Annuities are the only practical private financial product today that provide guaranteed streams of retirement income for as long as you will live. And survey after survey finds that retirement savers would be willing to forgo a fair amount of upside on their investments in return for the safety and predictability of a guaranteed monthly income payment.
Why is it, then, that annuities languish as a retirement product? Is there any way the nation's widely projected retirement shortfalls can be addressed without turning to this product or something similar to it?
There is a long list of reasons why annuities are a turnoff. While this may be a marketing expert's nightmare, I urge you to work through the downside and at least give yourself a chance to evaluate fairly whether annuities should play a meaningful role in your retirement.
The anti-annuities arguments that will be thrown out to deter you include:
1. Annuities involve future gain for present pain. Turning over a wad of cash to an insurance company today in return for promises of a future stream of payments is a mind-over-emotion decision that is hard for us. Behavioral research has demonstrated that humans are wired from an evolutionary perspective to prefer a current benefit to a future gain. Historically, survival depended on what you could eat today, not on tomorrow's possible hearty meal. This bias is seen over and over again in retirement saving, investing and spending decisions.
The solution: Work your way through this emotional deterrent, and accept the need and benefit for serious retirement planning. These plans should consider all retirement vehicles, including annuities.
2. If I turn over a lot of cash to an insurance company for an annuity, and then die at a young age, the insurance company will keep my money at the expense of my estate and loved ones. The loss of control is too great for me.
The solution: Annuity products have loads of guarantees to protect you from loss of principal. You also can elect a payment stream that will extend through your life and the life of your spouse or for a "period certain" of 10 years, 20 years or even longer. You should be aware that every such product guarantee will cost you money and cause your annuity income payments to be less than with a "pure" annuity that does not carry guarantees.
3. I can earn much more money if I invest my nest egg, and my investment adviser agrees. Not only will I end up with more money in my pocket, but I'll also keep control of my money and can pass my nest egg on to my heirs.
The solution: Slow and steady is an acceptable way to run and win the retirement race. Knowing the amount of your monthly annuity payment from a plain, boring fixed annuity can be a blessing. The world can be a volatile and scary place. Just think back to 2007 and 2008 when investment and real estate markets plunged. Can you handle the risk of a 40 percent swing in the prices of your investment assets?
4. Annuity payment guarantees aren't backed by the federal government like bank deposits. I don't trust the payment guarantees from private insurance companies. Heck, I don't trust anything about insurance companies.
The solution: Only buy an annuity from an insurance company with a solid financial rating. There are private insurance guarantee funds that will step in if an annuity issuer cannot fulfill its commitments, but this hasn't happened. In terms of gouging consumers in order to make a buck, insurers don't do a very good job.
Perhaps the most compelling argument against annuities is that they are simply too complicated for individual investors. "Most individuals have little or no experience making annuitization decisions, let alone the ability to learn from the experience of having an annuity (or not) later in their own lives," according to a research paper, "Decision Complexity as a Barrier to Annuitization," published last month by the National Bureau of Economic Research.
Economists have long favored annuities as a solid retirement choice. The NBER paper explores the extent to which consumers have avoided the product simply because it's too hard for them to decide if an annuity makes sense.
"Valuing an annuity is particularly complex inasmuch as it involves both uncertainty and events that will unfold far in the future," the paper says. "As a result, individuals are only willing to buy or sell an annuity when it is an exceptionally good deal, and this tendency is strongest among the least financially sophisticated."
Perhaps the best recent argument in favor of annuities is to look at Social Security. The program's payments are similar to those from a fixed annuity – known and fixed in advance, due as long as you live and guaranteed. In the case of Social Security, that guarantee also includes annual cost-of-living adjustments to protect the buying power of Social Security from being eroded by inflation.
[See: 10 Trendy 401(k) Plan Perks.]
Recent retirement proposals have included annuity-like components. The Obama administration has long proposed a new type of private retirement account that would provide predictable income payments and protect people from stock market swings. Many supporters of Social Security believe the best approach is simply to boost payroll taxes and turn the program into a more robust source of retirement income. Even proposals to improve private 401(k) plans often include broader use of annuities, particularly when people close to retirement face decisions about how to convert their account balances into retirement income.