You may have been encouraged by an insurance agent to purchase annuity with the assurance that you are going to receive a steady stream of funds during your retirement. The reason that more and more people become interested in investing in annuities is the promise that they will profit from their investments once they are in their retirement age. With the different types of annuity in the market, fixed annuity has been getting the most attention from potential investors.
This is because of the expectation that they will receive a fixed amount every month upon retirement. In order to illustrate the benefits of investing in annuities, some financial consultants use annuity calculators that will compute for the earning potential of a person’s investment. While it is true that some forms of annuities are expected to increase in value after some time, in fact the S&P 500’s average return in the last 10 years is more than 6%, when you compare this against your investment, you will find out that you have not really earned as much as promised. Upon realization of this hidden fact about annuities, some investors went into selling annuity and look for other investment options.
“Now what do I have to know about annuities and your investment,” you may. Let us look into the details on how annuities can be tricky investment options.
Let’s say you purchased an immediate annuity for the amount of half a million dollars and was promised that you are going to get $2500 every month upon your retirement. This is not an unusual scenario since many people who are approaching their retirement age opt for immediate annuity. With the optimism that you will gain about 6% on top of your investment, this is an irresistible offer.
Getting Your Investment Back
But let us face reality here. During the first 15 years that you will receive $2500 a month from the annuity company, you are not earning anything yet. The company is just returning a portion of your investment every month. So the $500,000 that you spent to purchase the annuity is no longer yours and will not be completely returned to you until the end of the 15th year. You may be wondering now, “Should I just sell my annuity?”
Starting to Earn from Annuities
On the 16th year that you are receiving $2500 a month from the annuity company, that is the time that the company will start giving you money that is not part of your initial investment. Since you expect to earn $30,000 for that year, it is easy to believe that you earned 6% off your investment. While it is true that $30,000 is 6% of your $500,000 investment, remember that your money has been with the annuity company for more than 15 years. And for 15 years, you have not been earning anything from your investment. So if you take your average earnings for the 16 years that you have been receiving annuity payments, it will definitely be less than 6%.
The Internal Rate of Return
The IRR or the Internal Rate of Return is used to measure the percentage of gain that you will get from your investment. During the first 15 years, when you are just getting your money back, the IRR is at 0%. On the 16th year, the IRR for the investment will be at 0.92%. This means that you haven’t really gotten 6% annually for your investment.
Twenty years after the investment, the computed IRR is just at 3.47%. So when will you get a 6% IRR for your investment? This is very unlikely. Thirty eight years after purchasing an annuity – many of the investors will be around 100 years old by this time – the IRR will just be at 5.57%. Take into consideration if the investor died before the 15th year of the annuity, then he wouldn’t really have earned anything from his investment.
Factor Inflation In
Receiving $2500 every month during retirement may be acceptable to many. After all, this will be enough for him to live comfortably right now. Yes, right now $2500 is enough to support a decent lifestyle. But will it be the same in 5 or 10 years? At an average inflation rate of 4.5%, in 20 years, the purchasing power of $2500 will just be halved.
It would be great if you do not spend the whole $2500 every month, so that you can still save a portion to take care of the impact of inflation in the future. If you manage to maintain a modest lifestyle during your retirement years, then maybe inflation should not be big issue.
In reality, it is difficult to find a quote of $2500 every month for an annuity purchase. You may get a quote for a few hundred dollars less, and this means that you will even earn less from your investment. Instead of investing in annuities, consider other financial vehicles that will give you more value for your investment.
Mark Long is a respected financial expert in annuities and retirement planning. If you have concerns with your investments and think, Should I sell my annuity, then he will check your risks to advise you if you should start selling annuity.
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