The sales pitch emphasizes the prospect of gains in the market rather than the safety and security of the contract. Hundreds of insurance-annuity companies have rushed in to sell their Mutual Funds to unsuspecting retirees, in the form of a much-more-speculative-than-meets-the-eye retirement program. In it's zeal to claim its share of the investment dollar, the industry has rationalized away the risk of equity investments. Financial Planning computer models are programmed to include variable annuities in their asset allocations, shifting the retirement income risk to the consumer. And it's such an easy sell because what the customer hears is: a guaranteed retirement income plus stock market appreciation.
Unfortunately, the stock market never has been able to generate guaranteed levels of income, and sometimes fails to move higher just because we think it should. Serious problems occur when mutual funds are packaged with annuity contracts and the critical differences between them are either overlooked or undisclosed, perhaps innocently, perhaps not. The founding fathers of the annuity contract would not be pleased with today's glitzy versions. Let's back up a century and consider some basics. Just who needs an annuity anyway?
Keep in mind that the annuity produces the largest possible commissions for the salesperson and the largest potential penalties for the purchaser. The variable variety adds the commissions from the mutual funds to the package, and uncertainty to the income benefit. Here's how to determine if an annuity makes sense economically. Is it clear that there is no such thing as a guaranteed variable annuity? The key suitability numbers are easy to develop and to analyze.
The most important number in the equation is your personal expense estimate. How much income is needed at retirement? Always estimate conservatively (that means to use numbers higher than you really expect). If you need a calculator, you're making it too difficult. Let's pretend that the number you decide upon is $48,000, or $4,000 per month. Next, subtract the amount of any guaranteed income you expect to receive from all sources, including social security, pensions, etc. Do not include the value of your investments or properties you plan to sell in this calculation. Again, be conservative, keeping your estimate a bit lower than what you actually expect, and make sure you know why investment earnings should not be included. Let's say that this number works out to be $27,000.
That's it. Now all you have to do is to determine if the investment portfolio can safely generate the difference of $21,000 per year in income (dividends and interest only, please). For the purposes of this analysis, the current market value of the portfolio is used, so make sure that you include the value of everything that is marketable. At today's interest rates you could get the job done safely with under $300,000 but not with normal equity mutual funds or any form of Index Fund. It is totally irresponsible (actually, its worse than that) to rely on equities to provide retirement income. BUT, if the numbers are just short, and (a) a "windfall" (inheritance) is anticipated within a few years, or (b) the retiree is in poor health, an annuity is the last thing that should be considered! You should be able to invest the money conservatively, generate adequate income and have an estate left over for the heirs! Remember to satisfy the income need before looking at equities. There are no exceptions!
So here we have a last resort product, designed for the poor, that the industry has chrome plated, spit-polished, and supercharged for marketing to people who should know better than to include equities in an income portfolio. Why? Is it because financial pros really think these products are universally suitable? Is it the commissions? Or is RISK just a board game that they played in college?
Today, it's difficult to distinguish one financial institution from another as they compete for the ever-growing pool of investment dollars. Insurance companies, now publicly owned, have become am integral part of an industry that seems uninterested in protecting anything other than their obscenely paid leaders.
So here we have a last resort product, designed for the poor, that the industry has chrome plated, spit-polished, and supercharged for marketing to people who should know better than to include equities in an income portfolio. Why? Is it because financial pros really think these products are universally suitable? Is it the commissions? Or is RISK just a board game that they played in college?
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Annuities - Part One <--
