The Pros And Cons Of Lifetime Annuities

One of the biggest fears among the aging population is outliving retirement savings. The cost of modern living coupled with the miracles of modern medical technology means that money could eventually get tight if retirees live far beyond their retirement age.

However, one popular financial product, the lifetime income annuity, seeks to eliminate the risk of outliving retirement savings. Is a lifetime annuity the perfect path to guaranteed income for life? Here are some of the pros and cons to lifetime annuities.

Pros

Lifetime annuities, in principle, do guarantee consistent income for life. Many retirees do not have a substantive pension income stream, and an annuity can fill that void.

In times of economic turmoil, investments in mutual funds and bonds often produce negative returns for investors, but annuity payments remain unaffected by market swings.

Finally, locking in a fixed income stream with a portion of retirement savings can free up the remainder of savings for more aggressive investment alternatives. With the annuity's guaranteed income stream locked in for life, the potential damage of other financial mistakes or poor investments can be mitigated.

Cons

Possibly the single biggest con to lifetime annuities is that they actually exist in the first place. Insurance companies are not charity organizations. In other words, if insurance companies weren't making a net profit off of selling annuities, they wouldn't be doing it.

The fact of the matter is that companies that sell annuities use statistics based mostly on buyers' ages to model how much money they expect to pay out given each buyer's age and life expectancy. Certainly some healthy buyers will "beat the system" and profit from their lifetime annuities, but insurance companies know that, overall, the average annuity buyer will not generate a positive return.

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Another con to annuities is opportunity cost. Cash tied up in an annuity may be difficult or impossible to access after the annuity is purchased. Buyers are giving up financial flexibility and freedom by committing a large portion of savings to an annuity.

Finally, annuities are theoretically guaranteed. But as American International Group Inc AIG demonstrated during the Financial Crisis, even a $100 billion insurance company could potentially collapse. The fate of any annuity policy held by a company that declares bankruptcy could be a matter of the language of the particular agreement and/or a courtroom battle.

The Bottom Line

Is a lifetime annuity the right choice?

A decision about a lifetime annuity should involve consideration of a large number of factors, including the specifics of the agreement, the financial situation and goals of the buyer. Before making any investment, investors should make sure they fully understand the pros and cons of the decision.