Beware Annuities

A lifetime annuity is where you pay a lump sum today and receive monthly payments for life.

Estimated amortization of a current lifetime annuity.

A recent quote from an A-rated insurance company for an age 65 $100K immediate annuity was $542.43 per month for life. This $542.43 is both a return of principal and interest. The insurance company's goal is to make exorbitant fees AND pay less over your lifetime than you pay in. The company keeps your money and makes payments for as long as you live. You COULD live much longer than the insurance company expects!

Of course, you could muck up your contract with complicated and costly riders including death benefits and/or continued payments to beneficiaries. These usually only confuse buyers and their main purpose is to increase fees. Buy and price each rider separately. So, no bundled riders!

How do we evaluate this quote?

One way is to look at a similarly rated corporate bond with the duration equal to your life expectancy. Using that measure, checking today's market, a 20-plus year $100K A-rated corporate bond pays about 4%, that is, $4000 a year or $333.33 a month. Bonds don't care what your age is, bond prices do not go up and down based on your age, annuities do!

$100K lifetime immediate annuity pays $542.43 monthly for life and zero at the term end.
$100K 20 year 4% bond pays $2000 every six months for 20 years plus $100K after 20 years.

Which deal is better?

Annuities have an illiquid secondary market. Bonds have an active secondary market.
Annuities are not quoted daily, bonds are.
Insurance company fees are opaque and huge. Ask agents what their total compensation is for selling annuities! Bond fees are much lower and transparent.
You lose your principal in an annuity. You keep your principal in a bond.
Annuities do not pass on to heirs upon death. Bonds pass on to your estate.
Annuity payments end upon death, Bond payments continue to maturity and accrue to your estate.

Note that lifetime annuity payments include interest plus a return of principal: $542.43 = $333.33 interest + $209.10 principal to start. With time, the interest portion will fall and principal will increase just as a mortgage would. If you live to your life expectancy, you may get your principal back.

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Disclaimer: Posts are for education only and not investment advice, may be subject to change without notice, and, while prepared with care, may be subject to omissions and errors.