Variable Annuities: Debunking the Ignorant Press
Found an annuity article in the local paper with an error so glaring that I had to debunk it. Here's the article:Income for Life
And here's the critical error, conveniently in the first two paragraphs:
Interested in annuities? The type known as an immediate annuity may pique the interest of some investors. But the first step is to clearly distinguish between an immediate annuity and a variable annuity.
Both are insurance products. A variable annuity is used to invest for a future need, such as financing retirement, and the benefit comes after years of compounding. An immediate annuity converts a chunk of cash into a monthly income guaranteed for life, with the payments starting right away.
BUZZ! Thank you for playing, and be sure to pick up our wonderful parting gifts. Of course you won't be any good at the home game, either.
When considering annuities there are two main categorical choices you need to make, and they are completely independent of one another, as five minutes of research would have told this person.
They two main categorical splits of annuities are immediate versus deferred, and fixed versus variable. Whatever your choice on one axis, it has nothing to do with your choice on the other axis. I can name annuity products in each category of immediate fixed, immediate variable, deferred fixed, and deferred variable.
The immediate versus deferred choice has to do with whether or you start getting monthly (or yearly) checks immediately or at some point in the future. Actually, this is a less bifurcated choice than it appears on the surface, because the difference between deferred annuities and immediate annuities is that you don't have to annuitize a deferred annuity today when you buy it - but you can annuitize it tomorrow, or you might wait fifty years or more. Annuities in general are designed to convert a fixed sum of cash into a stream of income, whether right away (immediate), or after they have received tax deferred income for some period of time, which can be days or decades (deferred).
The fixed versus variable choice has to do with where the money is invested. In fixed annuities, the money is invested in the general account of the insurance company carrying the annuity. In variable annuities, the money is invested in subaccounts that work very much like Mutual funds. I go into moderate depth of explanation of pros and cons in this article on Annuities, Fixed and Variable.
"Well, how do you annuitize a variable annuity?" you ask. You've got all of the same payoff options as a fixed annuity, of which "life with period certain" is the most common, and the most common of those are life with ten years certain, which makes payments at least ten years or however long you live, whichever is longer, life with twenty years certain (as before, except the minimum period is twenty years) and joint life with twenty-five years certain, which pays as long as either member of a couple is alive, or a minimum of twenty five years. The account balance is still invested in the subaccounts, although there is less than complete control over the full balance. Then they make use of what is called an "assumed rate of return" of which 4.5 percent is probably the most common.
"That's a rotten rate!" I hear you cry, and correct you are. Nonetheless, it not only is very little below the guaranteed return of the fixed account of the company, which varies from about five to about six percent depending upon company, recent market experience, and other factors, but it is intentionally lower than the rate of return you will most likely earn.
This means you're likely to start off with a lower payoff from the same amount of money in a variable annuity than in a fixed annuity, but the cute thing is that this is typically a minimum guaranteed payout for then and forevermore (or at least until the end of your payout period), guaranteed by the insurance company. When your actual rate of return exceeds your assumed rate of return, your payout goes up. It can subsequently go down as well if you have adverse investment results as will happen, but over time the stock and bond market have a lot more eight and twelve and twenty percent years than they do zero percent or minus five percent years. The average over time is somewhere between about ten and thirteen percent, depending upon who you ask and how you frame the question and when you ask it. So given the gap between an assumed rate of return of 4.5 percent, and actual rates of return that average somewhere about ten percent, what usually happens?
If you guessed that over time, your periodic payout tends to increase at a more than the rate of inflation, then DING! DING! DING! DING!, you win the grand prize - knowledge of how the system really works, and how you can manipulate it to your advantage. Which answers these paragraphs below from the article, wherein the author makes another error that could also have been avoided by that same five minutes of research:
Keep in mind, though, that if you live for decades, the fixed monthly income may lose buying power due to inflation. A few insurers offer products that raise payments to keep up with inflation, but they start out paying much less. A $100,000 premium might get a 65-year-old man only $464 a month, about 30 percent less than with a fixed-payment annuity.
Also, this may not be the best time to get an immediate annuity, even if one would make sense for you eventually. Interest rates are relatively low these days, keeping these products' returns low. In 1999, when rates were higher, the 65-year-old man could get a return of around 8.6 percent.
As you've just seen, payoffs for variable annuities can and do increase over time, even after annuitization. The downside is that only the original minimum payoff is guaranteed, but most folks have better experiences over time.
Now the article does have some good information in other particulars. Women receive lower payouts than men of the same age because they tend to live longer. The older you are when you annuitize, the higher the payout per month (although this can be a trivial difference if you're choosing a long period certain).
However, I cannot finish this article without mentioning the worst abuse of the public trust. The last line of the article recommends a website that I just refuse to link, among several other reasons, because they are apparently trying to sell fixed annuities only. Why? Because they are more profitable for the company and therefore pay a higher commission. I tried seven different scenarios looking for one variable annuity quote, and despite the fact that several of their listed companies offer variable annuities, got not one quote based upon a variable annuity. Variable annuities also have somewhat smaller and shorter withdrawal penalties and periods that said penalties are in effect (I should mention that most annuities will waive any withdrawal penalty if you actually annuitize). But an idiot could and should have spotted the fact that it's a commercial website looking to sell annuities rather than looking to provide information to the consumer (there isn't an online Frequently Asked Questions or any education on what an annuity is and is not, instead, you are told to call a toll free number that shills for a sales appointment), and from what I can tell, the author did all of the minimal research he did at this one website shilling for the fixed annuity industry. He would have done better to check with a few people with actual experience in both fixed and variable annuities.
In short, whereas I cannot prove that anyone was paid by the companies involved to write or print this article, in my opinion it should have been labelled an advertisement for fixed annuities.
And people trust these writers for financial advice?
Caveat Emptor
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