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Should You Buy A Fixed-Income Annuity For Retirement?

FYI: Plenty of people shudder when they hear the word, “annuity.” Many financial advisors sell them as if they’re life preservers. But they’re usually filled with holes.

Variable annuities, for example, are widely oversold. An advisor might croon, “These products guarantee that you won’t lose money. They’re also linked to the stock market. So when stocks rise, the value of the annuity rises too.” In 2005, columnist Scott Burns published, Seven Reasons To Avoid Variable Annuities. Today, his logic hasn’t lost its sting. Investors pay stratospheric charges, averaging 2.24 percent per year. That hurts investment returns. Variable annuities can also attract unnecessary taxes. And if investors withdraw early, they usually pay stiff exit penalties.

Fixed-income annuities, however, look more attractive to retirees. Here’s how most of them work: You pay an insurance company a lump sum. In exchange, they provide a regular income stream for life. It’s much like buying a defined benefit pension. But in most cases, there’s no upward adjustment to cover inflation. *


  • While I agree that VAs are widely oversold, you'll notice that the second and third paragraphs above are comparing VA deferred annuities with fixed income immediate annuities. Not especially meaningful, but it makes for a great sound bite.

    Do you care what the average VA costs, any more you care what the average fund costs? Or do you care what your annuity or your fund costs? Vanguard offers a VA that costs 0.48% (average across the funds offered in the annuity). And unlike the "usual" VAs that charge "stiff penalties", low cost annuities like Vanguard's charge no penalties.

    Likewise, do you care what the average SPIA pays, or what you can get by shopping around? says that the best current payout rate on a $100K joint life annuity for a 60 year old couple (i.e. younger than the example in the article) is 5.586%. That's quite a bit more than the 4.38% average rate cited in the article. (Admittedly, I'm ignoring the quality of insurer, but then so is the article.)

    The article says that according to Vanguard's Monte Carlo Nest Egg Calculator, using the 4% rule with a retirement investment portfolio (with what asset mix, it doesn't say), you've got a 9% chance of having no money left over for heirs. That's a euphemistic way of saying that you have a 9% chance of running out of money while you still need it.

    The point of insurance is to protect against worst case events. What happens if the worst happens and you live longer than 30 years?:-) Your odds of being left destitute increase.

    The articles presents a particular perspective, and in doing so shades wording, frames numbers, and speaks in generalities that advance this perspective. That's not to say there isn't validity in the picture it draws. Just that it's drawing only part of the picture.
  • Thank you msf, a thoughtful analysis.
    I am an uninformed bystander in the annuity world. But what I do know (or think) is that an investor should not use annuities for all their retirement investment but they should consider replacing a portion of their fixed income sleeve with one.
  • A low cost VA is somewhat like a nondeductible IRA - a tax sheltered investment that you fund with post-tax money, and that you pay ordinary income taxes on when you take your money out.

    The cost of paying ordinary taxes on earnings tends to outweigh the tax sheltering benefits of VAs. That is, unless you trade frequently or hold bond funds in your VA. It sounds like you're thinking about the latter. That can make sense, though one should fully fund other tax-sheltered vehicles (IRAs, 401(k)s, etc.) before looking into VAs.

    When it comes to really fixed income (think CDs), fixed annuities may be reasonable alternatives. Insurance companies have traditionally paid more than banks. These days, though, that doesn't seem to be the case. For example, the best three year rate I'm seeing is around 3% whether for a fixed annuity or an NCUA (credit union) insured CD.

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