Retirement Planning: Annuities Aren't Perfect

Tina Haapala |


By Gary Silverman, CFP®

In my last column, we looked at problems associated with cash flow when it comes to retirement planning. But mostly we were considering problems with your expenses if health (or death) interrupts your ability to generate income. Today, let’s consider flow problems associated with so-called “Guaranteed” Income Streams.

Okay, guaranteed income is not a problem. It’s wonderful. It’s dancing through the daisies, cherry on top of the sundae wonderful. But these guaranteed income streams have their own problems.

Some experts suggest having about 20% of your income in some form of annuity (explained in more detail below). Others suggest using an annuitized stream of money for basic living expenses: the lowest level of food, clothing, and shelter. Still others, though a distinct minority, suggest that anything short of 100% guaranteed income is just plain stupid. I’m in the 20% camp. For most folks, Social Security covers that and a lot more.

Three of these are the most common ways you get those guaranteed income streams: Social Security, pensions, and annuities.

Now for the problems.

First, annuities. What a lot of people don’t like about creating a guaranteed income stream out of an annuity (called annuitization) is that you trade your lump sum for an income stream and you will never see that lump sum again. So while you may never run out of money, you won’t have anything left over for your heirs either.

Then there is inflation. Most annuities do not keep up with inflation. If you start with $1000 a month at age 65, when you get to age 95 you are still getting $1000 a month. My guess is that it won’t spend the same 30 years in the future. This applies to most pensions as well (pensions are a type of annuity).

There are some annuities that allow you to “recover” some of the principal you gave to the insurance company. Others have an inflation rider built into the policy. But for every protection against problems you buy there is something you give up—make sure you understand what you are giving up. That’s not my problem with them.

My biggest problem with annuities is the poor returns.

Poor returns mean that in normal circumstances you’d be better off investing your money yourself than getting someone else to guarantee future income. Usually a lot better. Of course this assumes that you invest your money in a sane and practical way, not taking too much nor too little risk and not allowing emotions to control your investment strategy. In other words, it assumes a lot. But you’re reading my columns, so that’s a start.

None of this should be interpreted as my not liking annuities. They are a great tool to use if your situation warrants them. But like any tool you should read the cautions and warning labels before using them.

Gary Silverman, CFP® is the founder of Personal Money Planning, LLC, a Wichita Falls retirement planning and investment management firm and author of Real World Investing