Updated Thursday, April 17, 2014 as of 12:19 PM ET
Annuities vs. Bonds: Do the Math
Wednesday, November 27, 2013
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As Americans face growing longevity risk, some are turning to annuities for guaranteed lifetime income as insurance against outliving their assets.

But while annuities are popular, they are not without controversy. Brian Rezny of Rezny Wealth Management, based in Naperville, Ill., says annuities are "inferior and expensive“ investments. 

Rezny, a fee-only financial planner, argues that as investments, the returns are less than spectacular for investors, who typically receive 3% or less on a 25-year investment with no inflation protection.

Less than 3%? Rezny breaks it down like this:

An annuity offers the investor income for life -- but that income never increases. So, given current levels of inflation, each year the investor effectively receives 3% less. That means over the course of 20 years the income stream from an annuity that starts off paying $5,000 a year shrivels to the equivalent of $2,000. And, of course, there’s a good chance that inflation will increase well beyond 3%.

The income that the client does receive is generated from the money they used to purchase the annuity, he says, and it generally takes around 15 years for an investor to get his or her money back. Life expectancy for most people is 85 or 86. If a client purchases the annuity at age 65, then he would be 80 years old before he actually begins seeing a return on his investment. Clients who live only to 81 or 82 would see almost no return at all.

Those returns are diminished by the fairly hefty expenses that most annuities charge -- ranging between 3.5% and 5% a year. So a retiree whose annuity is earning between 5% and 7% (a fairly typical range, according to Rezny) is only receiving between 1.5% and 3% a year after expenses. Although they’re structured and sold a bit differently, both the expenses and the returns are similar for variable and hybrids.

“Annuities are sold because of the commissions they generate for the brokers,” Rezny argues. “They lock people into unrealistic expectations.”

Most of his clients, he says, would be better off simply buying U.S. Treasuries, which are far more secure and for which they would get a similar return without locking up their money for 20 years or having to pay surrender penalties.

What's your take on annuities for clients?

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(17) Comments
Dear Mr. Kass,

You write "Those returns are diminished by the fairly hefty expenses that most annuities charge -- ranging between 3.5% and 5% a year".

That is not accurate. While variable deferred annuities with guaranteed lifetime income riders can impose total annual costs of around 3.5%, that's the upper, not the lower limit. And it applies only to variable contracts. Fixed deferred annuities generally impose no annual fees, except for optional lifetime income riders (which generally cost 1.5%/yr or less).

Moreover, not all annuities - immediate or deferred - fail to offer inflation protection. Some offer annuitization options that guarantee an annual increasing benefit; others offer guaranteed lifetime riders with guaranteed annual increases.

I am not "for" or "against" annuities. I am for accuracy and against inaccuracy. For accurate information, I suggest "The Advisor's Guide to Annuities", by myself and Michael Kitces (National Underwriter Co., 3rd ed., 2012).

John L. Olsen, CLU, ChFC, AEP

Posted by John O | Saturday, November 30 2013 at 7:10PM ET
Fee-only advisers only do financial plans so they'll get paid their fees. Yes, that is an equally vapid statement. Like all the other Suze Orman disciples Mr. Rezny appears to conflate three different types of annuities into one animal. I'll put my laddered EIA income plan, with principal protections and guaranteed predictable income increases, up against your bond portfolio any day.
Posted by Gary D | Monday, December 02 2013 at 11:10AM ET
Let's see......invest in an annuity generating life time income..assuming 20 years....or invest in a "secure" US Treasury for 20 years. Interest rates rise and value of bond goes down....annuity stays the same. Bond income stays the same annuity income stays the same. What is the catch??

Oh, money is locked up for 20 years....bond is liquid to a degree..what about the interest risk when cashed out? Isn't that a "deferred sales charge"?

Let's face it, every investor should have a series of income generating vehicles, annuities are one that provides the client with excellent ROI...not return on investment but RELIABILTY OF INCOME!!!

Good luck and good selling.....we are all sales people, commissioned or not!

Posted by Dennis A S | Monday, December 02 2013 at 11:15AM ET
Mr. Olsen has delineated the salient weaknesses to this article about immediate annuities (vs. deferred annuities) and has a background which merits our attention when it comes to the uses of these products.

Immediate annuities are risk management tools and serve clients very well who have income needs beyond the capability of assets to produce the needed income and low risk tolerance. Too many advisors seem to discount the realistic vs. mathematical possibility of a client outliving the ability of their financial resources to produce adequate income that lasts as long as they do. How would you like to be 85, in good health, and have the majority of your income cease? Do too many advisors not understand their client's fear of this risk or recognize their ignorance to the possibility?

A fixed vs. variable immediate annuity has no "annual expenses," or rather they are built into the guaranteed income provided per amount of capital used to purchase the annuity income stream. Immediate variable annuities DO typically have substantial annual expenses and seriously deplete net investment returns. A joint and survivor income stream assures that the last to die will be assured of a lifetime income. Inflation-hedged immediate annuities are hard to fine, but available. Set annual/guaranteed increases in the income can also be provided at some additional cost.

The most significant disadvantage of an immediate annuity is the lack of access to capital if required at some point after the guaranteed income begins as well as the possibility of passing capital to heirs. These "luxuries" are just that for clients who have substantial capital totaling at least 25X their income need AND the risk tolerance to live without at least some level of guaranteed income. Most clients are most comfortable if the can afford to rely on a combination of pensions/Social Security/immediate annuities and income provided by investment assets.

J. Wood Burriss, CFP, CLU, ChFC, CASL

Posted by J W B | Monday, December 02 2013 at 11:29AM ET
Put $100,000 in a bucket and take out $5,000 per year. It would take 20 years before the bucket is empty if the bucket earned ZERO. Brokers are leading investors to believe that they are earning 5% interest and not income. I testify in FINRA arbitration cases (approx. 40 per year) and have yet to come across a broker who actually told the client that the IRR (internal rate of return) on the income guarantee is somewhere between (1 & 1.5%) nor have any of the individuals who have so far commented discussed the IRR. Why? It's simple, your clients wouldn't invest in a product that only paid them 1.25%. I remember a case where the respondents expert, who was also a JD and consultant to the insurance industry tried to avoid testifying as to the IRR by giving long not to the point answer for at least 20 minutes before he testified that the IRR was 1.25%. The broker had no idea what the IRR was for the 5 policies he sold to the 76 year old client. So if John O is interested in full disclosure I hope he has been telling his clients what the IRR is on the policies he sells.

Ronald H, AIFA CRCP

Posted by RONALD H | Monday, December 02 2013 at 2:11PM ET
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