Annuity offerings have improved in the past few years, adding new features and lowering fees. As the baby boomers close in on retirement, the fear they'll eventually run out of money is driving sales. Guaranteed minimum returns of 6 percent, plus a guaranteed income stream, make annuities an easy marketing tool to frightened retirees. My sense is that baby boomers are not fully aware of the downside to annuities. I would like to explore whether they're even necessary.
Annuity salespeople market products with guaranteed minimum returns. Who wouldn't want to participate in the stock market with no risk of a loss? The question becomes, "Who is an annuity suitable for?" Annuities are most appropriate for people in their 70s or 80s who do not have time on their side. An 80 year-old male has a life expectancy of approximately 7 years, which is not enough time to recover from a bear market.
This year, the oldest baby boomers are turning 61. The oldest baby boomers have a life expectancy of approximately 20 years (males about 18 years, females 22 years). This 20-year time horizon gives much more room for investments to recover from a bear market.
Let's look at rolling 20-year total returns for the S&P 500 Index. The worst 20-year period during the past 55 years was an average annual return of 6.42 percent for the period ending May 21, 1979. The average return for the S&P 500 over the past 62 years has been over 11 percent per year. Even looking at the worst 10-year rolling return in the past 55 years reveals a low of only 0.5 percent per year for the 10 years ending September 30, 1974. If you were to add bonds to the mix for a balanced portfolio, the lowest returns increase. So if you have a 20-year time horizon, should a 6 percent guaranteed minimum returns excite you, when the worst 20 year period for the S&P 500 for the past half century was greater than 6 percent? It's like the old joke about the homeless guy with a dog. The dog says, "Why do I need this guy? I could have done this on my own."
In Las Vegas, the longer you sit at the blackjack tables, the more you lose. When it comes to investing, the longer you are invested, the higher likelihood of having a gain. My argument is this: why pay for a product that has high fees, heavy surrender charges and taxable gains at an unfavorable ordinary income tax rate when you can do the same without an annuity. There are two free lunches when it comes to investing: diversification and a long time horizon.
The average investment advisor or mutual fund charges around 1 percent to 1.5 percent of assets under management. With an annuity, you pay an additional 1.5 percent, approximately, plus about an additional 1 percent for a guaranteed minimum benefit. The additional 2.5 percent in fees can make quite a difference during a 20-year period. If you were to invest $500,000 for 20 years at a 10 percent per year gross return, you would end up with $2.8 million using a 1 percent fee, while only $1.8 million using a 3.5 percent fee. In the 20 year time-frame, your $1.8 million in gains would be taxed at long-term capital gains, while your $.8 million gains in the annuity would be taxed at ordinary income tax rates, which likely will soon be raised.
While the debate over annuities will continue for decades, it's important to make sure your boomer clients are not paying for a fancy belt when you're already wearing suspenders.
*For further information or to contact this author, please use the forum below.
Annuity salespeople market products with guaranteed minimum returns. Who wouldn't want to participate in the stock market with no risk of a loss? The question becomes, "Who is an annuity suitable for?" Annuities are most appropriate for people in their 70s or 80s who do not have time on their side. An 80 year-old male has a life expectancy of approximately 7 years, which is not enough time to recover from a bear market.
This year, the oldest baby boomers are turning 61. The oldest baby boomers have a life expectancy of approximately 20 years (males about 18 years, females 22 years). This 20-year time horizon gives much more room for investments to recover from a bear market.
Let's look at rolling 20-year total returns for the S&P 500 Index. The worst 20-year period during the past 55 years was an average annual return of 6.42 percent for the period ending May 21, 1979. The average return for the S&P 500 over the past 62 years has been over 11 percent per year. Even looking at the worst 10-year rolling return in the past 55 years reveals a low of only 0.5 percent per year for the 10 years ending September 30, 1974. If you were to add bonds to the mix for a balanced portfolio, the lowest returns increase. So if you have a 20-year time horizon, should a 6 percent guaranteed minimum returns excite you, when the worst 20 year period for the S&P 500 for the past half century was greater than 6 percent? It's like the old joke about the homeless guy with a dog. The dog says, "Why do I need this guy? I could have done this on my own."
In Las Vegas, the longer you sit at the blackjack tables, the more you lose. When it comes to investing, the longer you are invested, the higher likelihood of having a gain. My argument is this: why pay for a product that has high fees, heavy surrender charges and taxable gains at an unfavorable ordinary income tax rate when you can do the same without an annuity. There are two free lunches when it comes to investing: diversification and a long time horizon.
The average investment advisor or mutual fund charges around 1 percent to 1.5 percent of assets under management. With an annuity, you pay an additional 1.5 percent, approximately, plus about an additional 1 percent for a guaranteed minimum benefit. The additional 2.5 percent in fees can make quite a difference during a 20-year period. If you were to invest $500,000 for 20 years at a 10 percent per year gross return, you would end up with $2.8 million using a 1 percent fee, while only $1.8 million using a 3.5 percent fee. In the 20 year time-frame, your $1.8 million in gains would be taxed at long-term capital gains, while your $.8 million gains in the annuity would be taxed at ordinary income tax rates, which likely will soon be raised.
While the debate over annuities will continue for decades, it's important to make sure your boomer clients are not paying for a fancy belt when you're already wearing suspenders.
*For further information or to contact this author, please use the forum below.
