As many clients know, we sometimes recommend and offer annuities in our practice. Annuities are the only product which guarantees lifetime income backed by the claims paying ability of large insurance companies. They are among the most misunderstood of all investment vehicles. Many of the misconceptions are based on outdated viewpoints which do not take into consideration the tremendous advances in product design. Some of the features that clients did not like have been eliminated. For example, most of the annuity products today do not require annuity owners to “annuitize” their policy in order to get guaranteed lifetime income. Annuitization means that you convert your account value into a stream of payments. Many people did not want to annuitize because it usually meant that there was no death benefit left to their heirs. Annuity owners could receive less money than they originally invested if they annuitized and then died prematurely.
The newer annuity policies typically have Guaranteed Minimum Withdrawal Benefits (GMWB) or Guaranteed Minimum Income Benefits (GMIB). These features guarantee income for the lives of one or both spouses. However, each withdrawal is being subtracted from the actual account value. In this scenario, there is typically still a death benefit equal to the remaining account value, as long as the contract value is not depleted during your lifetime. If your account value is depleted, then the insurance company is required to continue making the monthly payments for the remainder of your life. In essence you are transferring the risk of running out of money to the insurance company.
Many contracts also have enhanced death benefit riders which increase the death benefit each year by a predetermined percentage regardless of any increases of the actual account values. Therefore, annuities typically are guaranteeing lifetime income, a minimum death benefit or some combination of both.
Naturally annuities have fees, surrender charges and other restrictions. It should be pointed out that the guarantees described above are typically riders (or optional benefits) which may not be included in the basic annuity contract. The riders may have additional fees or charges which need to be considered in your evaluation. Annuities are not right for every investor or every situation. So you need to do your homework and work with a financial advisor who you trust.
A few months ago, there was an excellent article in the NY times on annuities. The article was written by Richard Thaler, a well regarded professor of economics and behavioral science from the University of Chicago. A link to his article follows below:
Annuities are generally considered long term investments. This is not a solicitation to buy or sell. Before investing or sending money to any financial professional, investors should carefully consider the investment objectives, risks, charges and expenses of annuity and its underlying investment options. Investors should be read carefully the prospectus before investing. All guarantees are based on the claims-paying ability of the issuing company. Withdrawals are subject to income tax and prior to age 59 1/2 a 10% federal penalty tax may apply. Not all annuities and riders are available in all states or through all financial advisors. Annuities are not a deposit, are not insured by any federal government agency and may go down in value.