Are you working for a company that has a 401(k) plan but offers no pension? Did you know that the US Treasury has made rule changes to 401(k) plans that will now allow them to offer annuities? The federal government has had as an option an annuity system for Thrift Savings Plan participants for years upon their retirement. It works for government employees that when they retire they have the option of moving a portion of their savings into an annuity that will guarantee them an income stream for the rest of their lives. Now private employers will be able to offer annuities to their plan participants as well. From early research on the subject it seems one main difference will be that private plans will offer the annuities as part of a Lifecycle investment option or as a lump sum payment after you have amassed a sizeable amount in your plan.
Typically annuities are sold through financial institutions, brokerage firms, financial advisors and life insurance agents who all earn high commissions. In addition to these high commissions, these annuities are loaded with fees and often have extremely high early surrender charges that make them unattractive to investors. And in its basic form an annuity is just a contract between the purchaser and the insurance company in which for a payment of cash today the purchaser is guaranteed an income stream later in life.
For the reasons stated in the previous paragraph, the word annuity is often considered a bad or negative things for investors. And yes, many annuity products are poorly designed to help investors and are geared towards earning money for the issuing insurance company. So it is no wonder many people equate annuities with something negative or bad. But that is all about to change with these 401(k) annuities as the insurance company will no longer have to pay high commissions to its sales force to get the annuities into the hands of the end user. Also, these annuities will only be offered in 401(k) plans so they will be featuring lower fees than the annuities that are sold outside of 401(k) plans.
Regardless of if you buy an annuity through your work’s plan or an outside source you need to figure if it is a good deal for you. One way to determine this is to take the projected monthly payments and your estimated life expectancy to see if you will recoup your original costs or something close to it. In a perfect world, you would recover your costs and any income generated by the initial investment. Insurance companies have gotten excellent at estimating these figures to ensure that they do not lose money on these products while the annuitant receives the funds they are due.
While there are several factors, which will influence an annuity’s payout the single largest are interest rates. As insurance companies have to invest the funds in safe and secure investments, it is easy to see that their return is directly tied to the interest they are earning. In today’s low-interest-rate environment, you can expect lower monthly payments later in life due to the fact your money is not earning a high rate of return. While insurance companies are investing in the same underlying investments open to the general public, they do get some special rates due to the size and duration of their investments we would not achieve.
A second factor that plays a large role in an annuity payment is the annuitant’s life expectancy. If someone is younger and begins their payments, the payments will be lower due to the fact the insurance company will be making them for a longer period. This means that someone who is 65 can expect a much lower payment than someone who starts their annuity payments at age 75 or 80. Again, the longer the insurance company has to make the payments, the lower the payments will be on a monthly basis. In order to project a possible payment go to one of the many online calculators and just plug in some variables and see what you can expect as a monthly payment. Then figure your life expectancy based on your health and family history to see if it is a good deal for you or the insurance company.
Annuities are some of the most sophisticated financial instruments offered to the average investor. There are many different types of annuities offered and even more options that are offered by each annuity. It is also difficult to compare one annuity to another as fees differ a great deal from company to company. So before you consider an annuity make sure you thoroughly understand how the annuity is structured and all of the fees associated with the product.
If you have further questions or need additional information feel free to contact me.
