * [1 – [ (1 / 1+r)^n] / r].
I think she was expecting an answer that was a little more concise—and affirmative.
Each time a certificate of deposit matured, she would ask me, “How about putting some money in that K of C annuity?” As a dutiful son—and after the third time she asked—I promised to contact the knight who sold her the annuity those many years ago.
Sir Keith was duly contacted and asked to provide details on my mother’s annuity. He was a very nice man, who promptly mailed my mother her most recent statement, which didn’t exactly answer my question.
When I called Sir Keith back, he claimed that was all he could do. When I asked for a prospectus, he informed me that there was no such thing and that I should look at my mother’s contract. I only mention this to show my commitment to resolving this issue, not to demonstrate how little I really knew about annuities.
“Ah ha, now we’re getting someplace,” I thought. But I immediately realized how this would go. When I asked my mother to produce the contract, she replied with the expected answer, “What contract?”
The Supreme Knight was contacted and my mother received a copy of her contract. Trust me, this was easier—and quicker—said than done.
Unfortunately, the nine-page contract was less than illuminating. It was filled with terms such as “assignment,” “maintenance of solvency” and “the accumulation value as of the maturity date.”
The fact that the contract was in my late father’s name—and that it was now eight years after the contract’s maturity date—made everything that much more confusing. Sir Keith assured me that all of this was not a problem and that, basically, the contract was now in my mother’s name.
I reported all this to my mother—or should I say the “owner,” or maybe “beneficiary,” or possibly the “annuitant”? She was still quite insistent on “investing.” Or should I say making a “premium payment”?
What could I do? Catholic guilt can be a powerful product feature.
My mother died at age 99. During her final years, she never needed to take any “payments,” or should I say make “monthly withdrawals,” because during her later years—besides a cup of coffee and a Bavarian cream doughnut at Dunkin’—her extravagances were few.
After her death, her beneficiaries were paid a handsome death benefit, which appeared to be the answer to a trick question, as it could be either “the sum of the premiums paid, less any withdrawals” or “the accumulation value as of the date of death.”
One of the features that stocks, bonds and certificates of deposit offer is that you know exactly what you’re getting. One share of IBM is just like any other. This isn’t true of annuities. Even the simplest ones are still guided by the specific contract you have with the insurance company—or, in this case, the fraternal benefit society.
I don’t mean to offer an unduly harsh take on annuities, as they can be a useful component of retirement planning. Besides the aforementioned Catholic guilt, I really have no idea why my parents purchased this flexible premium annuity. But I have a feeling my mother wasn’t aware of two of the annuity’s features.
First, as the contract’s beneficiaries were limited to the exact people named, her predeceased daughter’s children were not considered beneficiaries.
Second, most of the accumulation value that was paid to the beneficiaries was now considered taxable income—basically transferring her tax liability to her heirs. Since the exact amount of the payment was somewhat unknown, this complicated the Rothification efforts of at least one of the beneficiaries.
Michael Flack blogs at AfterActionReport.info. He’s a former naval officer and 20-year veteran of the oil and gas industry. Now retired, Mike enjoys traveling, blogging and spreadsheets. Check out his earlier articles.
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About the only kind of annuity I’d want to buy is a fixed immediate or deferred annuity. I pay you a lump sum now, you pay me a specified amount per month for the rest of my life. No more, no less. My perception is if you start adding in other features, such as variable interest rates, death benefits, long-term care, etc., it seems like a way for the insurer to tack on extra fees. It’s harder to tell if you’re better off buying all of the components separately (term insurance, mutual fund, LTC insurance). I prefer products I can understand. It reminds me of the (small) bets I place on gambling sites. If I bet on a single play, I can easily tell what the odds are. When I do parlays, everything gets lumped together, and I expect the betting site is taking more of a cut. I suspect it’s the same with annuities.
Thanks Mike!
I like the idea of “forever” income and have set up 5 “for life” streams. My Traditional IRA was started and transferred 3 times to different companies. I had been in a Prudential Variable contract for several years and doing quite well with gains. It was designed to capture the DAILY highs to the income generation part of the contract. I was told of course that variable is a baaad word and moved everything to a fixed, Nationwide Ins policy with accumulation anniversaries of 3 years.
This Oct was the latest anniversary with any gains being awarded and I elected to turn on distributions and use it to help pay most of my regular taxes.
Of course, I will wonder if switching the last time was a good decision, which would have paid out the most?
And I might add that I really want to live a long long time and soak up the milk of my efforts!
Unfortunately, this article less than illuminating.
About how much did your mother invest in this annuity? If you don’t know say so.
You say her beneficiaries were paid a handsome death benefit. How much was it, and what was the answer to the trick question?
Knowing what you know now, what would your advice have been to your mother when you first became aware of the annuity contract?
booch221, appreciate your straightforwardness! I didn’t include the amount of the annuity as it had nothing to do with the story. If I told you it was $100,000, would that change your appreciation (or lack thereof) of the article? Same for the death benefit.
I didn’t include the answer to the trick question as I thought it was obvious.
btw: do you sell annuities for a living?
thanks!
I always think of annuities basically as a form of life insurance. And thinking about this annuity in this way illustrates one broader issue with all “whole life” or similar life insurance policies. In the early days, the annual cost to insure someone is small because the risk of their dying is small, and so it has little effect on an annuity, and the earnings can accumulate. In the late days the cost of the insurance component of an annuity policy is much larger, and at some point, it will exceed the earnings, except in the best policy situations. (My Northwestern Mutual policy earnings still exceed the cost of the insurance each year, even though I am 71.) But as the earnings grow and the cumulative premiums for the life insurance component also grow, those (untaxed) earnings take up more and more of the value of the policy. Thus, one should always expect that when an elder with life insurance dies, most, if not all of the life insurance payment (or lump sum annuity distribution) will be fully taxable.
With tax-deferred fixed annuities (which is what Mike is describing) and tax-deferred variable annuities, the pricing — as far as I know — never varies with the age of the annuity owner.
It feels like there is more to this story…?
I suspect Thrivent is another annuity and whole life insurance promoter…beware of inferior products disguised as fraternal investments.
Thank you, Michael, for describing your mother’s situation, and also for the formula that I was not aware of.
Not all annuity plans are bad. Contracts offered through employers can be excellent savings vehicles during the accumulation phase. Some provide the possibility of different types of income streams upon annuitization, including lifetime payments or just required minimum distributions.
For more than three decades, I contributed pre-tax earnings regularly to the TIAA traditional annuity and to T-CREF accounts. My investment returns over this time have been solid, especially for fixed income (TIAA guarantees a minimum rate and typically well exceeds that). Now 64 and retired for six months, were I to fully annuitize the accounts tomorrow the annual payout would be several thousand dollars a year larger than my last salary. I feel well served.
Lastly, I agree that annuities, at least TIAA’s, are associated with a fair amount of actuarial mystery. Doing a rough estimate using the formula above, however, suggests that TIAA’s life expectancy tables are similar to those of the IRS. That seems fair to me.
I’m always pleased to read about people’s positive experiences with the TIAA traditional account. I’ve been contributing some money to it since I was 31 years old. Right before I retired, I moved a substantial sum of my retirement savings–which had been in an index fund–into it. I know a lot of people would tell me it’s far too conservative of an account for someone my age. I, however, am not a risk taker when it comes to my money, so I appreciate the slow and steady growth I have with that particular account.
When I showed your article to my spouse, her comment was “I thought you wrote it”. The only difference between your experience & mine was my mother never consulted me before I took over her finances. Also, she still had the contract and lived to 103. When I called the Supreme headquarters for more information, I told them that I didn’t think accepting a $5000 payment into an annuity of a 94 year old was appropriate. They agreed with me. Luckily, it was never annuitized. Thank you for your article, it validated my frustration.
A touching and sensitive topic you brought up. I experienced the same rigamarole with my parents investments where I learned they had a variable annuity with annual fees of 3.50+%. Once the surrender period had ended, the annuities were sold (taxes paid) and placed into an index fund. Selling the annuity saved well over $150K in fees alone for their remaining years.
On the other hand, selling variable annuities is fantastically profitable. The salesman gets about 2% the first year, and then up 1% each year the contract is in force. If you can manage to sell $50 million in variable annuities, you will have an annual income of $500K for life without having to get out of bed.
Have you ever wondered why these salesman are so determined to make sales? Well, now you know.
Just type “Annuity” into your google search and you will get page after page of Ads, websites, financial brokers, insurance agents, blogs…well you name it. So, there must be money in selling those “things”.
Each individual has to decide for themselves, can they manage their retirement money, is a fixed annuity enough, so they can sleep well at night, can they max out their social security payment at age 70 or at least at FRA. It’s a decision tree that an hourly fee CPA, CFA or RIA could analyze for you. Well worth the money to get a snapshot of annuities and alternatives to annuities in retirement. There’s no such thing as a “free lunch”.