Why the Guaranteed Income of an Annuity Isn’t Always Worth It For Retirees
Everyone likes a guarantee. It’s like a warm house that shelters us from the cold, unknown outside of diminishing returns and tragic losses. So, for the retiree, someone like you who has a lot to lose, the idea of your income being unaffected by market fluctuations sounds inviting. The assurance that you won’t ever outlive your assets wraps itself around you like your favorite blanket.
But sometimes a guarantee isn’t worth what it is costing you. And sometimes the world outside the guarantee is a little bit sunnier than you might think.
I have found this to be the case with retirement investments. Annuities in general—indexed, variable, and others— often do not live up the glory of their sales pitches, and the world of a conservative investment portfolio with a financial advisor is not nearly as cold and harsh as some might assume.
Let’s start by looking at some of what you are giving up by going with an annuity. Because I’ve found that my clients are less enamored by these products once they see beyond the warm and fuzzy sales tactics.
Access to Your Funds
No matter how you parse it, you are giving up liquidity by choosing an annuity. When you invest your money in an annuity, you are giving up your rights to access your money as a lump sum as the annuity gives you your set dollar amount of income every month. They are kind of like a parent, giving you an allowance for monthly expenses, but scolding you with penalties for taking out too much too fast. Although they will allow you to take out up to 10% per year, more often than not, you will incur a 10-15% penalty for taking out any more than that.
This might not seem like a big deal if you aren’t planning on any big purchases anytime soon. However, this can change on a dime. What if you come across a real estate steal for a snowbird home in Florida? Or what if you find a promising investment and cannot take advantage of it because your “parent” company will slap you on the wrists for accessing your own money? Then you might start to feel a bit smothered.
But if the lack of freedom doesn’t drive you crazy, I think what I am going to explain next will.
Fees and Returns
This is where the rubber meets the road when it comes to investments. If you aren’t making money with your money, then it is hardly worth it to invest. And, unfortunately, the truth about annuities is that the return is not all that great. Sure, agents make it sound nice with the guaranteed 5% income or maybe a 10% bonus in some cases, but the return (how much money you are really making) is a lot less flashy. Why?
There are a lot of really complicated reasons, but the most drastic one is the draining fees. From the typical annuity options I have come across, the total comes to about 3-4% when you add up all the insurance, rider, and mutual fund fees. Now…that percentage does not sound like a lot when you see it printed on the contract. But the effect it can have on your nest egg over your life expectancy is shocking, especially when compared to the fees of other financial advisors, which are typically 1-2%.
For an example, Let’s say you are investing a $100,000 portfolio, and let’s say this portfolio averages a hypothetical 5% return over twenty years (a typical life expectancy for those heading into retirement). The annuity with its fee of 3% will allow your nest egg to grow to $168,595. Not too bad, right?
But how does that figure sound when you compare it with $219,112, the dollar amount you would have with a financial advisor who charges 1% in fees? That is over a $70,000 difference, a difference based off only a couple measly percentage points.
It’s also the difference between the warm security of an annuity and the few brave steps out into the world of a conservative portfolio.
The Air is Fresher Outside
Although I understand the hesitation, it is really not that cold or scary outside of that guarantee as long as your portfolio is conservative and diversified sufficiently. It is easy to look at recessions and stock market crashes and worry about running out of money in retirement, but even then a conservative portfolio can save you from any devastating losses.
For a solid example, I like to point to the recession surrounding the stock market crash of 2008, often called the lost decade (January 1st, 2000—December 31, 2009). Even during this severe downturn, when the market was consistently in the negative, the conservative funds we manage were still averaging 6.23% per year after managing fees. Even the most aggressive funds we manage were still making almost over 2% per year on average. Of course, that isn’t a good return by any means, but it sure isn’t doomsday. It’s more like a chilly breeze than a devastating snowstorm.
So, when it comes to retirement investing options, I recommend stepping out into the sunshine. Your nest egg needs some vitamin D to grow up big and strong.
Want a Certified Financial Planner to analyze your portfolio at no cost to you? Call Seniormark at 937-492-8800 for a free consultation.