Annuities

The FINANCIAL COUNSELOR

by ARTHUR W. JOYCE

FOREMOST among the lessons taught by this depression is the value of an unshrinkable investment income. The steady decline in the market value of securities has been devastating, but it has remained for the extensive reduction or passing of dividends long held to be secure, together with certain unexpected defaults in interest payments, to bring home to investors the full force of the disaster. Unfortunately, this loss of investment income has been superimposed upon reduced earning power at precisely the wrong time. This condition will pass, but it will have left scars behind it to emphasize the value of an investment income which is dependable under pressure.

Annuities definitely satisfy this requirement. Their issuance by life insurance companies is sufficient evidence of their stability. There is nothing new or untried about them. Even prior to the writing of the first known life insurance contract in England in 1583, the issuance of annuities by several European governments was an established practice. In the United States, the unequaled ownership of life insurance undoubtedly foretells a widespread investment in annuities. This sequence is logical, leaving life insurance in the prior position it deserves, and bequeathing to its lusty brother, the annuity, the happy function of lightening the financial burdens of advanced age.

An annuity is an investment of money in a life insurance company, made to obtain a guaranteed, unshrinkable return, payable yearly (or at more frequent intervals) for a definite length of time, usually for life. The exact forms which it takes are as varied as the many needs it fills. Since the investment is made in the entire assets of the issuing company, it is obvious that its quality is unsurpassed. Moreover, it stands alone among investments as the only self-sustaining method of producing a fixed return which can be guaranteed for an entire lifetime. This return is comparable to the income derived from fixed interest-bearing obligations, but still there is sufficient difference between them to require explanation if the annuity is to be fully understood.

An investment of money in bonds produces interest, which represents income from capital. Theoretically, the capital itself remains intact, but as a practical matter its value can only be its market value, the future level of which is always unknown. The return from an annuity is literally a return of capital, including the interest earnings thereon. No question here arises as to market value, present or future, because it is definitely intended that the return shall eventually absorb the entire capital sum. Since this latter condition obtains, the annuitant is justified in expecting that his investment will be accompanied by advantages not otherwise available. There are two such advantages: first, the amount of the return, since it combines capital and income, is naturally greater than the income alone from bonds; and second, both the amount and its duration are guaranteed for an entire lifetime. Such advantages are only possible through the medium of a life company, whose facilities for the measurement of such risks are too widely acknowledged to require technical explanation here.

An annuity is the only method by which the owner of capital may enjoy the full use of it while at the same time escaping the dread that its eventual exhaustion will leave him without any return whatsoever, By any other method, the process of dipping into capital to augment an insufficient income eventually eliminates both. If an individual has enough capital to enable him to live as he wishes upon its income alone, he is in an enviable position, provided his capital is safe and its income secure, because he can preserve his capital intact tor the second generation. Such an individual does not urgently need the large return ot the annuity, but would be attracted to it primarily by that certainty of result which cannot be obtained elsewhere, and which doubtless accounts for the widespread ownership of annuities by wealthy people. But for the individual whose capital is not sufficient to sustain him from its income alone, the annuity offers a short cut to a larger return without departing from conservative methods. There are many people whose capital has been severely depleted by the investment reverses of the last few years. If they are young enough, there is still time to recoup; but if they are past middle age, time alone is a tremendous barrier to recovery, and, to them, the value of the annuity is something in the nature of a godsend.

Consider the case of a man who is seventy years old, whose earning power has ceased, who has $10,000 of savings, and who requires $1000 a year on which to live. No conservative bond investment will produce the income which he needs with real dependability beyond the normal 5 per cent rate of $500 a year. He can, of course, eat into his principal to provide the annual sum he needs, but each bite must be larger than the last to offset the diminishing income. If he dies soon enough, he escapes disaster, but the dread of this result can scarcely be conducive to a happy old age. Now an annuity at his age will return at least $1000 annually, guaranteed for his entire lifetime. He need not, and should not, be concerned about his capital — what he wants, and gets, is the annual return he must have, at the time he needs it the most, plus the comforting assurance that it will never fail him.

There are several fairly definite misconceptions of the annuity which ought promptly to be dispelled. For example, there is the widespread belief that if the annuitant should die prematurely (before his return equals his original deposit) the remaining funds revert to the issuing company. Annuities can be, and frequently are, written this way, but only because the annuitant demands the higher return which this method provides. Suppose that the seventy-year-old annuitant previously referred to had no dependents at all, and needed the largest return he could get. Would he not be better off with a life annuity which returned nearly $1300 annually, all his life, but ceased absolutely upon his death at any time, than with a refund annuity which returned $1000 annually all his life, but also refunded any unused part of his deposit at his death to someone else who might not need it then nearly so much as the annuitant did while he lived?

Suppose, however, that this man has a daughter as his heir. In this case, the choice of types is reversed, since he certainly would want his daughter to receive any unused portion of his investment. Or again, suppose that this man’s wife, of similar age, is also living. He will then want a joint annuity, which will return about $900 a year as long as either he or his wife lives, thus providing the maximum return for them both, even though the death of the survivor of these two ends the contract absolutely. These examples in no sense exhaust the annuity’s possibilities — they merely suggest its adaptability to different conditions.

Many people also feel that an annuity is something which requires the immediate deposit of a substantial sum of money, so that it is only available to comparatively rich people. This unfortunate error has no foundation in fact. In the first place, an immediate annuity (one whose return starts within one year) may be purchased for $100(1, and certainly possession of $1000 is not limited to wealthy people. In the second place, there are annuities available under which the funds necessary to obtain a stated return later may be accumulated by annual savings with the life companies of as little as $25. So much for the myth that annuities are only for rich people. Then there are those who believe that one should be old in years before an annuity becomes appropriate, with perhaps much the same reasoning as that which used to hold that old age was a prerequisite to embarking upon the game of golf. It is true that ripeness of age increases the annuity’s fixed return, but these very passing years with which age is achieved may themselves be employed in accumulating with the life company for a return to be used when the retirement age comes. Even with immediate annuities, at as young an age as forty (male), a refund annuity (guaranteeing the return of all the principal in any event) produces about 5.75 per cent annually, guaranteed for life. At ages of fifty, sixty, and seventy, its return is about 6.60 per cent, 8 per cent, and 10 per cent respectively. The older the annuitant is when the return starts, the greater the return; but on the other hand, the older the annuitant, the shorter becomes the time in which he can enjoy it. There is a happy medium somewhere within these limits which each individual can identify as appropriate for himself.

Annuities may be obtained without physical examination, since no life insurance is involved, and of course they are available to women, although their return is less than that for men, since women annuitants live longer than men. In touching upon this element of expectancy of life, it is interesting to note that annuitants as a group live longer than any other class of people; and it is not too much to believe that the financial peace of mind which the annuity confers upon its owner doubtless contributes to this greater longevity.