Why would an insurance actuary call annuities the best financial product no one really wants? And why would he go on to say that in retirement he might not even purchase an annuity himself even when he knows they make good sense?
Dick and Eric discuss why individuals purchase annuities – even though they don’t want to…
**Guarantees, including optional benefits, are backed by the claims-paying ability of the issuer, and may contain limitations, including surrender charges, which may affect policy values. During this segment, Dick and Eric are referring to Fixed Annuities unless otherwise specified.
Annuities: The best financial product no one really wants
“Annuities are not sexy. You hand over your money to an insurance company who then puts you on a seemingly stingy allowance for the rest of your life”
People who save through RRSPs have a choice to make when they retire. They can transfer their RRSP balance to an RRIF and draw it down at their own pace (subject to a minimum) or they can buy an annuity.
The simple fact is, an annuity may be a great idea, but hardly anyone buys one.
It is easy to blame low interest rates, which depress the amount of annuity income one can buy these days. But annuities were not in vogue even when interest rates were much higher a dozen years ago.
‘Let me be honest. When I retire, I am unlikely to buy an annuity myself, even though I’m an actuary and know all the advantages’
Economists have come to refer to this phenomenon as the “under-annuitization puzzle.”
Buying an annuity seems like an elegant solution since it removes the risk of outliving one’s assets (what actuaries like to call “longevity risk”), it eliminates the hassle of making investing decisions after retiring and the income stream it provides is super safe (it really is, at least in Canada). So why are they so unpopular?
In recent years, however, the economics of annuities have improved greatly. Annuities in Canada now generally return 95% to 100% of premiums paid. In fact, with the recent fall in long-term government bond yields, annuities now return more than 100% return of premiums paid in many cases. The economics, then, can no longer be blamed.
Another often-cited reason for not annuitizing is that the retiree wants to leave a large lump sum to a survivor in the case of early death. This argument, however, does not hold up on closer examination.
Even when people have little or no interest in leaving assets behind for their heirs, they tend not buy annuities. Moreover, annuities can come with generous survivor income options, if one is prepared to pay for them. Another excuse shot down.
There are other explanations for this puzzle, including: The desire to have money on hand in retirement for a rainy day; the recognition that income needs might vary and the fixed income from an annuity might not match up well; and a reluctance to give up the chance to do better by investing in equities within a RRIF if stock markets do well.
Let me be honest. When I retire, I am unlikely to buy an annuity myself, even though I’m an actuary and know all the advantages.
I would be the first to admit this reaction is not entirely rational. The reason, plain and simple, is that annuities are not sexy. You hand over your money to an insurance company who then puts you on a seemingly stingy allowance for the rest of your life. [Read the Full Article from Fred Vettese at the Financial Post]
Annuity Guys® Video Transcript:
Eric: The topic is annuities. The best financial product no one really wants.
Dick: Can you imagine that no one would want an annuity, Eric? Is that a true statement?
Eric: No, the people I talk to every day, everybody wants an annuity.
Dick: But that’s different. Folks, the people that we talk to may be someone like yourself that’s actually went to our national website, as Eric likes to remind me, international website.
Eric: International website.
Dick: But goes to our website and they’re already in the mindset of annuities.
Eric: Right, they’re doing their research. They’re doing the background on why this might work for them.
Dick: So we might be just a little bit skewed, do you think?
Eric: We’re taking it based off an article, and interestingly enough, it was written by an actuary who works for an insurance company. His comment and I love this, “Annuities are not sexy. You hand over your money to an insurance company who then puts you on a seemingly stingy allowance for the rest of your life.” Well, that sounds pretty pathetic, if you ask me.
Dick: I do have to say that, before I knew much about annuities, many years ago that never entered my mind, never crossed my train of thought. Would I rather have a new car, a new house, or an annuity?
Eric: Rather than an annuity. That’s not fair. Everybody would rather have a new car or a new house.
Dick: That’s right, and really when you think about it, and that’s a lot what this article gets into is we built this money up. We accumulate this money and we like the idea of hanging onto it, controlling it, investing it, whatever we choose to do with our money, but to hand it over to an insurance company and let them give us money back, it’s kind of a transitional state that we go through to make these types of decisions, and there has to be a pretty good reason behind it.
Eric: I come from a family of educators. I’ve talked about that before.
Eric: You know right now in Illinois, we’re fighting. They’re fighting to maintain their pension. Well, what’s an annuity really?
Dick: It’s a pension-style income.
Eric: I mean for today’s 401k investors they’re basically, when you get your retirement you’ve got this lump sum. Do you want to keep the lump sum or would you rather have a pension?
Dick: The vast majority of retirees before they retire and they have this choice, not all companies give this choice; but there are a lot of corporations that will give the employee the choice of a lump sum or a pension. Now the vast majority choose the pension. They’ve worked their entire life.
Eric: For the seemingly stingy income for life?
Dick: Yeah, and yet, even those that would take the lump sum, in many cases will turn right around with that lump sum, and buy a commercial annuity that they feel is a better option, than maybe the pension the company was going to offer. So we tend to get it when it comes to that lump sum that comes from the employer, but yet many times we’ve worked all of our lives, built up all of this money and what’s the purpose of it?
Eric: It’s mine. I want to keep it.
Dick: What’s it supposed to accomplish?
Eric: That’s exactly it. It’s just future spending. It’s not savings. Its future spending is what we’ve save for, but we don’t think of it in those terms. We think of it as “This is money I saved. I don’t want to give it to somebody and then have them, give me a seemingly small allowance.”
Dick: Right, and that’s where the insurance company’s job, their job is to look at risk, to manage risk, to know what’s realistic. You’ll have to read this report, folks and kind of get the gist of what this person’s saying, because he actually is an actuary and he’s really laying out that these insurance companies don’t always win on this stuff.
Eric: And he talked about annuities are much better—the design and what they payout in today’s era, is much better than they were 10-20-30-years ago.
Dick: Right, a lot’s changed.
Eric: You really do have an actuarial advantage to buying an annuity and he admits that, even though I know this advantage exists, I’m not so sure.
Dick: I might be standoffish when I first retire, but maybe as my age advances I’m going to be more apt to do this. This kind of brings me back to a lot of the buzz that is out there and things we talk about with the hybrid annuity but one of the things that appeals so much to folks, on a hybrid-style annuity is that they are able to control that lump sum. What we call majority control the first 10-years or so of an annuity. You have some surrender charges, so you control about 90% of it during that first 10 years, and those surrender charges decline, so after 10 years, you control 100% of it and you still have a lifetime income. And yet, if you haven’t used that money in your account, it can all go on to your heirs, your spouse, whatever is important to you.
Eric: Exactly. In his life point, I guess in summation here he talks about you know what? Everybody has, even if you have that lump sum investment you have, usually a portion that’s in equities and you have a portion as you get closer to retirement that we should all be moving into those fixed payments, bonds, CD-style. What would be wrong with taking those more conservative assets, turning that into an annuity and then just truly letting your equities run, and knowing you have that **guarantee that income coming on?
Dick: Well, Eric obviously this is what we talk to our clients about. We talk to them about balanced allocation. Not putting everything into annuities, not necessarily having everything in the market. Finding that balance that works for each individual, and so to me, he’s right along the lines of what we continue to explain to people.
Eric: Exactly, yes. He takes care of the foundation very well.
Dick: So Eric, would you say that an annuity is something that no one wants?
Eric: All right, there are a few people that want annuities.
Dick: Well, folks we’re not saying that an annuity is going to be the end-all and the be-all or exactly what you need, but you do want to look at it closely and determine where it might fit into your overall financial picture. We really appreciate you spending the time with us, today.
Eric: You have a great afternoon.