This Is the Sound of Settling: Annuities

This Is the Sound of Settling: Annuities

By Jason Prattes
Prattes Wealth Management

A friend in New York called me the other day to ask my advice on a new investment idea pitched to him by Fidelity, one of the largest mutual fund companies in the world. He made it sound like a proposition from “The Sopranos.”

“Let’s say a guy you trust walks up to you and says ‘Gimme $100,000 for five years, and after that, I’ll start paying you $600 a month. For the rest of your life. And your wife’s.’” And then my pal asks me: “Would you do it?”

Nobody would do it. Nor should they. But lots of people do.

Give up $100,000 cash forever, wait five years before seeing any payback at all, and then settle for—at best—a 6% annual return? If you had put that $100K into the S&P 500 index for stocks five years ago, it would have grown to $140,000 by today, up 40% instead of up zero in five years. And this is after absorbing the 20% decline in stock prices since the start of 2022.

But this pitch is being made to thousands of investors in these incredibly volatile and dark days in the stock market. It is called an annuity, and, last year, Americans invested more than a quarter of a trillion dollars in annuity sales, up 16% from the year before.

When stocks look too risky, an annuity can feel like a security blanket—the idea of a set, predictable, constant stream of extra income to augment your Social Security check each month. This is why Fidelity was pitching my New York pal just now; and why a Connecticut friend of his is getting a similar annuity come-on from an agent for Guardian Life Insurance, the eighth-largest insurer U.S. insurer with $12 billion in annual revenue.

Annuities most times are based on various kinds of insurance products, although they also can be used for large lawsuit settlement payouts, lottery winnings and other uses. For insurers, an annuity amounts to a bet that enough customers will die earlier than expected, so as to leave behind funds for those who live longer.

The insurers pocket what’s left over, and they have the actuarial expertise (and soon, AI tools) to ensure they set up the annuity to their own financial benefit. Which is fine. Everyone selling anything in investing gets something out of it, right?

It’s just that… an annuity feels like defeat. It feels like a loss of hope, giving up the search for higher yield and better places to park your hard-earned wealth. While you wait to die.

The contradictory thing about annuities is that the older you get, the more appeal they have for offering stable, guaranteed income—and the older you get before you buy in, the better the odds for the insurer rather than for you, in terms of the exacting the fullest payout.

Those are psychological factors, and financial reasons second that emotion. You are confining your $100K, or however much you put into it, to a 6% return for the rest of your life, just when inflation is roaring up past 8% for the first time in 40 years. After you and your spouse die, the monthly payments end and no windfall is handed to your heirs.

And when you buy the annuity up front, your money is gone, unavailable for  emergencies, sudden windfall opportunities, or, say, a new $94,990 Tesla Model S. This is called “opportunity cost,” the lost alternative of what else you could have done with the cash.

Some annuities are based on life insurance, and life insurance is a downer. You have two choices, “term” or “whole.” Meaning a cheaper monthly investment in a limited “term” insurance policy that returns no cash and expires after, say, 20 years with no payoff at all if you outlive it; or a policy for your “whole” lifetime that leaves a big fat bundle of cash after you die.

“Whole” can return cash early if you want to withdraw some, but it costs you five to 15 times as much in monthly premiums. Forevermore. Term insurance is the better choice, in that it will lose less ground to inflation and the stock market compared with a whole insurance policy that duns you monthly for the rest of your entire life.

Though, maybe I just have commitment issues.

Cleary, better investments are out there, waiting to be found, even in these rather tense and rocky times in the markets. They are all around us, we just have to see them. More on that is coming up in my next column.  #StayStrong.                   

Jason Prattes of Prattes Wealth Partners in Newport Beach, Calif. advises executives, entrepreneurs, and professional athletes.

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