Last week, Steve McDonald wrote about a good problem to have: We’re living longer.

The problem is that we have to pay for our extra years. Or, as Steve said, we have to “hedge against our own longevity.”

One solution he suggested is to buy an annuity.

Steve is my go-to guy when it comes to bonds. There’s no one better.

[ad#Google Adsense 336×280-IA]But on the issue of annuities, I couldn’t disagree more.

To be clear, annuities aren’t wrong for everyone. They’re just wrong for most people.

Guaranteed Peace of Mind

When you buy an annuity, you fork over a lump sum to an insurance company. It then pays that money back to you over the course of your chosen timeframe.

The payouts usually occur on a monthly basis.

But the amount you receive depends on many factors. If the annuity is “fixed,” you’ll get the same amount every month. If it’s “variable,” the payout fluctuates. A variable annuity’s value is tied to the performance of the S&P 500 or other index.

The cost and payout of the annuity will vary according to the term you select. For example, you might receive lifetime payouts or payouts over a set period of time. Electing spousal survival benefits will affect the cost and payout, too.

The nice thing about annuities, as Steve pointed out, is that they are “guaranteed.”

One reader commented on his article that, “If you choose a reliable company… you can sleep at night” since some insurance companies have paid their bills for more than 100 years, even during the Great Depression and Great Recession.

That’s the positive. But the negatives far outweigh the benefits.

A Costly Trade-Off

First of all, annuities are expensive. Do you want guaranteed income no matter what the market is doing? Well, you have to pay for that.

Wall Street and insurance companies don’t just give away money. Annuities are typically three times as expensive as mutual funds.

And the cost is often accompanied by a big commission for the salesperson – as much as 10%.

That’s money that could be working for you instead of making a couple of mortgage payments for the guy from the insurance company.

And good luck trying to get an answer on how much you’re paying in fees. Annuities and the people who sell them are notorious for making the fees and commissions difficult to understand.

A well-known industry expression captures it brilliantly: “Annuities are not bought; they’re sold.” Think about that the next time you’re considering an annuity.

“The House” Always Wins

When it comes to calculating how long you’ll live and how much to charge you, the deck is stacked in the insurance company’s favor.

I don’t care if you’re in great shape and eat kale and quinoa salads three times a day. The insurance company has a better idea of how long you’re going to live than you do.

They employ brilliant actuaries whose jobs are to calculate life expectancy.

And some types of annuities will cause you to forfeit all your money if you die before you’ve been paid out.

If you buy an annuity and think you’re going to live long enough to collect more money than you put in (and could have made on your own), you’re likely going to lose.

It’s like going to a casino. You could get lucky, but you probably won’t. The odds are stacked against you.

Oh, and remember those “guarantees”? As long as you work with a quality company, you’re guaranteed to get your money if you live long enough, right?

Well, it’s not quite as rock-solid a guarantee as you may think.

Insurers Going for Broke

Ultra-low interest rates have wreaked havoc on insurance companies’ ability to pay.

You may have signed up to receive a 5% fixed rate, but to get that 5% today, the insurance company has to invest in riskier assets than it did a few years ago.

As a result, insurance companies that offer annuities are taking on much more risk than they used to. They’re putting money into speculative investments like startups, subprime mortgages and even railroads in Kazakhstan.

Annuities and insurance companies are not covered by FDIC insurance.

Fixed annuities are covered by state insurance programs, but the coverage level varies state by state. Variable annuities are not covered at all.

So if the Kazakhstani railroad isn’t a success and the insurance company goes belly up, you could lose some or all of your investment.

Some insurance companies also change the terms of their contracts after the fact. They may require investors to lower their balances or accept buyouts…

All because they simply cannot pay what was promised with interest rates being so low.

And annuities are not liquid. So you won’t have access to your money unless you’re willing to pay very steep penalties.

While any gains in the annuity are tax-deferred, you’ll pay ordinary income tax rates on the payments you receive. So you won’t benefit from the lower capital gains or dividend tax rates that you’d pay on many other investments.

A No-Brainer for Retirees

You are almost always better off managing your portfolio yourself – or with the help of a broker – than buying an annuity.

I recommend investing in dividend-paying stocks, bonds and mutual funds. You can withdraw funds when you need them so long as you meet the government’s age requirements concerning money in a retirement account.

This way, more of your money will work for you. You won’t be ripped off by a salesperson who is more concerned with his mortgage payment than yours.

And if you die unexpectedly, you or your heirs will keep all of your money instead of it going to an insurance company. You also won’t have to worry about the rules changing or your “guarantee.”

Good Investing,

Marc

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Source: Wealthy Retirement