Annuities

What Type of Annuity Is Safe for You?

Retirees who want to supplement their Social Security and pension income can look to their savings. They can invest those savings to generate an income or they can annuitize all or part of them. The annuity – as an insurance product – can offer a lifetime income. But are annuities safe? Well, that all depends on what you need to be safe from? 

Because annuities are insurance products, insurance companies can guarantee a lifetime income. Their vast number of annuity contracts allows mortality statistics to govern predictable payout obligations as a whole. So, these insurance companies need only keep their funding, investments, and finances in good order for the duration of their payout obligation to you for your safety.

AM Best and others monitor each company’s ‘financial health’. But companies can potentially fail their obligations – although this possibility is generally low. If you start with annuities that have a safety rating of A+ form AM best and AA from S&P, your annuity safety will be high.

Retirees either want to begin annuitization (getting monthly payouts) right away or delaying it until there much older. The latter option is a form of insurance against running out of income due to living too long. These days, retirees have a 50% chance of living longer than 20 years once they turn 65. So, the projected duration of any annuity contract is a significant amount of time – if you’re healthy. Note also that lifetime annuities generally leave nothing for beneficiaries.

Annuities come in two essential flavors: fixed annuities and variable annuities. For fixed annuities, the insurance company pays you a constant income for life. The contracts rely on long term interest obligations from high grade bond investments to assure your constant income.

The benefit of a fixed annuity is your assured of this lifetime constant income. But living 20 years will allow even minor inflation rates to significantly erode the value of that income.

Payouts from variable annuities – and these include indexed annuities – are vulnerable to market variations. These also can give you a lifetime income – but one that continually varies. That’s because their funded by stocks and mutual funds and other similar investments whose values fluctuate. Such investments may compensate for inflation.

Although a rising economy can increase your payout, a downturn can significantly erode the amount of payout you get. So, variable annuities leave you vulnerable to market variations – which will occur.

It appears that choosing a fixed annuity offers more safety for the retiree who needs to rely on savings’ income. He may have to risk the threat of inflation.

Those that can afford more investment risk, might consider a variable annuity. But for the possibility of a retirement cut short, a better approach may be to split his savings - put part into a fixed annuity and judiciously invest the rest for growth.

Note that annuities once annuitized cannot be surrendered for value.  Income from deferred annuities is taxed as ordinary income and withdrawals prior to age 59 ½ are subject to a 10% penalty.  Income from annuitization is taxed part as ordinary income and part as return of capital. Any guarantees are based on the claims paying ability of the insurance company. Annuities should be considered long term investments. Annuities are insurance products and subject to insurance related fees and expenses.

If you are considering an investment in any type of variable annuity please carefully consider investment objectives, risks, charges, and expenses of the Variable Annuity and its underlying sub-accounts before investing. For this and other information about any Variable Annuity investment, always obtain a prospectus and read it carefully before you invest.

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Safety is a relative term because what is safe to one person is risky to another.  For instance you may consider a U.S. Treasury bond one of the safest investments since it is backed by our government. But a true skeptic might say, “Suppose the U.S. government went belly-up? The bond could then be worthless.” Or he might argue that the government’s unabated printing of money will debase our currency making dollar investments worthless. Yes, he could have a valid point. However, putting the extremes aside, safety is one of the top reasons that people buy fixed annuities.

There are several independent rating agencies that regularly assess the financial strength of insurance and annuity companies. Included are A.M. Best, Duff & Phelps, Moody’s, Standard & Poor’s, and Weiss Research. These firms will give you an evaluation of a company’s balance sheet strength, operating performance, and ability to meet ongoing obligations. In addition, all companies must follow the “legal reserve system.” This is a set of rules on asset management, accounting, and reserve requirements.

The reserve requirements assure that funds are set aside specifically to protect against an insurance company’s portfolio losses. Furthermore, insurance companies are state regulated. And all 50 states, the District of Columbia, and Puerto Rico have guaranty associations to which licensed life and health insurers must belong. When states determine that an insurer is insolvent, a mechanism within the association protects the policyholders and can possibly help pay the claims against financially-troubled insurance companies.

This does not mean you should throw caution to the wind.  Weiss Ratings are the most conservative and rate the short term liquidity of the insurance company if they had a short term “run.”   Weiss Rating of B or better is strong.    AM Best ratings are the least useful as over the years, they have freely given out A ratings to companies that had not earned such.

When First Capital failed, an annuity company in Southern California that had a high percentage of junk bonds in its portfolio, it had an A rating form Best.  And although no investors lost any money because of the State’s efforts to have another insurance company assume First Capital’s, there was a moratorium on withdrawals and investors could not access their accounts for 5 years.

A good source of annuity safety ratings is to consult the “Comdex ratings” given by Vital Signs.  A Comdex rating of 80 or better is very good. An experienced retirement consultant will have access to Vital Signs reports.

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