This baby boomer and no doubt many others are giving more consideration to fixed annuities as alternative investment vehicles. Fear of more market losses and a need for a reliable source of retirement income is driving this.
A fixed annuity is a contract in which you surrender a lump sum of money to an insurance company in exchange for a guaranteed monthly income.
Theoretically, this removes market risk from the investment. However, I think that baby boomers need to carefully assess all of the financial risks associated with fixed annuities before making a purchase decision. In my mind, those risks include inflation risk, death and survivorship risk, and company failure risk.
Annuity Inflation Risk
As one example, at my age and in my state, I can spend $100,000 for a single-life annuity from Vanguard that will pay me $622/month for life. If I use that same $100,000 to purchase an inflation-adjusted fixed annuity, my initial monthly benefit is reduced to $454. That is a significant difference. Nevertheless, depending on how much of your retirement nest egg you intend to use for an annuity, you need to give careful consideration to including some level of inflation protection in the annuity payout.
Annuity Death and Survivorship Risk
In a conventional fixed annuity, once you have surrendered the premium to the insurance company, its gone. You may die after receiving only one monthly benefit payment but the insurance company won’t give your estate any of your money back. There are lots of options that would change that outcome but, of course, that changes the premium you will pay.
The other aspect of the death risk is what happens to your surviving spouse. Again, in a standard single-life annuity contract, your survivor receives nothing. From an income point of view, that may not work out well for your spouse. That is why you should consider a joint life annuity to reduce the death risk.
Again as in my example, my $100,000 premium can be used to buy a Vanguard annuity that will continue payments for the life of both spouses. That monthly benefit would be $539 compared to $622 for the single life annuity.
Annuity Company Failure Risk
Annuities are not financial instruments that are guaranteed by the FDIC, SIPC, or any other agency of federal government. If the insurance company that issued your annuity contract fails, no one in the federal government is obligated to bail you out.
Most states have state guaranty associations that provide some protection to policy holders in their state if an insurance company doing business in that state fails. In most cases, the limit of such protection (if it exists at all) is $100,000. (Here is an unofficial list of state guarantee association limits.)
As a risk control strategy, you should contact your state insurance commissioner and confirm that your state has a guaranty association and, if so, what limit would apply to an annuity contract. Using that information, you should then consider dividing your annuity protection among more than one insurance company so that you receive the maximum possible protection.
Concluding Thoughts on Fixed Annuity Risk
Fixed annuities can play a helpful role in an overall retirement income plan. (Consumer Boomer offers another take on fixed annuities for baby boomers.) I plan to continue my research and study but want to wait and see which annuity companies emerge strong from the current economic mess. I also want to assess if and when the equity markets might rebound and what will happen with inflation. Only then can I make an informed judgment about the risks and benefits of purchasing a fixed annuity.