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« Interview Lessons from a Video Contest | Main | The Psychology of Why People (Used to) Hate Annuities, Part 2 »

June 29, 2009


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Great article. An annuity is a very helpful tool, and those who don't like the payments stop when you die part, you can by annuities that have minimum payouts. For instance, Mr. Red could by a single-life 20cc annuity that will continue to make payments for 20 years, regardless of whether Mr. Red is alive. If Mr. Red lives another 30 years, the annuity will still keep paying out. Downside: in TX for 65 year old male, the $100,000 monthly annuity payment would drop from $684 to $596 to pay for the 20 year guarantee. Annuities get a bad rap, when variable annuities are the only real villains. The immediate annuity Mr. Red purchased is a great investment, in effect buying a pension.

Part of the "trick" to quiz #2 is the way the earnings are stated: Red earns $650/month while Gray earns 4%. This frames the issue as though Red has an income while Gray is investing. You don't actually "think about the return" in each investment in terms that can be easily compared.

To state things equally, Red is earning 7.8% yearly but loses his principle when he dies and can't compound interest, while Gray earns 4.8% yearly but keeps his principle when he dies. Red's investment has a much higher return but is less flexible and has a large fee at the end, while Gray's investment has a lower return but is flexible and has no fees.

When stated this way, it becomes clear that it's an interesting tradeoff. Whether or not it's worthwhile depends on how long you live and how much you plan to consume. (Just one example: if Red wanted to spend only $400/month, he could reinvest the remaining $250/month at the same rate Gray is getting, and 20 years later he'd have rebuilt his original $100k. At that point, Red could preserve his new principle and begin drawing $1050/month!)

I sold MYSELF an annuity as I was a fin planner for 15+ years before I retired! Today's new variable annuiites w/ many situational riders can offer families in different situ's a great way to access dollars AND have income! As well get your $$ back if you want to unwrap the contract/decision down the road. For me, putting ALL my tax defered $$, about 25%~ of my liquid net worth (it's gonna be orduinary income anyway) w/ a guarenteed 7% WITHDRAWAL RATE rider, annual step up's and a guaranteed return of principal - if I choose out before starting the rider(among other possibilities the contract has) allows me to "aggressively invest" in the annuity w/ no downside loss. Nvver put ALL money into one but, to supplement a social security check, military retirement and VA pension, this "4th check" gives me no loss possibility and a combined $7500+ a month at age 62 - and I'll take SS at age 62, pay it back at age 70 w/ I binds due from early this century and never worry about $$ (see prevous articles here ref SS decisions) for even MORE income later. again, almost all middle income earners should consider an annuity as a SS, and pension suppplement...nuff said!

Good job completely discounting the ridiculously high costs (fees, not just losing all of the principle) of annuities, which is the main reason people avoid them. It is not just trading an investment for an income source, it is more like trading a positive return investment for a fixed investment with a highly negative yearly return.

Also, anyone can be a "financial planner", it requires no significant certifications or education. Be wary of people like the poster above me (obviously).

BS, MBA, Registerd Principal, Registered Advisor, CFP, multiple state licenses, etc., etc., you must have SEVERAL "credentials" licenses to practice in ANY state bTW...and they all cost, require significant study and continuing education...My customers portfolio of over $135+M included the same (nameless but, from a few very large Superior rated Insurance co's) and, I'll trade MY portfolio anyday (I only worked Full-time for 25 years after college grad w/ BS i '82, care to take that bet?? HA! Sometimes in life you GET what you paid for! In my case the annuity has already paid for itself in a lifetime of very modest costs, especially in lite of the market meltdown of the past few years...I MADe money, did you?? Retired at age 47 forever!

I realize chynalmemay is right, you can get several HQ variable annuities w/ the guarantees he mentions and NEVER give up your pricipal, even at death, they work pretty good, especially for those that need/ want income, upside potential and no downside..and for deferred money like IRA's/401'Ks make sense since that "deferred money" is ordinary income anyway, my accountant recommend I look into one last time we met so I'll met w/ my advisor to do so...

I would have chosen mister Red's choice because if you look at the second proposition of mister Gray you see he can get his money back if he wants but if you consider the annuity he can get a month without never consumming his capital, it is only 333 $ (100 000 * 4% / 12). This isn't worth doing it.

But the first time you read it, you think yeah all right but after calculating all stuff; the choice is easy.

I didn't see anything "subtle" about the different way the scenarios were presented. In the first quiz the contract choices were stated in general terms. In the second quiz specific percentage returns were presented, allowing the reader to do some calculations. The second quiz provided more meaningful information than the first quiz.

Yes, the first quiz focused on how much you could spend, but the second quiz told you exactly how much was being invested as well as % return, in addition to the "subtle" difference of leading the reader in the direction of how much they would have to live on (which automatically implies choice), compared to how much they could spend.

Neither example disclosed fees.

Psychology is clearly at work here, but the examples are hardly the same in concrete terms.

The 2nd example didn't make sense to me. Both Gray & Red were 65 when they retired and started this example? That would mean that Gray was drawing $250 per month for 20 years into his principle before it was eaten up... Actually not completely true because the interest payment is decreasing as the principle is coming down. Well $250 per month is $3000 per year so even after 20 years he would have used $60k of his principle.

Maybe I need to put this into excel and model it but the idea is that after 30 years his principle will be exactly zero?


A plain old immediate annuity is nothing bad as long as fees are not excessive. That is the kind of annuity the article talks about. Simple contract where you pay $100k today at retirement age and get $650 a month for life.

Variable annuities and abuses around them have given annuities a bad name. Variable annuities are more complex and can have various fees and options that are not clear. With a industry average of 2.4% expense ratio, plus loads and commissions a variable annuity can be a real crappy deal.

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