Immediate Annuities: Security or Snake Oil?

Last Updated Apr 7, 2009 4:15 PM EDT

These days many companies are marketing immediate annuities as the solution to the retirement income problem. The sales pitch usually starts with a scary summary of the stock market declines over the last year and a reference to how comfortable a guaranteed income would be in times like these.

Prior to buying an annuity, however, you should think long and hard about its benefits and burdens.

The benefit of an immediate annuity is that it provides you with a guaranteed income for life. That sounds nice, but in exchange for this guarantee, you must give up a lot:

  1. Give up your money. Basically, the insurance company gets to keep your money in exchange for guaranteeing to pay you an income for the rest of your life. You get a monthly payment, but no more access to your money.
  2. Give up the ability to fight inflation. Most annuities are fixed annual payments and they don't change throughout your entire life. A payment that looks good today may not be worth much 20 years from now. If inflation runs at three percent a year, about every 23 years your purchasing power is cut in half. And if we go into an accelerated period of inflation, that annuity income can quickly lose its value.
  3. Give up diversification. While the safety of an annuity is attractive, the guarantee is only as good as the insurance company's ability to pay it. When you buy an annuity, you are making a big bet with one company. As you have witnessed, when there is a global financial panic, even strong companies can be put under severe financial pressure. If your annuity company gets into trouble, it may end up causing you more stress because you can't get your money back.
Immediate annuities may have a place for a portion of your retirement money, but thoroughly investigate the benefits and burdens of any contract before you move ahead.