Your Annuity Isn’t Guaranteed The Way You Think It’s Guaranteed
This post is a bit nerdy, delving into the mass-advertised guarantee of annuity products in the US. In summary, if you purchase an annuity for your retirement then you are often told, by damn near everyone, that you shouldn’t worry because your annuity is guaranteed. You are even told, in many ways, an annuity might even be safer than a Wall Street investment strategy because of this supposed guarantee.
I have done my research and found that the word guarantee is grossly misrepresenting the backing of your annuity. Only certain types of annuities are covered and only a certain amount is covered, AND it depends on the State.
QUICK OVERVIEW OF ANNUITIES
There are a ton of annuity products out there, many are perfect for the seller and horrible for the buyer. They aren’t all bad products, it’s just that the wrong ones are pushed on the wrong people, often by greedy salespersons.
It’s like chemo and radiation, fantastic even for metastatic testicular cancer in a young male, but a horrible treatment for an elderly end-stage metastatic pancreatic cancer patient. Nevertheless, it’s still widely offered to the latter group for various unethical reasons.
One of the most interesting and useful products in the annuity market is a SPIA, Single Premium Immediate Annuity. You take a sum of money, hand it over to an insurance company, and they pay you a monthly payment for the remainder of your life.
Why an insurance company? A SPIA is sold by an insurance company because they are insuring that you will have income for the rest of your life. Real simple, nothing else to it. It’s the comprehensive auto insurance equivalent for income-guarantee.
How much can I get? This is calculated based on mortality tables. Your life expectancy is used to calculate your payments and generally an interest rate of 4-ish percent is added to your money. There are numerous online SPIA calculators which you can mess with.
HOW IS IT DIFFERENT FROM INVESTING ON WALL STREET?
You don’t get your principal investment back with a SPIA. You are giving up that money to make sure you have an income. It’s gets more complicated when we venture outside of the SPIA market into annuities where you make monthly payments until the need arises for you to take an income, to insure against a crazy long life expectancy (payments kick in after age 80+) and all sorts of other variations.
Your Wall Street investment (mutual fund) can return a certain percentage to you every month based on its performance. It’s even possible that your principal investment goes up even with you taking some off the top, but of course the opposite can happen as well.
If I have $2 million dollars invested and I use only the quarterly dividends then I get around 2% a year, or $40k a year of income. On top of this, the price of the fund could go up (called appreciation), so that after 1-2 years I might have my portfolio be worth $2.1 million. I can let it ride and collect and even higher dividend income, or I can sell the appreciated funds and create an even higher income for myself.
WHY IS AN ANNUITY GOOD?
Annuities are helpful if you need to build a floor… well, it’s good and bad for many reasons but let’s quickly talk about this ‘floor’ thing. If you don’t have a whole lot of money and really need your assets to generate you some income to cover the most critical expenses and if you don’t have a whole lot of income potential left then a SPIA can be a very potent tool, implemented by your financial adviser, to cover your expenses.
Also, you may not like the ups & downs of Wall Street investments, another great reason to build something that will generate a steady income. Remember, in return you will give up that asset principal completely. It’s not like you get $500/month from a $100k investment and get the $100k back upon your death.
You don’t have to use all your money to build the annuity, you can use $100k of your money and invest the rest or setup some other ratio of annuity to Wall Street to real estate investment ratio.
Sample portfolio:
- $600k invested on Wall Street
- $200k in annuities
- $300k in a business
- $500k in real estate
LET’S TALK ABOUT THIS GUARANTEE THING
I always digress like crazy, so let’s get back to the reason I am writing this post. The annuity is pushed on us because it’s guaranteed. Read any sales pitch and the guarantee thing always pops up.
Imagine if you’re a scared old couple with $300k between the 2 of you and only social security income – a “guaranteed” monthly income sounds a lot better than a wild stock and bond portfolio.
The problem is as follows, this supposed guarantee is a smokescreen. The guarantee has multiple layers, each more vague and confusing than the other. To write this post I have read page after page of very detailed, very boring federal literature, insurance company filings, guarantee association websites and some other crap.
So, the first guarantee comes from the insurance company itself. It states that if the insurance company fails then the insurance company will try to sell your annuity product to another company to administer it. Problems: there could be major delays (on average 2 years), no company may want to take over your annuity and the devil is in the details of the contract you signed.
The next layer is that the State forces the insurance company to be regulated by a guarantee association. Oh I feel so safe now, a guarantee association, it’s like burying my face into a pile of warm laundry. Actually, it’s like burying your face in the ass-crack of a sweaty plumber. Problem: Because this “company” is not an actual State organization, they have no power, they are simply yet another middleman who will take over the management of the insurance company’s insolvency. If you go on such websites the wording is vague and complicated. The guarantee company have no cash set aside to back up or “guarantee” anything.
Next, let’s talk about the actual financial guarantee, let’s talk dollars. After all, we were told that the annuity value is guaranteed. Problem: Not all annuity types are protected, that’s the first problem. Next, only a certain dollar amount is protected, somewhere in the $250k range but it all depends on the State. So, tell me, how the fuck is my $500k annuity guaranteed when I can only get $250k of it protected?
I swear, it’s easier trusting my ex who said that she was “just helping her male friend with his zipper… in the bedroom…. with Barry White playing in the background… in her underwear… because it was hot.”
“Yea, but there must be money set aside in a vault somewhere to cover these insurance company failures!” In my exhaustive research I found no such fact. There is no stash of money set aside (unlike with the FDIC) to cover such losses. Where does the money come from? I think it’s like the social security game, one poor bastard pays for the next poor bastard.
DO INSURANCE COMPANIES FAIL?
Well, I checked my State’s website and there are over 100 insurance company failures in the past decade. So yea, I would say there are plenty of insurance company fails.
Here is one list I found from the umbrella group for all these State guarantee associations, which doesn’t coincide with the list I found on my own State’s website. So who do I trust? The federal guarantee group or the local State guarantee group?
It all goes back to transparency. There is simply no transparency. People who are sold financial products are expected to NOT read the fine print and upon such a concept are built layer after layer of commissioned sale products.
It’s not your fault, don’t buy into the guilt trip that some DIY-ers want to impress on you. Even if you sat down and read the hundreds of pages of contracts, prospectus, company summaries, quarterly updates etc., you would understand maybe the bigger concepts but be completely lost in the detail.
If a contract lawyer with years of experience and years of doctoral education was hired to draw up the contract or legal speak, do you really think you have a chance of understanding it?
My interesting and shocking sources: