Are annuities a good deal or not?

(MoneyWatch) Should you consider buying an annuity? You'll hear lots of passionate opinions on both sides of this debate, each with valid points. Let's cut through some of the confusion to help you decide if an annuity might be a good investment for you.

First, understand that there are good annuities and bad annuities, just like any other product or service that you might buy. When I hear someone say they'd never buy another annuity because of the poor performance or high fees they experienced with the annuity they had purchased, I have the same reaction I'd have if I heard someone say they'd never buy a car because they had a bad experience with a lemon they'd previously owned.

Second, it's important that you distinguish between deferred variable annuities and immediate annuities. These products are as different as a Hummer is from a Prius. Would you decide to never purchase a Prius because you experienced bad gas mileage and expensive repairs with your Hummer? Of course not.

Deferred variable annuities are used to accumulate savings for retirement on a tax-advantaged basis, and they often come with high fees and poor performance. In my opinion, the best deferred variable annuities -- meaning low cost and good performance -- are offered by mutual fund companies such as Vanguard or Fidelity. You initiate the purchase of this type of products by contacting these institutions. If a broker or advisor is trying to sell you a deferred variable annuity, chances are good these products will come with high commissions and fees that drain your savings. This leads me to an important recommendation: Go shopping, and don't be sold!

In fact, you should never purchase a deferred annuity until you've maxed out on your 401(k) or IRA contributions -- these two investment vehicles usually offer lower costs and better tax advantages. Even then, as an alternative to a low-cost deferred annuity, you should probably consider other ordinary investments, such as index funds and municipal bonds that have special tax advantages, before purchasing a deferred annuity.

On the other hand, immediate annuities are used to generate reliable income during your retirement and aren't usually used to accumulate savings for retirement -- that's the big difference between an immediate annuity and a deferred variable annuity. Think of an immediate annuity as a do-it-yourself pension. The most straightforward immediate annuities are quite simple: You give your money to the insurance company, and they promise to pay you a monthly pension, no matter how long you live and no matter what happens in the economy. You can also opt to continue the monthly pension to your spouse or partner after your death. Retirees who bought an immediate annuity just before the Great Recession are a lot happier than their friends who remained invested and saw their nest egg crack open.

Many immediate annuities are fixed in their dollar amount, but some are indexed for inflation or increase at a fixed rate, say 3 percent per year. As with deferred variable annuities, you can buy low or high-cost immediate annuities. Both Vanguard and Fidelity offer annuity bidding services so you can shop your annuity among a number of well-rated insurance companies; the transaction charges are low and transparent. You can find other effective annuity shopping services at Income Solutions and ImmediateAnnuities.com.

Annuity salespeople don't like me
Create a do-it-yourself pension
What happens if your insurance company fails?

Individual investors and advisors often worry about insurance company bankruptcies -- they point to AIG as the latest example of why you shouldn't buy an annuity. But no AIG annuity policyholder suffered any losses, and there are good reasons for this. First, the life insurance subsidiary of AIG remained healthy throughout the crisis, and creditors of the AIG parent company could not touch the assets of their life insurance subsidiary. Even if the life insurance subsidiary of AIG became insolvent, most insurance policies are protected by state guaranty associations.

Because insurance companies are highly regulated and very conservatively managed, there have been very few insurance company bankruptcies, unlike bank bankruptcies, which happen much more frequently. In the few instances of insurance company insolvencies, benefits have been protected by the state guaranty association, or another insurance company has stepped in and taken over the policies. As a result, there have been very few instances where policyholders have lost money when an insurance company goes bankrupt. For an excellent article that describes the low risk of insurance company bankruptcy, read How Safe Are Annuities? by Joe Tomlinson.

Here's the bottom line: Annuities can be the Rodney Dangerfield of financial products. But they deserve your respect and consideration. And as with any important product or service that you'd buy, you need to do your homework to make sure you're getting the best deal.

[drumtwigs]

Steve, why would you entitle this article "Are annuities a good deal or not?" and only discuss variable's and spia's? Why would you leave out deferred fixed (traditional and fixed indexed) annuities when they account for roughly a third of all annuity sales nationally? Did you forget, or are you unaware of their significance? Perhaps you should consider retitling your article to "Are Variable annuities a good deal or not?".

If you were buying your first car would you agree you were being mislead if the salesmen said you could only buy a Prius or a Hummer?

[stevevernon]

Hi KeepitSimpleStupid23

Thanks for your feedback. You are a wise consumer to check credentials, but looking for a securities license is insufficient.

FYI I am a Fellow in the Society of Actuaries (FSA), which requires a rigorous 5+ year program of study of investments, insurance, demographics, mathematics, and is quite exclusive. It is far, far more rigorous and relevant to generating retirement income than the requirements for a securities license. To use your analogy of a pilot, having a qualified actuary writing about these issues is like flying with a pilot who is an aeronautical engineer and designs and flies planes.

Regarding the simple immediate annuities that I write about, the market is very mature, very competitive, and profit margins are thin, which is good for the consumer. Properly purchased Immediate annuities are a good way for middle class Americans to generate a reliable lifetime retirement income.

Best regards, Steve

[KeepItSimpleStupid23]

Steve, it's not my goal to discredit you. I have a tremendous amount of respect for you and for the FSA - you're right in that it is an extremely prestigious title. You do not, however, have a securities license. I am sure you are a smart guy, but without a proper license to give advice, you shouldn't. I don't care if I get on a plane with Howard Hughes at his best in the cockpit; if he doesn't carry a license to fly I'm not leaving the ground. I suggest your readers take advice from individuals with proper credentials - go to finra.org to check the background of your financial advisor.

I know a lot of actuaries and wouldn't trust one to manage my money.

[KeepItSimpleStupid23]

Steve, I'm sure you travel a lot. Would you ever get on a plane if you learned that the pilot wasn't licensed to fly? Retirement, like a flight anywhere in the world is a journey. I would suggest any reader or follower of yours never take advice from individuals that don't carry a securities license. I have searched FINRA.org's broker check and can't seem to find your license to provide investment advice. Taking advice from someone without the proper credentials is no different than getting on a plane with an unlicensed pilot. It's suicide - in this case financial suicide. Immediate annuities are the most profitable investments insurance companies offer - profitable for the insurance company that is. They don't carry any fees, that's true, but they are the quickest way for an investor to eliminate their net worth.

[drumtwigs]

All due respect, but you may be keeping it a little too simple, stupid. I wouldn't hang my hat on a source solely based on whether or not they have a completed a course which allows then to sell a product. Sure, designations and credentials lend credibility, but not experience nor success. There's many other designations and credentials other than securities registrations that absolutely have a place in the financial landscape and can provide a legitimate and valuable service to consumers. Your analogy is fitting as it assumes the only way to travel is by airplane.

[CathCoy]

"Retirement, like a flight anywhere in the world is a journey. I would suggest any reader or follower of yours never take advice from individuals that don't carry a securities license."

This is simply nonsense, in my opinion. Being securities licensed doesn't automatically confer expertise in retirement strategies. There are people who aren't licensed AT ALL who, through thorough reading of the subject matter, can do a better job than many of the Series 7 licensees I know. And to compare a physical activity--such as piloting or surgery--with a strictly intellectual pursuit such as retirement planning, is like comparing a Prius and a Hummer, as Steve suggested. I agree with Drumtwigs.