We've all seen or heard the guy on TV and radio say, "I hate annuities and you should too," or something to that effect. Of course his goal is to sell you something. That's why he's advertising, right? He's not paying thousands of dollars for these ads simply to educate.Nearly everyone reading this sentence has an annuity whether they know it or not. If you've paid into Social Security or are receiving payments from Social Security, congratulations, that's an annuity. Lottery winners, when they take payments over 20 or so years, purchase or receive an annuity. Professional athletes are often paid through and with annuities.
An annuity is a contract between you and an insurance company where a lump sum of money is guaranteed to be paid to you and/or your beneficiaries for a period of time, often for life. These payments can be annual, monthly, etc.
Think of annuities as the other side of the coin to life insurance.
With a life insurance contract the insurance company looks at your lifestyle, health, family history and then makes a decision as to whether you are worth the risk or not. They take on the risk of you dying too soon and them having to pay out the claim. The higher the risk you are, the higher the premium. If the risk is too high, they will either get help spreading the risk among other insurers or they will simply walk away from that risk.
With annuities the insurance company doesn't take risk into consideration for the most part, you do. You take on the risk of dying too soon and thus a portion of your invested money staying with the company. They have a general idea of how long you may live and how long they may have to make annuity payments. There is some risk on them and it's the risk of you living too long and them having to pay out more than what they intended. For instance, if you are 65 and give them $100,000 they may promise to pay you $583.33 per month for the rest of your life. They are figuring that on average you will live to 80 and at that point they will have paid out $105,000 all the while profiting $10,000 from the investments made with the money you gave them. However, if you live to be 95, then they'll be paying out nearly $210,000!!
Simply put, with life insurance, the insurance company wants you to live a long and happy life. They want you to pay premiums as long as possible so they can invest that money, have enough to pay the death claim when you pass, and some left over to keep the lights on. But with annuities, the company wants you to live a happy life and a long one, but not too long. Depending on the contract, the longer you live, the greater risk the company has of losing money. They want to take the money you invest in the annuity, have enough to invest and make money for the company and enough to pay your monthly payments. It's a balancing act.
Should you "hate" annuities? I guess that depends on the individual contract but for the most part I'd say no. To use a blanket statement, I hate blanket statements. All or nothing statements are usually trouble. Whether it's hating annuities, buying term and investing the rest, avoiding permanent policies, blanket statements are most often sales pitches and don't account for individual needs and situations. Annuities, term life insurance, permanent life insurance, CD's, stocks, etc., all have their place. The important thing is to know when, where, and for what purpose each can be used. In the next post we'll take a look at how an annuity should or should not be used. We'll examine who should have one and who shouldn't. I hope you'll join me.
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