HapiMoney

The NY Times has an interesting article on lifetime annuities here. Basically, a retirement annuity is when you give an insurance company an upfront lump sum of cash, and they provide you with smaller guaranteed payouts for life.

My favorite part of the article is how commission based financial advisors can no longer profit once a client puts their money into an annuity (since they make money for every time you trade) , thus leading them to call this process “annuicide”.

Another interesting issue is based on how low the payouts are. Lets take the example they gave in the article:

So let’s say a 65-year-old man in Illinois turned over $100,000 in exchange for $632 a month for life, a recent quote from immediateannuities.com.

At first glance, $632/month translates to about $7500/year which looks pretty good when you invested $100k (7.5%). Unfortunately, you don’t get the $100k back at the end which means that you have to live 13 additional years just to BREAK EVEN without inflation- and to compensate for inflation you will need to live an additional 5 years on top of that…and to reach a return that would be afforded to you buy the purchase of a long term bond (assuming about 5% yield), you’d have to live until the age of 88.

For those interested in doing this experiment yourself, there’s a function in Excel called IRR, which stands for Internal Rate of Return. In one column type -100,000 (which is your investment in the annuity), and then type the series of payments for each consecutive year below the 100k ($7500 for simplicity’s sake).  In another cell, type =IRR(select the values you entered in followed by a comma “,” then enter a guess, say 1%). You’ll see what the actual return this investment provides you is.

The reason that insurance companies price these annuities so that it takes 13 years to earn back is because the average life expectancy is only 78 years of age. That means, on average, an insurance company will have 13 years just to pay you back with effectively no interest…a no interest loan! So when do annuities make sense? If you were planning on living to 100 is a good choice, or if you just don’t want to deal with the hassle and worry of researching other fixed income investments. Either way, it’s probably better to diversify if you end up going the annuity route, so don’t put all of your eggs in the “annuity” basket.