First of all, what is an annuity? It is a contract, plain and simple. Usually, these are made with investment institutions, particularly life insurance companies. And they are sold, by salesmen, who often use pressure tactics to sell them. So first thing - carefully think over what you are doing here and don't be cowed into signing something that isn't in your best interest.
And yes, some salesmen have pressured Seniors into unattractive annuity products, where income or access to funds was difficult, if not impossible to obtain. In one celebrated case, a 70-year-old man was pressured into signing up for an annuity that did not pay out for 20 years. In other words, he'd have to live to be 90 to see a single penny of it.
So beware of insurance salesmen offering Annuity contracts. You KNOW how I feel about insurance salesmen. And they are on commission - lucrative commission, too!
A Life Annuity contract guarantees you payment of X dollars a month, for life. For many people, this is a comforting thought - for the rest of their life, they are guaranteed a monthly payment that they can live on - no matter how long they live!
However, if you don't live very long, obviously the insurance company comes out ahead in that deal. And in that regard, like life insurance, an annuity can be a way of spreading risk among a number of people. And that is why life insurance companies generally sell these things - they have a good handle on actuarial tables and life expectancies and can make calculated risks about how much money they should take in versus pay out over time.
Are these a good deal? Well, probably not. If you are very risk-averse, you may find the idea of a Life Annuity comforting - as it provides the proverbial "peace of mind". But as I have noted time and time again in this blog, if someone tries to SELL you "peace of mind" - watch out! Chances are there is chicanery involved, or at least a bad deal.
You see, just like extended warranties (which also claim to sell you "peace of mind"), the person selling the contract has to figure out how much they will have to pay out and how much you have to pay in, in order to break even. Then they tack on a substantial profit. The salesman gets his taste (often a percentage of the amount invested) and then the life insurance company gets their taste as well.
So right off the bat, you can see that for the money you are putting into this gig, the life insurance company is hoping to pay out less than what you paid in (or, to be more specific, what you paid in, plus the interest it earns). And the same is true of the extended warranty. You pay money in, and they have carefully calculated how much, on average, they expect to pay out and then factor in a profit margin.
Unless your car breaks down a LOT - or you live to be 100, you rarely come out "ahead" on these deals. The "average" person comes out slightly behind, and the person who has no car repairs (or lives only to 66) gets nothing or almost nothing.
And in both cases, it is a form of gambling. You are betting, in an extended warranty, that your car will blow up. And in an Annuity, you are betting you will live to be 100. Note this is the opposite bet of Life Insurance - where you are betting on an early death!
And like Life Insurance and extended warranties, an Annuity is a contract between you and a company. It is not FDIC insured, guaranteed, or otherwise "safe" - beyond the financial soundness of the underlying company. Now of course, life insurance companies rarely go bankrupt, right? Well, it does happen on occasion. Some States may have guarantees for Annuities, but only for limited amounts (e.g., $100,000).
Like life insurance, there are many different types of annuities out there - deferred annuities, annuities with period certain, life annuities, fixed, variable, guaranteed, joint, "impaired life", and so on. Before you sign a contract like this, you need to fully understand what it is you are buying. Oftentimes, people are pressured into signing contracts like this (as noted above with our 70-year-old friend) and then discover later that they have signed a document that is contrary to their best interests.
And some salesmen, on commissions ranging from 1 to 10% of the amount invested, will push customers to sign deals that are pretty odious.
So, should you buy an Annuity? It depends, but my gut reaction is "No" and let me tell you why.
One of the basic rules of finance that I have is this:
The more complicated you can make any financial deal, the easier it is to rip off the customer.
Keep that in mind before signing any contract. Car leases are a bad deal because of this - the document can be very opaque and the real cost of the vehicle - the purchase price, the turn-in price, the interest rate - are all obscured in favor of "monthly payment".
And in fact, an annuity is sort of the same way - the customer sees only that "monthly payment" number, which is attractive to people who live on monthly incomes all their lives. They may fail to realize that they just handed over 5% of their portfolio to a salesman and that the average cash they will get out of the deal may be far less than what they would have received as an investment return.
The other problem with these contracts is that they limit your options. If you decide, later in life, that you need money for something - whether it is buying a home, paying medical bills, or whatever, you won't have it. Even buying a car may be hard to do if all your money is tied up in an annuity. You'd have to get a car loan and then pay for it with the annuity.
If you plan on leaving money to your heirs, this also might be problematic, if all your money is tied up in an annuity, unless perhaps, it is a joint annuity.
And as "guaranteed income" an annuity is problematic - if the company goes bankrupt, where does that leave you? Broke is what.
But the fundamental problem is that, since the company is taking a profit chunk out of your money (and the salesman his commission) it is likely you will get LESS out of your annuity than you will out of ordinary savings.
And in fact, one way life insurance companies try to make up for this, is by taking on riskier bets than you might ordinarily make at age 65. You'd put your money in FDIC insured accounts earning bubkis in interest. They put it into junk bonds, construction projects, and the like. Which is, of course, what sank Executive Life.
So as a SOLE INVESTMENT VEHICLE, an annuity is probably a raw deal and a bad choice. As a way of spreading risk and diversifying your portfolio, it may not be a horribly bad thing to have - provided it is not a major part of your investment strategy.
Also, investigate your State's guarantees (if any) of annuity contracts. Invest no more than what is guaranteed by the State, if you really want a safe investment.
Note that many whole life insurance contracts can be converted to annuities once you retire. You can flip the entire contract around so you are betting on long life - instead of short. I suppose I might think about converting one of my policies this way. But having cash does provide a lot more flexibility.