The potential for loss makes buying an immediate annuity scary, especially for people with health issues.
Dear Dan,
I am getting pitched by a local acquaintance an “immediate annuity” that pays a guaranteed interest rate of over 7%. My brother says that is not possible and even if it were true, buying such a product would be a bad move for me given my poor health. What do you think?
Puzzled About Annuities
Dear Puzzled,
Listen to your brother.
An immediate annuity in its purest form pays a fixed sum of money at fixed intervals (usually monthly or annually) for as long as the annuitant lives. Guarantees offered in immediate annuities are backed by the financial strength of the insurance company offering the annuity. By law, the insurer must be very conservative with their investments. Because of this conservative mandate, there is no way the issuer is paying over 7% interest.
What the quoted figure probably represents is the payout percentage. An annuity purchased with $100,000 that pays $7,000/year has a 7% payout rate. Payouts are higher for older people and there are many contracts with payouts over 7% but that is not the same as the interest the insurer is using to determine the payout or the return on your investment.
With the purest form of immediate annuity, your heirs receive nothing after you die. If you bought an annuity with a 7% payout, received one year of payments and died, you will have received just $7,000 on a $100,000 purchase. That is a loss of 93%. It takes more than 14 years to get back all of the $100,000 purchase payment.
The classic annuity payout does not adjust for inflation and guarantees that at your death, there would be no money available for your heirs. There are contracts available that offer an inflation increase of some sort, a guarantee that payments will continue beyond your death for some time period, or otherwise offer funds to your beneficiaries after your death. All of these features come at the cost of a lower payout.
The potential for loss makes buying an immediate annuity scary for some, especially for people with health issues. Immediate annuities are a much better choice for those that are in good health and have an above-average life expectancy. This is probably what your brother thought about when he brought up your health.
In addition to healthy people, an immediate annuity can be attractive to people who are worried they will spend through all of their assets before they die, can’t handle the volatility of financial markets, have other assets to tap if they need cash, have little or no desire to leave a bequest to family, friends or charity, and are comfortable with making an irrevocable decision.
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Dan Moisand is a financial planner at Moisand Fitzgerald Tamayo serving clients nationwide from offices in Orlando, Melbourne, and Tampa Florida. His comments are for informational purposes only and are not a substitute for personalized advice. Consult your adviser about what is best for you. Some reader questions are edited to aid the presentation of the subject matter.
Originally published on MarketWatch. Read the original article here.