By David Wilkening, Contributing Writer
REGION – For decades, people have been buying annuities for a lot of reasons that sounded positive. They are long-term investments issued by insurance companies. Through annuitization, your purchase payments of what you contribute are converted into periodic payments that can last for life. Reasons for buying them include added income and others. For people at or near retirement age, the goal of annuities is often to help guarantee a certain amount of income. They can provide a hedge against longevity risk, which is the risk of living far longer than you thought you would. If you’re buying it for that reason, an annuity can be a good investment.
All annuities are not alike. There are many types, each with its own pros and cons. Some annuities require fees while others don’t. The high fee situation has sometimes discouraged lower income investors. But perhaps that should not always be a deterrent.
Economist makes the case
“For lower-income individuals, I would say annuities might still make sense if they don’t plan to leave a bequest,” said Gal Wettstein, senior research economist for the Boston College Center for Retirement Research. “We have more recent work that has not yet been reflected in the working paper of ‘The Value of Annuities’ that shows that almost all socio-demographic groups would benefit from additional annuitization once there are no bequest motives.”
Wettstein points out he is not a financial planner who can suggest advice for topics such as buying certain annuities. Annuities are far from a simple product. So most observers suggest professional help when considering to buy or not. But Wettstein has done research on the topic, including his working paper “The Value of Annuities.” His co-authors in the paper from March of last year from the Center for Retirement Research were Alicia H. Munnell, Wenliang Hou and Nilufer Gok.
Cost and value are concerns
The brief’s key findings were that annuities were one solution for retirees having to draw down their nest eggs but “few people buy them partly to cost concerns.”
The study estimated annuity values with two measures: “(1) expected present value of benefits per premium dollar, and (2) the insurance value. It found the expected present value was about 80 cents per dollar for immediate annuities, and 50 cents for deferred annuities. “But accounting for the insurance value suggests that everyone gains from purchasing annuities with deferred annuities offering the best deal,” was a key finding.
The values of 50 and 80 cents per dollar have remained stable since the turn of the century “as rising life expectancies and falling interest rates have been offset by lower payouts per dollar of premium. Furthermore, the value of these products including their function as insurance has also remained constant.” But the insurance value is greater because they protect “more effectively against outliving one’s assets.”
Pros and cons
Pros of annuities include principal protection, income options that can include income for life, tax-deferred growth, steady and predictable income, penalty-free withdrawals and many others. Cons include major aspects such as having money locked up for a period of time (surrender period), high fees, some penalties for early withdrawals, and annuities may lose a step up of basis at death (gains are taxable to beneficiaries).
Wettstein had some insight into an aspect of both pros and cons.
“Possibly misleading is the inflation protection pro: That is questionable and depends on the precise product,” he said. Real inflation protection is somewhat hard to find. “More common are products that have a fixed COLA (Cost Of Living Adjustment). But that is less about inflation protection (because the COLA does not go up if inflation is high) and more about the convenience of not needing to save early in retirement (when nominal prices are generally lower) for later retirement (when they are generally higher)” he said.
The other insight he offered was the “step-up basis at death of annuities.”
“This is often irrelevant unless the annuity has some refundable element to it. I am not sure how common those are, but to the extent that principal is refunded to heirs upon the death of the annuitant, the annuity payments will be lower, undercutting the insurance value of the product,” he said.