Monday, June 16, 2008

Annuities Are Never Stupid

On June 12, 2008, The Motley Fool published an article by John Rosevear entitled “Are Annuities Ever Not Stupid?” The article mentioned that “we [the Motley Fool] really don’t like most annuities,” and it referred to equity indexed annuities as “ugly.”

In our opinion, Mr. Rosevear did not adequately answer the question he posed, so here is our answer. We believe that our answer does a better job of explaining why annuities are popular financial products.

Are annuities ever not stupid? Of course. Immediate, fixed, indexed, and variable annuities all provide an attractive value proposition to certain customers.

Immediate annuities: Retirees face a dilemma. They have a limited amount of savings, and if they dip into the principal to provide an adequate cash flow during retirement, they face the prospect of running out of money one day. Immediate annuities are the one financial product that can allow you to liquidate your principal yet be guaranteed not to run out of cash flow, no matter how long you live. This is because insurance companies pool the longevity risk across a large number of annuity owners, ensuring that there is adequate money to pay those who live a long time. As Mr. Rosevear mentions, the March 2005 issue of the Motley Fool’s Rule Your Retirement newsletter includes an article showing how adding a lifetime income annuity to your retirement portfolio can help ensure you don’t outlive your retirement savings.

Fixed annuities: Fixed interest rate annuities include so-called “CD-style” annuities. They are available in a variety of durations with a variety of interest rates. They are very comparable to bank CD’s and are often sold by insurance-licensed employees of banks. Because of the different investment strategies employed by banks versus insurance companies, there are times when fixed annuities offer much higher interest rates than bank CD’s of the same duration. When they do, fixed annuities are a smart choice for consumers who would otherwise put their money in bank CD’s.

Indexed annuities: Indexed annuities get some bad press because some writers and consumers by mistake think that these annuities are designed to replicate stock market returns. They are not designed to do that. They are designed to have similar safety of principal features as bank CD’s, money market funds, and savings accounts. They are an excellent choice for consumers who are looking for safety of principal yet the potential for a higher return than those other comparable products. You can even make a good argument that indexed annuities are more attractive than bond mutual funds. See our article, “Turning the Fixed Indexed Annuity Critic into an Advocate.”

Variable annuities: Variable annuities get some bad press because some writers (including most at the Motley Fool) believe that all customers should be willing to bear stock market risk in order to achieve stock market returns. But there is some risk of losing money in the stock market, even over long periods of time, and many consumers cannot stomach bearing that risk. So, variable annuities offer a way for such consumers to put money in risky securities. Consumers give up some of the return in the form of fees to the insurance company, which provides various guarantees to protect the invested principal. This provides a way for risk-averse customers to achieve some element of stock market return at a risk level that is comfortable for them.

Why do you think most commentators ignore the fact that annuities are a good option for consumers who are looking for safety of principal? What can we do as an industry to better educate these commentators? Click the “Add Comment” link below to share your thoughts.

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