People in affluent zip codes probably receive at least two or three invitations each month to educational seminars related to social security maximization or retirement planning. These are typically followed by a complementary meal at a decent local restaurant.
I attend these once in a while just to keep up on what’s being said. I often get questions about information other people hear at these events. My latest experience was a seminar entitled "Maximize your Social Security." The first speaker led off with a statement that went something like this:
“There are 72 different combinations of choices available for a couple at full retirement age regarding how to choose their SS benefits. My job tonight is to have you leave here very confused.”
He proceeded to run a PowerPoint slide show detailing the pros and cons of taking early benefits, waiting until full retirement age (66 for Boomers) or delaying collecting until age 70. He also went into lesser-known choices such as "claim and defer" while taking spousal benefits instead of your own.
A second speaker (the closer) then took over. Each attendee was to take out the self-evaluation form handed out as you entered. In true lawyer-ly fashion the only questions asked were ones where the sponsors already knew the answers.
After everybody checked off their fives on these forms the staff came around to collect them and schedule free personal consultations while dinner was served.
The sponsoring office called to confirm the appointments. They strongly suggested bringing tax returns, brokerage statements, 401k quarterly reports, etc., to this no-obligation consultation.
Wow. The friendly "We’re only here to give you a little friendly free advice" had turned into a full-blown sales job. Selling long-term care insurance and especially annuities were the primary goals. Those two products are among the highest YTB products on the market.
YTB? YTB = Yield to broker.
Most agent-sold annuities pay upfront commissions of 6% to the selling brokerage. The take on a $100,000 annuity is $6,000. On a $1 million policy it’s $60,000. No wonder these firms can absorb the costs of "free" dinners.
Immediate annuities are pitched as high-income vehicles you can’t outlive. Are they good deals for buyers? The November issue of Money magazine shows a photo of a smiling man next to a box that states a 65-year old man (in NJ) can expect $554 in monthly income from a $100,000 immediate annuity today. That’s $6,648 annually.
Getting a 6.648% income from $100,000 sounds like a dream come true compared with today’s CD rates. Here’s what the five-year rate looked like as of Oct. 31, 2012.
$100,000 in a five-year CD gets $1,800 a year in income. That $100,000 annuity promises $6,648 a year. Should we give these guys a medal? What’s the catch?
To secure the promised lifetime income stream? Your $100,000 principal is gone forever.
Unless you get special riders, which would lower the monthly payments, your heirs will get nothing upon your death.
Also, there is no inflation protection. Your income stream will never rise (unless you buy a rider that specifically provides for cost of living increases). Adding COLA would further reduce your monthly payments.
Annuity salespeople rarely point out the potential for absolute losses. The chart below illustrates that living to age 80 would not even have recouped the original purchase price. Annual returns (shown as simply interest) are extremely unattractive even after 20 to 25 years.
An annuitant that lives to his actuarially predicted life span would have earned payments equal a whopping 0.85% (simple interest) rate over the entire 17.2-year period. That’s less than half the current, artificially depressed five-year CD rate.
Here’s what would happen if our retiree simply kept $33,240 (five years spending money at $554 per month) in cash while earning a modest 5% in a conservative, well-diversified investment portfolio on the remainder of his nest egg.
Our happy retiree took the same $554 in monthly spending money in each example. It was always there to use simply by withdrawing the cash from the previous savings that would have gone to purchase the annuity. Actual results on the second chart probably understate how much better he’d do. It assumed no income on the $33,240 set aside in advance for the first five years or for any of the subsequent periods.
Buying the annuity meant making a bet that you’d live well past 91 years of age. It subjected you to potential forfeiture of your life savings in case of an early demise. It failed to protect you against the ravages of inflation.
A greater than 5% average annual return would make this comparison even more dramatically favor not buying the annuity. Don’t let a free meal cost you thousands of dollars.
I welcome comments from those who’d like to make the case that the annuity would be the superior choice.
About the author: