24 Jan Is annuity too good to be true?

Q. My wife and I are retired. We collect Social Security and next year we will start taking Required Minimum Distributions. We saw an ad for the “AARP Lifetime Income Plan,” which said “How To Make $50,000 of Your Savings Last a Lifetime.” It says if you buy the annuity with $50,000, you’ll get a monthly check and other benefits. Is it worth it?
— Investor

A. The AARP annuity you are referring to is a Single Premium Immediate Annuity, or SPIA.

It is a fixed-rate product that can provide you with a dependable stream of income for as long as you live.

If you die before you have received income equal to your initial investment, your beneficiary will receive the balance, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

NY Life backs this product.

“Since annuities are not FDIC-insured products, you are relying on the claims-paying ability of the issuing carrier,” DeFelice said. “I think you are in good shape here as NY Life is a great company with high financial stability ratings.”

DeFelice said SPIAs can provide certain benefits that you can’t get from other products, primarily the assurance of lifetime income and a greater payout rate than what you can currently get from CDs or bonds.

He said the fixed nature of the product means that you have zero stock market risk. You will receive the same monthly income whatever the market does, and it won’t matter if stocks crash the day after you invest.

SPIAs can also help reduce or eliminate longevity risk – the risk that you outlive your money – because once your principal is spent down, you will continue to receive a paycheck.

“You’ve essentially created your own pension,” he said. “If you live to a ripe old age, you win with a SPIA. But if you pass away prematurely you don’t get your $50k back – your beneficiaries receive the difference.”

There are certainly cons to be aware of with SPIAs.

First and foremost, DeFelice said, you lose control of the funds you invest. They get turned over to the insurance company in exchange for the promise of lifetime income. Once you invest, the initial principal is no longer yours.

Then there is inflation risk.

“If interest rates rise then so will SPIA rates on new products being offered, but you will be locked into whatever rate you receive on your initial purchase since payments are fixed,” DeFelice said. “And right now with interest rates just off historical lows and the trend looking to be towards higher rates in the future, you could be locking in a very unfavorable rate by buying a SPIA in today’s market environment.”

So, he said, this is certainly not an investment you want to dump everything you’ve got to invest in, and you’ll need to have other investments that are more liquid to offset the locked rate on these products, such as a conservative stock and bond portfolio that will participate with some growth and rising rates.

DeFelice said it may be helpful to think of it this way: possibly using the SPIA to fund a portion or all of your fixed expenses such as property taxes, utilities and health insurance, while using your other investments to help fund more discretionary items such as eating out, travel, and entertainment.

Then, he said, when the stock market is having a bad year, you can scale back your discretionary spending to avoid liquidating things in a down market, but you’ll still have a fixed income stream coming in from the annuity to help pay your fixed expenses.

Determining if a SPIA is a good fit for you will also depend a lot on your money “personality,” DeFelice said.

You should ask yourself how much having a fixed monthly paycheck that you can budget for and count on would mean to you. Would you be willing to give up control and growth on a portion of your assets in exchange for it?

“Some people love the safety while others would hate to give up control,” he said. “It all depends on what you value and what will help you sleep at night.”

DeFelice said annuities come in many varieties, but at the end of the day they are all ultimately designed to do one thing: provide a stream of income that you cannot outlive.

“In today’s world where pensions are largely a thing of the past, we often find that annuities can be a great tool to use when designing a retirement income plan for suitable clients,” he said. “But it is just that – a tool, or a `single arrow in your quiver.'”

DeFelice said he doesn’t really believe in using absolute statements like “never do this” or “always do that.”

Whether or not the product is right for you is a question that is impossible to answer without knowing more details about your specific situation, he said.

“Before making any purchases we recommend you discuss options with a financial planner who can look at your complete financial picture and design an income plan based on your needs, goals, personality and risk tolerance,” he said.

And we agree.

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This post was first published in January 2017.