The stock market is wrapping up another good year, topped off by the Trump rally at the end. But rising interest rates are undermining bond prices, and the Federal Reserve has promised to raise them even more. There's no shortage of uncertainty for retirees worried about outliving their money.
As one option, insurance companies have been pushing immediate annuities as a way to produce a stable, guaranteed income for retirement in the face of market risk. For a big upfront payment, you can get a monthly income for life that's likely to beat what you could get from alternatives like bonds or dividends.
The website ImmediateAnnuities.com, for instance, shows that a 65-year-old woman paying $100,000 could receive $512 per month, or $6,144 a year. That looks like a 6 percent yield. You won't find bank savings that generous, and 10-year U.S. Treasury bonds are paying only about 2.5 percent. You might do better in stocks, but only by taking much more risk.
But there are drawbacks, and many experts advise careful shopping, or avoiding immediate annuities altogether. For one thing, the payout that looks like a generous yield actually comes in large part as a return of the premium paid for the policy. For the woman in the example, it would take more than 16 years before the payments received to equal the $100,000 she's paid for the policy. She'd come out ahead only if she lived to be older than 81.
Mark Avallone, president of Potomac Wealth Advisors in Rockville, Maryland, says immediate annuities are often a good choice "if you have genetics on your side and you lived a healthy lifestyle." That's because the longer you live the better the chance you'll get more in monthly payments than you paid for the contract.
But Paul Ruedi, CEO of Ruedi Wealth Management in Champaign, Illinois, says immediate annuities are inferior to investing in a diversified mix of low-fee stock and bond index funds which are likely to grow enough to keep ahead of inflation.
"The downside of most immediate annuities is that most offer a fixed payment," he says. "Over a multi-decade retirement, most retirees will face rising costs. At a minimum, their costs will double."
"I rarely suggest immediate annuities and, frankly, when investors see realistic side-by-side comparisons with alternative strategies they tend to not be all that interested," Ruedi says.
Immediate annuities can be more generous than other fixed-income options because the issuer assumes it will enjoy gains from investing policyholders' premiums, and it knows that many customers will not live long enough to collect much if anything.
With a bare-bones policy, the premium spent at the purchase is gone forever. It's not there to be cashed out or left to heirs. So a purchase is a big commitment.
The buyer can add provisions that guarantee income for a set number of years, assure payments will grow with inflation or continue for a surviving spouse, or guarantee payments equal to the premium even if the policyholder dies early. But those options reduce the payout.
And other products can do address those issues just as well.
"On some occasions, we do recommend immediate annuities for certain client situations, or we will research the best option for a client if they have already determined they want to purchase an immediate annuity," says Bryan J. Bentley of Bentley Financial Investment and Insurance Advisors in Roseville, California. But he say he generally prefers fixed-index annuities, which offer payments that can grow over time at a guaranteed rate or are keyed to an underlying index such as the Standard & Poor's 500.
Fixed index annuities "provide the option for a lifetime income stream, but they provide more flexibility and an opportunity for growth that an immediate annuity can't," he says.
Immediate annuity payouts are determined in part by prevailing interest rates, since insurers typically invest premiums in fixed-income securities. With interest rates climbing, does it make sense to wait in case policies become more generous?
Probably not, experts say, because rate increases are slow to affect payouts and the policyholder's age and life expectancy are bigger factors. Waiting can increase the monthly payout, but that's only because the customer will not collect for as long.
The woman mentioned above could receive $582 a month instead of $512 if she bought the policy at 70 instead of 65, but she'd have missed more than $30,000 in income during those five years. She would have to live to 106 for the higher monthly income to make up for what she'd lost.
In the end, the decision to buy an immediate annuity comes down to the individual's view of investing and risk, Avallone says.
"Older retirees who want certainty and don't want stock market risk will find some comfort in these vehicles," he says. "If you can tolerate stock market and other investment risk, then these might not be as attractive to you."
Mara Derderian, finance professor at Bryant University in Smithfield, Rhode Island, recommends careful shopping. In some cases, investors may find a variable annuity works better. These offer a variety of investing options in securities like stocks and bonds, and payouts can rise if the holdings do well.
"Annuities often times can have significant costs to investors including sales commissions, surrender charges and (for variable annuities) annual fees," Derderian says. "With that said, not all annuities have high costs. Investors should shop around to find an annuity that offers them the benefits they are seeking at the most reasonable cost."
Jeff Brown spent nearly 40 years as a newspaper reporter, columnist and editor, including 20 years writing about investing, personal finance, the economy and financial markets. He spent 20 years at The Philadelphia Inquirer and has been freelancing since 2007.