Annuities and the Cost of Guaranteed Income for Life

Over the past few months, the largest annuity provider in the United States has been training its advisers to take advantage of the current global health crisis to sell their clients annuities. Apparently, various consumer market studies have indicated that retirees right now are particularly receptive to the promise of “guaranteed income for life.” One study found that 33% of scared retirees bought an annuity upon hearing the words guaranteed income. 

This is predatory as it exploits one’s fear of economic insecurity to make a financial decision that is to the detriment of your household. And given the large sums of money often involved in annuities, the costs of the poor decision are particularly high.

Going into this year, the typical annuity provides $0.78 in cumulative lifetime value for every $1 purchased, provides $0.05 in commissions to brokers/sellers, and lasts 7.82 years. In other words, if you buy an annuity for $100,000, it is likely that you will only receive $9,974 annually for 7-8 years while the person who sells you the annuity is well compensated and receives approximately $5,000. It is an awful conflict of interest where the seller is heavily incentivized to sell a product with a negative expected value. The fact that the magnitude of the transaction involves the most vulnerable makes it all the worse. 

Statistically, when a potential annuity purchaser hears the phrase “guaranteed income”, they would be better served taking their own $100,000 in cash and just meting it out to themselves. According to Monte Carlo simulations, only 1 out of every 23 annuity purchasers  would be better off buying an annuity than just taking the money out in cash, and that number dips to 1 out of 87 if the hypothetical annuity provider instead puts the money in the S&P 500 and makes sales at a regular time. 

These poor odds though are why the phrase “guaranteed income for life” are the magic words of the annuity industry. The greatest insecurity that a retiree has involves outliving one’s money. The benefit of the annuity is that you will get to receive income if you stay alive past the point at which the savings or investments would be depleted in the alternate scenario. The prospect of being the “one out of 23” or “one out of 87” is what allows this significant wealth transfer from the pockets of America’s retirees to various insurance companies to occur. 

If you are working with a financial advisor or have a loved one who is, I would expect a heavy sell from your advisor in the near future. Not only is there a strong financial incentive for the advisor to do so, but Delaware case law (which most states follow) holds that putting older individuals in annuities cannot be a violation of the fiduciary rule if it can be shown that there is a chance that the client could outlive their savings, which is automatically proven if the client has under $500,000 in net worth (excluding the primary residence). 

The terms of an annuity are awful and so are the incentives and pressures relating to uncertainty. I hate it when fear is used as a marketing strategy. I cannot think of a single instance when a favorable financial decision was made based on fear. Annuities and the promise of guaranteed income are marketed in the best of times, but the advertising apparatus really activates when fear is in the air. In this case, the fear drives customers to give up a fourth of a meaningful portion of their life’s net worth. I run this blog so people can get ahead of these issues and sidestep the potential exploitation altogether. 

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