Annuities and the Flight to Safety

| February 03, 2023

One of the certainties in investing is that you pay a high price for certainty. You might crave it, understandably, but to get a high return you have to put up with a lot of risk. Amid a losing year for both stocks and bonds—a rarity—last year people fled to the relatively safety of annuities in record numbers. Sales reached over $310 billion in 2022, a whopping 17% higher than the previous record set in—you guessed it—2008.

Despite the record-setting 2022, there’s a good chance you’ve heard of annuities but don’t know what they do. Negative advertising about annuities abounds on the internet, much of it courtesy of a single advisory firm. Annuities have also suffered from a bad reputation because they can be confusing vehicles, with their tax implications and costs adding to ownership concerns.

But annuities don’t have to be confusing. They’re essentially income insurance. That’s why you can only buy them from life insurance companies. You give the insurance company a pile of money, and typically in return you’ll receive an income stream for the rest of your life.

If you’re craving certainty, that income stream is about as good as it gets. Companies that sell annuities need to be financially solid to guarantee those payouts. In fact, annuity company failures are pretty rare.

Because of this certainty, the interest rate offered for annuities is usually pretty low. That’s why I don’t consider annuities a real form of investing. It’s an insurance policy.

How much can you get monthly? It ranges widely, depending on your contract and the type of annuity you want. But you can find a lot of annuity calculators online. I recently had the Schwab calculator estimate what a 58-year-old Florida man would get monthly for life with a $250,000 contract that provided a fixed amount monthly beginning when he turned 65: about $2,100, if there was no death benefit for beneficiaries.

Of course, that doesn’t include the cost of the contract or any other fees attached. And there are a lot of options for annuities, such as riders that provide additional benefits. The costs can really add up over the course of a contract.

Annuity companies are like any other firm offering financial products, in that they’ll market new contracts and riders to take advantage of consumer trends. It’s questionable whether these bells and whistles are worthwhile.

With company-provided pensions going away, I can understand the appeal of annuities. Knowing that a certain portion of your essential monthly expenses will always be taken care of can provide a lot of peace. And when the markets are as uncertain as they were last year, people nearing retirement naturally will look to lock in a portion of their monthly income.

But make sure that you work with an advisor to buy one. Because unlike a stock or mutual fund, you can’t just get rid of an annuity contract, and they cost a lot to begin with. And if you don’t understand how the annuity works and what you’ll end up paying for it, you won’t ever feel truly secure about that income stream.