I recently received a postcard invitation to a nice local restaurant as part of a "retirement seminar". You may have found one of these invitations in your mailbox as well. The enticement of a nice steak dinner is alluring, but you really aren't sure what topics the talk will cover and your curiosity is piqued, so you decide to go.
When you get to the restaurant you notice that most of the other invitees are older. Most are already retired, which is odd since this is supposed to be about planning a retirement. Something just doesn't seem right, but you're getting a free meal so it's okay.
As the speaker begins his talk you realize that this is a sales talk. A woman walks around the room with an appointment book and when she gets to your table she asks when you would like to meet with the "planner". "And don't forget to bring any paperwork from your current financial professional."
The speaker tells the room how risky investments are, how global turmoil is going to get worse and basically the world is going to hell in a handbasket. He or she may even have a "team" of professionals, like attorneys and accountants who back the claims of the pending financial apocalypse.
So what is this whole steak dinner getting you?
In a nutshell, what the whole presentation will boil down to is that you need an indexed annuity. Or do you? But first, what is an annuity?
Annuities are products offered by insurance carriers in which you give them a lump sum of money and they promise to give you a stream of income, which usually takes place 5, 7 or 10 years later. I have maintained that all insurance products have a need with some people, but not all people need every product. An annuity is great for a certain segment of the population, but in truth, not everyone needs one and in a low-interest environment like we have now, it may not be worth it.
In a previous post entitled "CD's vs Annuities In A Low-Interest Environment", we examined the mechanics of an annuity and who should (or shouldn't) purchase one. Let's take a nice easy example of how this works.
Let's use the example of a 55 year old person with $100,000 to invest. In our scenario we will assume that the cap on the annuity is 6%. That means that's the most the contract will earn in a given period, typically annually. Using a formula called the rule of 72 we can determine that it would take 11.9 years to double the money. So we have $200,000 at the age of 67. At that point, we annuitize the contract (get a payout) of 5% or $10,000 a year for a lifetime.
To get the original $100,000 back we're waiting another 10 years, which means the client is now 77 years old. Our client, on the best day, waits 22 years to break even! And we haven't figured in the rate of inflation either.
Unfortunately, the annuity contract with a 6% cap doesn't guarantee you that rate. That's just the most it will pay if everything went perfectly, which we know isn't the way the world works. In this environment, it's safer and smarter to go with either a short-term annuity and wait for interest rates to rise, or to look into a variable annuity with a much better potential for growth. Or put the money somewhere else altogether.
I recently showed a few friends of mine this example. More than a few were disappointed in the numbers. Some said they could put the money in other investments like real estate and get better, not to mention quicker, returns. The low interest rates which affect the caps were the main issue. My informal survey did yield a consensus that an annuity would be a good fit for a very conservative person.
My advice to people is that if you are interested in an annuity, never put more than 50% of your assets into it, as they have serious liquidity issues as well as a lot of built in fees and charges.
Go ahead and enjoy the free dinner, but of course, call us before you make any decisions.