One of the attendees in my Investing For Retirees seminar asked me if I thought that annuities were a good investment for retirement income. Frankly, the answer that I gave her wasn’t very helpful. It caused me to go and do some research, and this is what I found.
- Annuities have huge sales charges
According to TheBalance.com, a website for insurance salespersons, the average commission on an annuity is 5-7%. That means that for every $100,000 investment, the purchaser immediately loses as much as $7000 of principal before even getting started. That is a huge hurdle to overcome when computing the return to the annuitant.
2. Annuities may return no more than other income investments after tax
The return on an annuity depends greatly on your age when you start collecting, and your sex. But according to the Sunlife annuity calculator, a 65 year old can expect around 6% return before tax on their investment. Compare that to a Real Estate Investment Trust (REIT) ETF such as RIT which returns about 5% or a High Income ETF such as ZMI that returns about the same. But also recognize that the REIT ETF and High Income ETF may have lower tax rates due to their tax efficiency. The REIT ETF may contain (depending on the year) significant qualified dividends and capital gains. The High Income ETF may also contain Canadian qualified dividends and capital gains, which at a taxable income between $46,000 – $76,000 are taxed at only 9% and 17 % respectively, compared to 33% for annuity income.
3. Annuities are (usually) worth nothing after your death
An annuity is a combination of life insurance and investment. Basically, the insurance company which sells you the annuity is betting that you will die before they have to pay you back all of the money that you invested. At death, your heirs receive nada. Compare that to an investment that grows by even a modest 3% per year (a very conservative High Income ETF like ZMI for example) , and the difference is startling.
Let’s look at an example for someone who collects an annuity for 20 years:
Annuity ZMI (3%/yr growth)
Investment 100,000 100,000
Annual income 6,000 5,000
Total income 120,000 100,000
Value at death 0 180,000
Total return 120,000 280,000
And this does not take into account the possible tax advantaged nature of the ETF which would likely even out the after tax income and thus make the ETF investment even more or an outperformer.
You may already have an annuity
OK, this is a fourth reason, but since it does not apply to everyone, I thought to add it separately. Simply put, if you have an Defined Benefit (DB) Pension, you already have an annuity. You have a guaranteed pension income, some indexed to inflation, until you or your spouse or dependents die. That’s an annuity. Since you already have a guaranteed pension income, you can afford to have more variability and risk in your investments than those without a DB pension. And more risk equals more reward. So instead of investing in an over priced and underperforming annuity, look to other income generators such as REITs or High Income ETFs to enhance your income.