Reader Question: ‘Should I Buy an Annuity?’


This reader has money to invest and wants to know what their best strategy is right now.
Question: “I’m age 70, have no debt with $100,000 to $200,000 available to invest but do not need the income. I’m considering buying an annuity that would pay for my life plus the lifetime of my wife. What do you consider to be the pros and cons of buying an immediate annuity? B.C.
Answer: With an immediate annuity, you give your money to an insurance company and they immediately begin sending you monthly payments that last for your lifetime. Since The Great Recession began in 2008, the Federal Reserve has been instrumental in driving interest rates to rock bottom levels wreaking havoc on retirees who depend on investment income to pay their bills. This low interest rate environment has created a lot of interest in annuities for retirees because the insurance companies selling annuities promise lifetime payments of 6% to 7% versus the measly 2% interest you can get from bank CDs. I’m generally not an advocate of annuities for the following reasons:
  • At the death of the last annuitant, there is nothing left for heirs. The reason that annuities offer a relatively higher payout is because the payments you receive include both interest on your money and distributions of your principal. What you are doing is amortizing your wealth over your lifetime.
  • With an immediate annuity, there is no inflation protection. It’s true that inflation has been very low these past few years, but I anticipate that to change dramatically before the end of this decade. With an annuity, your payments remain the same for your lifetime, meaning the dollars you receive each month will cover fewer and fewer bills.
  • If you have an emergency need for cash, you can’t access the money invested in your annuity. You can probably come up with a lot of possible scenarios where you would need cash for an emergency such as a medical emergency. With money invested in an annuity, your only option is your monthly payments so you’ll need a source for emergency reserves held elsewhere.
  • You are dependent upon the insurance company for your payment guarantee. If you buy an annuity, you take on credit risk based on an insurance company remaining a viable entity for your lifetime, in many cases for decades into the future. As we have seen with the banks in this latest crisis, financial fortunes can change in a heartbeat. One way to address this issue is to diversify by using several highly rated insurance companies.
Annuities are best suited in cases where there are no heirs and you don’t need your income to rise to offset rising lifestyle expenses (inflation).
This reader further asked if dividend-paying blue chip stocks would be a better alternative. If you’ve followed my column, you know I really like blue chip stocks. Today it’s pretty easy to put together a basket of blue chips yielding 4% or more. Advantages include the opportunity for your portfolio to grow in value as our economy continues to improve; access to your capital in case of an emergency; and money for heirs at your death. The downside is that these are stocks and as such are subject to the ups and downs of the market. For a retiree, you should strongly consider having at least four to five years’ worth of living expenses held in fixed income investments that are not subject to the stock market fluctuations. 
The best solution is to schedule a meeting with your financial advisor and have him or her complete a detailed retirement analysis and offer recommendations tailored to your specific facts.