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The Wrong Kind of Annuity

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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.

We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Longtime Fool contributor Selena Maranjian owns shares of National Grid. National Grid and Waste Management are Motley Fool Income Investor choices. Motley Fool Options has recommended writing covered straddles on Waste Management, which is a Motley Fool Inside Value pick. The Fool owns shares of Philip Morris International, which is a Motley Fool Global Gains selection. Try any of our investing newsletter services free for 30 days. The Motley Fool is Fools writing for Fools.


Read/Post Comments (3) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 29, 2010, at 8:20 PM, IBegtoDiffer wrote:

    You are sadly misinformed about indexed annuities. I suggest you educate yourselves prior to slamming a financial product that is working so well for so many. This compilation of untruths masquerading as an instructive article on finance is simply unacceptable.

  • Report this Comment On January 13, 2011, at 8:06 PM, dinofraser wrote:

    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.

    Nice quote guys....I assume 2008 was a banner year as well? The annuities I sell would of capped out at around 5-6% after getting a 10% bonus while the S&P "Soared" 19% after dropping 33% the prior year.

    Some people like knowing they have to listen to you guys daily to see whats happening with their retirement

  • Report this Comment On June 12, 2013, at 10:17 AM, fmr761 wrote:

    I read everyday many people regardind investements, I have worked the life insurance industry for 29 yrs, I have noticied the jeolosy between stocks and annutities, today annuities are very secure and with guarantees and bonuses not offered by stock houses. the Banking industry is the most cold and selfish industry I ever known. They just earn everything giving nothing to their clients. There are thousands of so called Financial advisors which at the end they dont know a thing about nothing. They work on the monkey see do businness. People are living longer, economy has been severly battered, trust on investments companies has diminished . Fixed income for life in an annuity is the best choice with your SSN benefits. You have to realize that people who write for us in different investment magazines or in internet pages create their own interests, ( neutral) I doubt that.

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Selena Maranjian
TMFSelena

Selena Maranjian has been writing for the Fool since 1996 and covers basic investing and personal finance topics. She also prepares the Fool's syndicated newspaper column and has written or co-written a number of Fool books. For more financial and non-financial fare (as well as silly things), follow her on Twitter...

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