It is rare that I check out a book at the library and then end up wishing I'd bought it so I could keep a copy for future reference. Such is the case with The Truth About Buying Annuities by Steve Weisman, published in 2009. He is an attorney and lecturer at Bentley College in the Department of Law, Tax, and Financial Planning. What he has done with this book is nothing short of a miracle- he has made annuities understandable.
Most books about annuities and other investing-related insurance products are written by those with something to gain from their sale, so they're generally overly-positive about the merits of these products. Not so with this book. He puts forward nothing but the facts. If you own an annuity, are considering buying an annuity, or would just like to learn more about them, you must read this book.
The book runs 200 8-inch pages, split into 50 “truths” (chapters.) This is one of the strengths of the book. Each chapter can be read in less than 2 minutes and covers a given subject completely. It's like the high-yield books you read in medical school. He begins with the history of annuities, including the “tontine”, which was a combination of a wartime tax, a pension plan, and a lottery. As others who bought the tontine died off, your payments got bigger until the final person left received a huge lump-sum payment. Talking about incentive to murder!
He then moves into descriptions of each of the various types of annuities, differentiating between fixed and variable, immediate and deferred, equity-indexed, and inflation-protected. In each chapter, he points out the pluses and minuses of the product, and gives his recommendations on its use. I was surprised he wasn't more negative about equity-indexed annuities, but if you actually read all the downsides he clearly describes, I suppose you don't need to hear his negative opinion about them! I also found his recommendation against inflation-protected single premium immediate annuities (SPIAs) surprising. He feels the inflation component costs too much, and that you're better off buying a regular old SPIA and investing the difference in an index fund to provide inflation protection. Given how few companies offer inflation-protected SPIAs, and how many offer regular SPIAs, I suspect he may be right.
He discusses payout options for annuities in their many forms, and gives a fantastic illustration of how that affects your payout. For example, here is the monthly payout for a 65 year old Massachussetts man who bought a $100K annuity.
- Lifetime payout with no payment to beneficiaries: $672
- Lifetime payout with installment refund to beneficiaries (get at least what you paid back): $632
- Lifetime payout with 5-year term certain to beneficiaries: $667
- Lifetime payout with 10-year term certain to beneficiaries: $649
- Joint Life (100% to the survivor) $577
- Joint Life (100% to the survivor) with up to 15 years to beneficiaries: $572
Most importantly, he points out the relationship between each of the “bells and whistles” of annuities, and the higher fees. He is quick to point out the tax advantages of annuities, but also the fact that no annuity carries the tax advantages of a 401K or IRA, and so he recommends you max those out first. He also discusses the risks of annuities as compared to the risks of other investments.
Some of my favorite parts of the book are where he points out when an annuity feature isn't nearly as good as the salesmen like to show. For example, the “death benefit” of annuities is not only severely overpriced, but also nearly useless for most people.
One product I hadn't heard of prior to reading the book is longevity insurance. Basically, this is a deferred annuity you buy at age 65, that doesn't start making payments until you're 85 (if you get there.) Because many of those buying this product die between those ages, the payouts can be quit hefty if you actually get there, over four times higher than a typical deferred fixed annuity (where your heirs would get something back if you died between 65 and 85.)
Throughout the book, Mr. Weisman reveals his true Bogleheadish nature to watch for fees and his preference for straight forward investments such as index funds. In the chapter where he compares variable universal life insurance and variable annuities he says this:
Variable universal life insurance policies are like luggage and herpes–once you get them, you have them for the rest of your life….The bottom line is that comparing variable universal life insurance policies and variable annuities is comparing two types of complex investments, where the best choice may well be to choose neither of them.
There is a great chapter on comparing mutual funds and variable annuities in which he concludes “Ultimately, the choice is clear. Mutual funds are a better investment than a variable annuity.” He also reveals why retirement age for IRAs, annuities, and 401Ks is 59 1/2, instead of some round number. (In insurance company actuary years, 59 1/2 is equal to 60.)
He does point out a couple of advantages to using annuities that you might not have thought of. First, you can use one to put money toward your children's retirement without it affecting their financial aid for college. The FAFSA doesn't consider annuities. A Roth IRA is better, but requires the kid to have earned income. Since there's no limit on how much you can put in an annuity, you can “shelter” a lot of money away from the FAFSA. Of course, if you can afford to save for your kid's retirement, you can probably afford to pay cash for their schooling. Second, like a 401K or IRA, an annuity can be protected from your creditors. The amount of protection varies by state, from no protection to complete protection (the book has a list of the protection available in each state.) California, Florida, Indiana, Louisiana, New Mexico, and Texas offer particularly good protections.
He talks about annuity scams (hint, don't buy a deferred annuity if you're 90 years old), how to get out of an annuity, how to exchange it for another, and where to buy an annuity (from a mutual fund company like Vanguard or Fidelity.) Then he finishes the book with 37 rules, which are basically a summary of the book. You can learn more in 2 minutes about annuities by reading these rules than in spending 2 hours in the office of an annuity salesman. If you want to know the truth about annuities, I suggest you read The Truth About Annuities.