retirement

Are Income Annuities Fair?

An off-kilter idea of fairness may be getting in the way of some people's long-term plans for guaranteed income.

If you get a chance, you might read this article, “Why Retirees May be Wary of Annuities.” Written by two knowledgeable academics and based on a study of consumers, the authors conclude that investors’ aversion to income annuities may be related more to a question of fairness than the value of the investment itself.

At the crux of the issue is the question of whether it’s fair that an insurance company can hold on to part of the money a person pays into an annuity if they die before getting their premium back in annuity payments.

Basically, there is a group of people who simply feel that deal is not right. They can’t get behind the shared risk model at the heart of annuities, which is that early deaths help subsidize the payments for those who live beyond their life expectancies.

At the end of the article, the authors suggest that what’s needed for annuity acceptance is a “highly personalized approach, in which the [planning] solutions are tailored to reflect the goals, circumstances of the individual.”

As an actuary by training and a designer of novel forms of income annuities, I may be the wrong person to ask whether they are fair. Like Social Security and pension plans, they enable group risk sharing and higher payments. When I look at fairness, I look at the pricing of the annuity payments — and I happen to be comfortable with the competitive marketplace for income annuities.

Here’s a point-by-point response to the study participants who expressed the fairness issue:

1. ALL insurance is based on the pooling and sharing of risk.

Who has paid for fire insurance and not had a fire, or paid life insurance premiums to cover a mortgage and lived until it was paid off — and didn’t get their premiums back? The peace of mind and protection from knowing you were covered is only possible if your reserve pays for the claims of other people who are insured. In the same way, while income annuities are paid for with an upfront premium, the pooling still exists.

2. What if you’re not convinced by the risk-sharing argument?

If you still believe it’s unfair, then buy some protection for your beneficiary — either through the income annuity itself or through a separate life insurance policy. If you do it through the income annuity, it will lower your income, but if it makes you feel better then go ahead. In that case the insurance company is holding on to a smaller part of your reserve and paying it to your beneficiaries.

3. You are getting paid for this loss of reserve in higher annuity payments.

When you are buying an annuity, what you are doing is generating more income without taking investment risk. In effect, you are “selling” this part of your legacy to the insurance company, which pays you back in guaranteed income. Often these are called longevity or mortality credits.

But enough of these technical arguments in favor of the income annuity as a singular product. The bigger issue in evaluating income annuities is that they are posed as an either/or product purchase decision rather than as a how/how much retirement planning decision. For example, very few investors would buy junk bonds or emerging market equities unless they were part of a diversified investment portfolio.

Similarly, you should look at your entire retirement income plan with and without income annuities and decide which is better, looking at all of the aspects of the plan. From legacy early in retirement to liquidity in mid-retirement to income late-in-retirement.

The problem for the consumer is that most sellers of income annuities don’t present them in the context of the personalized (planning) solution the study’s authors suggest. The people selling annuities are often life insurance agents and not investment advisers. So, in our view, consumers considering income annuities should consider them as simply part of a retirement portfolio, just like bonds, and find advisers who share the same perspective.

About the Author

Jerry Golden, Investment Adviser Representative

President, Golden Retirement Advisors Inc.

Jerry Golden is the founder and CEO of Golden Retirement Advisors Inc. He specializes in helping consumers create retirement plans that provide income that cannot be outlived. Find out more at Go2income.com, where consumers can explore all types of income annuity options, anonymously and at no cost.

Most Popular

The Perfect Storm for Retirees
retirement planning

The Perfect Storm for Retirees

Today’s retirees could face a perfect storm because they are living longer and spending more time in retirement, while at the same time losing access …
April 18, 2021
The Wrong Way to Achieve Wealth
personal finance

The Wrong Way to Achieve Wealth

For some down-to-earth, basic advice on money and life, I have a book to recommend: “Your Total Wealth: The Heart and Soul of Financial Literacy.”
April 17, 2021
Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs
Coronavirus and Your Money

Child Tax Credit 2021: Who Gets $3,600? Will I Get Monthly Payments? And Other FAQs

People have lots of questions about the new $3,000 or $3,600 child tax credit and the advance payments that the IRS will send to most families in 2021…
April 14, 2021

Recommended

The Risk with Fixed Indexed Annuities
annuities

The Risk with Fixed Indexed Annuities

Investors looking for safety and reliability often consider annuities, but fixed indexed annuities can have some variables to them that you need to be…
April 20, 2021
What You Need to Know about College 529 Savings Plans
529 Plans

What You Need to Know about College 529 Savings Plans

Do you know how much you’re able to contribute or what the funds could be used to pay for? How about how contributing affects your taxes? Check out th…
April 14, 2021
This Often-Overlooked Way to Fund Your Roth IRA Has Many Advantages
annuities

This Often-Overlooked Way to Fund Your Roth IRA Has Many Advantages

A Roth annuity can create tax-free lifetime income during retirement or reduce your risk while saving for retirement.
April 8, 2021
How to Build (or Rebuild) Wealth
Financial Planning

How to Build (or Rebuild) Wealth

Our 11-part plan will help you establish a solid financial foundation or take stock of your progress.
March 22, 2021