In the current interest rate environment, investments traditionally viewed as “conservative” such as money-market accounts or certificates of deposit are yielding investors almost nothing. As such, many retirees or “conservative” investors are in a bind and looking at alternatives to provide them with a yield that gives them sufficient annual income.
One of the alternatives being touted is an “immediate annuity.” An immediate annuity is an annuity that is purchased with a single premium and that begins income payments immediately or very soon after purchase. Unlike buying a bond, which can be sold at anytime or rolled into another bond when it matures, an annuity locks an investor into an interest rate forever. Investors are essentially making a bet on how long they will live. For investors who live into their 80s or longer, these investments could have an attractive payoff. However, for those who do not survive that long, immediate annuities become a poor investment.
With a traditional immediate annuity, the $100,000 investment initially made (for example) is gone forever. Therefore, insurers are willing to pay a higher monthly payment. The article “Are Annuities Being Overhyped as a Retirement Cure All?” in the February 13, 2010 edition of the Wall Street Journal provides the following example: if a $100,000 immediate annuity pays $7,500, a 65-year-old investor who lives an additional 20 years yields approximately 4.48%. However, as the years increase, the yield rises. After 25 years the effective yield is approximately 5.87%; at 30 years it is 6.61%. On the other hand, if the investor dies in 5 years, he effectively received $37,500 back on his $100,000 investment. To counter this concern, many insurance companies selling immediate annuities guarantee the annuity payments will continue for a set number of years. However, the investor receives a lower monthly payment in return for this guarantee.
The other issue investors face with immediate annuities is low payouts. Interest rates today are exceptionally low and are likely to rise in the future. To combat this problem, many investment advisors are recommending that investors stagger annuity purchases every five to six years. Ideally, this will lock in some of the income needed presently, as well as provide the opportunity for investors to receive higher annual payouts if and when interest rates rise.
The article suggests that investors to heed the ratings of insurance companies, and to stick to those companies with triple-A double-A claims-paying-ability ratings. Additionally, investors could diversify their annuity holdings across various companies and staying in the coverage limit available in their state.
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities and insurance related litigation and arbitration.