I spilled considerable ink this Spring bashing all manner of insurance products peddled as investment products. I base my un-sell of insurance products on their complexity, illiquidity, mediocre returns, and high costs. Now I will pull some of my punches and give a more moderated view of some annuity products.
The summary of my more moderate views: Some people are happy with their variable annuities and have had good returns, without paying excessive fees. If you already own an annuity product, I don’t think you should necessarily sell it right now, or right away. Finally, fixed rate annuities are at least simple. I like simple.
Don’t get me wrong. I don’t actually endorse these things.
Annuities generally put me in a dark place.
Other than their complexity, illiquidity, mediocre returns, and high costs, I like annuities just fine.
It’s like that awful joke: “Other than that, Mrs. Lincoln, how did you like the play?”
I’ve received numerous responses from insurance salespeople this Spring about how weak my arguments are regarding annuity products. I read their responses and think of Upton Sinclair’s wisdom: “It is difficult to get a man to understand something, when his salary depends on his not understanding it.” Occasionally, when feeling cheeky, I respond to those emails, with Sinclair’s words.
But a thoughtful column-reader recently responded to my variable annuity-bashing by sharing his carefully kept spreadsheet of his variable annuity with Vanguard, which he bought in 2004. Quite frankly, he’s has been happy with it ever since.
His annuity owns a mixture of seven different equity-based Vanguard mutual funds. Whereas most variable annuity funds I’ve seen charge 1.5 to 2.5% management fees, his funds average 0.55% management fee, which I find utterly reasonable. In addition, the “mortality and expense risk charge” accompanying variable annuity funds – which typically runs from 0.4% to 1.75% across the industry – is a mere 0.17% at Vanguard. Again, quite reasonable.
Not coincidentally, he’s happy to report, his returns since 2004 have been quite competitive.
With a starting value of $110 thousand in early 2004, his funds grew to $340 thousand by mid-May 2019. That’s a 7.7% annual return over a little more than 15 years.
That compares pretty well with an 8.7% return including reinvestment of dividends of the Wilshire 5000 Index of the broad US stock market, or an 8.3% return for the S&P500 index of large US companies. Given mutual fund management costs, I’d say his 7.7% annual compound return on his variable annuity is as good as one could reasonably expect.
His stated reason for purchasing a variable annuity product, rather than a straight brokerage product, is to simplify passing on wealth to his heirs. His belief is that the variable annuity will pass smoothly to his intended beneficiaries without the risk of going through a probate court. I am no estate-planning expert, but if this gives him peace of mind, then that’s great.
One of the distinguishing characteristics about this variable annuity investor is that he was not sold the product by a commissioned salesperson. That partly explains his low costs.
My second moderating comment about various annuity products is that I would not presume to tell anyone to sell theirs, if they already own one. That’s a question that I get asked whenever I talk about how terrible they are.
So I’ll say it clearly: If you have an annuity already, don’t sell it right away. Often in personal finance matters, inaction is the best course. This is because action is costly, and other alternatives could be worse. Maybe what’s done is done. Maybe your annuity works for you. Maybe you have plenty of money already. I’m mostly talking about what you should not buy in the future.
Without knowing anything about your specific situation, a plausible solution to your problem of “I’m currently paying into a terrible annuity product, what do I do?” is to cease paying in to that product, starting paying for a better product, and then over time evaluate whether and how the existing annuity you bought can play a reasonable role in your long term financial plan.
And then finally, what about a fixed rate annuity?
I recently received a quote from my preferred insurance provider for a fixed rate annuity. I wanted to know, assuming I turned over $100,000, what kind of monthly lifetime income could I lock in? The answer is $391.64 per month, for life. I’m 47 years old. Were I older, the monthly payment would be higher, since I’d be more likely to die quicker.
The expected return on my fixed rate annuity was 3%. I don’t find that sufficient. I would never advise anyone with a net worth less than, say, $5 million, to buy one of these.
On the other hand, it’s very straightforward. We can all have different preferences for risk. Some annuities, especially fixed rate annuities, provide certainty. Fixed rate annuities like this are terrible for growing wealth, but have the advantage of simplicity. I like simple. And no fees. You turn over your $100 thousand. You lock in $391.64 for life. They are easily explained and understood. They never let you down.
Except under conditions of medium to high inflation. Other than that though, they’re safe.
A version of this post ran in the San Antonio Express News and Houston Chronicle.
Please see related posts:
Annuities Rant Part I – Complexity
Annuities Rant Part II – High Fees, Low Returns
Variable Annuities – Shit Sandwich
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