Generally speaking, Darrell & King does not see much value in annuities and other financial products. We have three main reasons for this view. First, the allure of annuities consists of a guaranteed rate of return, a steady stream of income payments, and no loss of principal. However, we analyzed a list of “America’s 50 Best Annuities: Guaranteed Income for Life.” We found in the immediate-income annuities category high end annual returns of 1.5% and low end of 1.2%. In the category of deferred-income annuities, we calculated high end annual returns of 2.9% and low end of 2.2%.

Over the last 19 years, which included two dramatic downturns, the S&P 500 returned 6.2% annually. The annuity company makes money on the fee that comes out of the annuity holder’s account/return as well as on any difference between what return the company can earn on the annuity holder’s assets and the promised return to the holder. Most annuity purchasers focus on the dollar income generation of the annuity rather than these sorts of percentage comparisons. Meanwhile, the higher percentage return from investing the funds outside of an annuity structure would allow for higher dollar incomes to be generated compared to the annuity.

Second, for annuity purchasers buying annuities today, even a 2.9% annual return may not protect that person’s purchasing power. The Federal Reserve’s stated inflation goal is 2%. If US inflation crept up to 3%, that 2.9% annual return annuity would be effectively losing the holder money.

Third, taxes on gains within an annuity structure are taxed at the annuity purchaser’s income tax rate rather than the capital gains rate. This could significantly affect the net value of stated annuity payment, especially when a couple filing jointly may have a marginal income tax rate of 32% or above – compared to a capital gains rate of 20%. We note also that the annuity structure does not provide the annuity holder the ability to utilize realize losses within his or her tax planning. This tax element receives very little attention because the annuity seller focuses the purchaser on the guaranteed dollar payment rather than the mechanics in the background.

We believe that a portfolio of high quality stocks, directly owned, provides the greatest potential for return over a given economic and/or market cycle. If one wants to reduce volatility through a cycle, bonds (directly owned) can accomplish that at a much lower cost and with higher earning potential through that cycle than financial products such as annuities.

The question of annuities and dealing with volatility vexes all of us, especially as we age. If you have any questions about the above, please contact us.