My wife is part of a group which typically, on the third Friday of the month, has lunch together at a different member’s home. The last time it was at our house. As I was sneaking into the kitchen to get a cup of coffee, my wife spotted me from the dining room and called out, “Dear, could you come here? Ellen has a question about annuities.”
It turned out that Ellen’s advisor had suggested that she should take $125,000 of her savings and buy a deferred income annuity that would start paying out $850 a month for life at age 66. Ellen is 60 years old and single. She did not like the annuity suggestion. “If [the advisor] thinks I’m going to give him $125,000 in exchange for $850 a month, he’s wrong. That’s a bad deal.”
I did some quick mental math and mentioned that getting a little more than $10,000 a year in income meant she’d have her money back by age 79, and if she made it to age 86 she’d have gotten back $204,000. She responded, “Why didn’t the advisor explain it like that? That doesn’t seem that bad.” And then a minute later she asked, “What happens if I die?”
I said if the quote had been for “life only,” then the income would stop when she died. “So, if I die in a year the insurance company keeps the money. That’s not right,” she said. I asked her if she had any children or other beneficiaries that she wanted to leave money to. She replied, “No.”
I said that this type of annuity could also be set up so that the payments continued for at least 10 years or until the $125,000 was returned if she died early, but the income would be a little less. This seemed to mollify her for a minute, but then she remembered she wouldn’t have access to the $125,000 lump sum if she bought the deferred income annuity. “What if I need the money for an emergency? If I put it in the annuity it’s gone,” she observed. I asked if she had other assets she could use for emergencies and she said “yes.” In fact, she shared that this annuity purchase still left her with quite a bit of other money, but it really bothered her that with this type of annuity she’d lose immediate access to that $125,000.
I mentioned that there was another type of annuity. It also provided lifetime income; however, she would always have access to the cash value. The negative being that it wouldn’t provide as much income—perhaps around $750 a month—and although she’d have access to the cash value, it would go down over time because she’d be getting more income than she was probably going to earn in interest. She said she understood that if she spent more than she earned that the cash value would go down—that was common sense. She also said it was worth getting $100 less each month to know that she’d have access to the remaining cash value and to know that the insurance company wouldn’t “cheat” her by keeping the money if she died early. Her last question was, “Why wasn’t I told about this [guaranteed lifetime withdrawal benefit] annuity?” I didn’t have an answer.
There have been several studies done in recent years investigating why people don’t generally buy a life income annuity for retirement, and my impromptu encounter highlights several reasons.
• Valuation. Many people can’t see the value of a future income, so you need to bring it into the present. Showing that she might get back $204,000 for her $125,000 premium seemed a much better deal than getting $850.
• Fairness. The fact that the insurance company might “win” overrode the financial realities of transferring longevity risk and getting a higher income.
• Being in Control. Ellen was willing to take $100 less a month to have access to whatever cash remained in the annuity.
My meeting with Ellen (not her real name) shows that buying an annuity is a multi-layered decision, not merely a financial one.
