The Wrong Kind of Annuity

Indexed annuities are selling briskly these days. We kind of wish they weren't.

The folks in annuity research at LIMRA have reported that insurers sold $8.7 billion in equity-indexed annuities during the third quarter, up 16% from last year to a new record high. It seems that indexed annuities have grown to make up 41% of the fixed annuity market. That's a lot of money being plowed into very problematic investments. 

Danger, danger!
In theory, annuities are great. You fork over a (usually sizable) sum of money to an insurance company; in exchange, you receive a guaranteed income for a set period. There are many kinds of annuities, but equity-indexed (and variable) ones are particularly noxious.

Equity-indexed annuities are pitched as great ways to grow money in the stock market, while limiting your exposure to market downturns. If the market goes up, you gain. If it goes down, you don't lose much, or anything. Unfortunately, your gains are capped. If the market soars, as it did in 2009, you may only get a fraction of those gains. Making matters worse, you'll typically face steep fees and tax disadvantages.

The better annuity
If you like the idea of an annuity in your golden years, consider looking at lifetime income annuities. There, you know from the beginning just how much you'll be investing, and to a great degree, what you'll be paid every month during the term of the policy (which might be to the end of your life). These annuities offer a guaranteed income rather than controlled growth, but they usually don't buy you as much income as you might make on your own. 

For another option, consider building your own annuity-like income stream with dividend-paying stocks. It's true that the payouts aren't guaranteed -- some dividends do get cut. But the right investments in healthy, growing companies could give you a pile of cash each year. Check out this way to split $100,000 between a few companies, with $25,000 in each:

Company	Dividend Yield	Annual Payout
National Grid	7.6%	$1,900
Philip Morris International	4.3%	$1,075
Abbott Labs	3.7%	$925
Waste Management	3.6%	$900
Total		$4,800

Source: Motley Fool CAPS.

If you're a 65-year-old man in California, $100,000 might buy you a $7,000 annual lifetime annuity, but it won't keep up with inflation. Good stocks will keep appreciating, and their dividends will rise as well. The companies above operate in the always-in-demand industries of energy, tobacco, pharmaceuticals, and trash. If their dividends grow by 8% annually, in 10 years they'll be paying you more than $10,000 a year.

Study annuities closely before buying, and give strong consideration to alternatives. Some annuities offer peace of mind, while others will rob you. Plan a smart path to your retirement.