Russell Bailyn's Financial Planning Blog

The biggest benefit to owning an annuity (in my opinion of course) is its convenience and flexibility. Creating a budget and sticking to it is difficult for retirees as they often can’t anticipate what their financial needs will be and how to budget a lump-sum of money. How do you know how long you will live, or who in your family will need money when you die? How can predict inflation, or guarantee that you won’t outlive your assets? These are the sorts of concerns that an annuity will bundle up and sell to you in a neat little package. The benefits included in the annuity are flexible and the expenses and fees which you pay to own the annuity contract vary depending upon which of these options you choose. Below is a list of the most popular features of variable annuities:

Death Benefit – The annuity will offer a payment to your spouse or other named beneficiary when you die. They will generally receive either the remaining balance in your account or some greater sum of money which was guaranteed to your beneficiary by the insurance company. The reason the sum may be greater is that you agreed to pay higher annual expenses during the life of your contract in exchange for this increased death benefit. This is often referred to as a “stepped-up” death benefit. It’s a form of insurance and will either be worth it if your investments performed well early on and you locked in a good rate of return, or not worth it if the expenses you paid watered down what would have been a better performance of your investments. Remember, investments have an element of compounding to them, and each percent (or fraction of a percent) which you shave off the return as an expense or fee to an insurance or mutual fund company is not only less money being invested, but also less money experiencing this compounding affect which can greatly improve the performance of your investments.

Guaranteed Minimum Income Benefit - When your accumulation phase is over and you begin to receive payments from your contributions, a number of factors can affect the amount of income you get. The most important factor is the length of time you choose for your payout (five years, ten years, or lifetime). If you have $100,000 in an annuity and take a five-year payout, you could estimate somewhere between $20-25,000/year in income. Why? $100,000 divided by five years of payout is $20,000/year. You may very well have more than $100,000 because of the style in which you invested the money. In the event that you invested most of the money in stocks and they performed terribly, your account may be worth $50,000 instead of $100,000. If this is the case, could you still expect the insurance company to pay you $20,000+/year? Well, you can elect to have a guaranteed minimum income benefit, which will pay you the larger sum of money even if your investments don’t perform well. You may be wondering why an insurance company would offer you such a good deal. Well, historically the stock market has never had a negative performance over a five-year period, so the risk they are running (historically speaking) is very low. It may cost you an extra ¼ or ½ of a percent of your investments to give yourself this “guarantee” of income. Since the overwhelming odds are that the investments will ultimately perform well, the insurance company profits off the higher expenses you paid. Is it worth it? It completely depends on your mentality and attitude towards risk and investing. I’ve seen many people elect to take the guaranteed minimum income benefit (just as I take travel insurance) and plenty, after hearing my argument about the impact of compounding investments, not take it.

Long-Term Care Insurance – People overlook the tremendous expense that comes with being unable to perform many of your day-to-day functions. In actuality, 40% of people over 65 years of age will need some form of long-term care in their lifetime. It may vary the simplicity of a part-time assistant, to needing 24-hour attended care. While putting into the annuity contract may be convenient and provide piece of mind, it’s something I’d give careful consideration to. Long-term care is generally a “rider” to an insurance policy (whether a variable annuity, or life insurance) and may be either not necessary or obtainable at a cheaper price. For example, I’d encourage paying a single premium (one-time payment) for long-term care insurance rather than allowing it to be deducted annually in expenses from a long-term contract. There are a lot of options when it comes to purchasing insurance and it’s generally speaking, the most convenient option is not the cheapest.

This is the basic story with annuities. Are they worth it? For some people they are. A true do-it-yourself investor could probably stack up a similar product by purchasing insurance contracts for the death benefit and income guarantees, and have a brokerage account full of bonds and dividend-paying stocks for creating an income stream. While it may ultimately be cheaper this way, it would require serious time and research to figure it all out. Like everything else in life, it’s up to you and your financial advisor to figure out the costs and risks.

Please feel free to e-mail me with all questions and comments.

Russell Bailyn
rbailyn@gmail.com

Note: This article is for informational purposes only. It does not represent a solicitation or endorsement to buy any particular financial product. There are risks inherent to investing and you should speak with a financial professional prior to making any decisions.