NEW YORK (MainStreet) -- Annuities can be an effective tool to trigger a lifetime stream of income in retirement, yet buying the insurance product is a process complicated by conflicts of interest and “kickbacks.” That said, for retirees seeking to create a personal pension, it may be well worth the effort.
In a comprehensive study just released by Mark J. Warshawsky, the visiting scholar at the Mercatus Center of George Mason University compares the vaunted “4% rule” to a life annuity. Annuities are insurance contracts that issue periodic payments, often monthly, for life. Portfolio withdrawal strategies, such as the 4% rule, call for disciplined annual distributions, adjusted for inflation.
After calculating the income produced and the risks associated with both of the strategies, Warshawsky concludes that annuities deserve a “prominent role” in a retiree’s income plan.
“I judge the life annuity an effective instrument to produce lifetime retirement income -- generally somewhat better than the commonly used withdrawal rules,” Warshawsky writes. “I worry whether the 'lump-sum' culture of 401(k) plans and IRAs will lead retirees to a sufficiently structured and prudent approach to lifetime retirement income. It is clear from my historical simulations that commercial individual annuities should have a prominent role in retirement-income strategies for many workers.”
However, Warshawsky doesn’t recommend an “all-in” approach, favoring instead a combination of the two strategies.
“I have found that the best approach in terms of lifetime income flows with upside potential, some flexibility, personalization, and low fees and risk is to use a mix of systematic withdrawals from a dynamic portfolio of a mix of asset types, and gradual laddered purchases of immediate life annuities,” he says.
Utilizing the guaranteed lifetime benefits of the annuities, combined with the flexibility of withdrawals from a diversified investment portfolio, provides a steady income while allowing retirees the flexibility to cover unexpected expenses from health issues or other unforeseen circumstances, Warshawsky says.
But the purchase of an annuity is anything but easy. Annuity contracts can be complicated, loaded with barely-explained restrictions and sold with appealing but intentionally vague performance promises. The industry’s integrity has been poisoned by deep conflicts of interest.
So much so that Sen. Elizabeth Warren (D.-Mass.) recently sent letters to 15 of the country's largest annuity providers, asking for information regarding the rewards and incentives the companies offer to brokers and agents who sell the contracts.
Citing such sales awards as a 27-month lease on a Mercedes-Benz, free trips to Oahu and Cape Town and diamond-encrusted ‘NFL Super Bowl Style' rings, Warren called for the industry to come clean on the “kickbacks.”
"I am troubled by this industry incentive system," Warren wrote. "Annuity agents that are more interested in earning perks than acting in their clients’ best interest can place Americans’ savings and retirement security at risk."
“Although these perks are widely known within the industry, there has been little public attention to the extent and type of awards given to agents for selling annuities or the impact that these kickbacks may have on agent behavior,” Warren added.
Warren called for annuity providers to reveal the incentives they offer, the number and value of the awards, and the companies' policies for disclosing the potential conflicts of interest to clients.
In the meantime, when shopping for an annuity, investors should ask agents to disclose any potential conflicts of interest and reveal how they are compensated for the sale. It’s also a good idea to shop around, comparing fees and features among different providers.