Financial Opinion and Insights

Why Buy An Annuity? Build Your Own!

Jim Lorenzen, CFP®

Jim Lorenzen, CFP®

You’ve heard the annuity pitch.  It says you can participate in market gains while being protected against loss!  You can do the same thing! 

Are insurance companies able to invest in some hidden market that you can’t access?   Of course not.   They access the same markets you do; so, why pay them to do what you can do yourself?

This is a nifty little strategy I learned when I first entered the investment business twenty years ago.   Last week  I saw an article in Financial Planning magazine that reminded me of it and I thought you’d like to see how it works.

In all fairness, there may be one reason to purchase an annuity, but I’ll get to that later.  For now, here’s how you can create your own.

I’ll use round numbers to make it easy.   Let’s say you’d like to invest $100,000.  You’re willing to pursue a strategy that allows you to invest some of it in the market, but you want a guarantee you won’t lose your $100,000 at the end of five years.

First let’s guarantee the $100,000

According to Bloomberg, as I write this, the 5-year U.S. Treasury is yielding 2.25%.  You can check current rates now.

What amount do you have to invest in 5-year Treasuries today at 2.25% so that the bonds will mature at $100,000 five years from now?  According to my trusty HP-12C, it’s $89,471 – I won’t bore you with the pennies.  You put the other $10,529 into stocks or something that replicates an index, like an S&P 500 Index fund or ETF (you can’t invest in an index itself). 

Now, let’s face it, anything can happen in the stock market.    Here are three hypothetical outcomes – the real world is bound to be different:

  1. You lose half your money.  You get $5,264 back from your stocks.   You end-up with $100,000 from your treasury + $5,264 from stocks:  Total: $105,264.   Not very good, but at least you have your money with a little profit.
  2. Your stocks go nowhere.  You end-up with $100,000 from your Treasury and $10,529 in stocks:  Total: $110,529.  Still not great, but you did average 2.2% per year on your money.
  3. Your stocks go up.   Let’s not talk about doubling your money.  Let’s assume 9% a year – an assumption everyone on the planet thought reasonable until the `meltdown’ of 2008 destroyed all the averages.   At that hypothetical rate – who can predict? – you’d end-up with $16,200 in stocks to add to your $100,000 in maturing Treasuries.  Total: $116,200 – you would average 3.05% per year.


Not bad, considering you’ve eliminated your risk of loss!

“But Jim”, you say, “Annuities are tax-deferred!”  

Yes,they are.  But, when you take your money out, it’s taxed at ordinary income rates!   Stock dividends get favorable tax treatment.   Not only that, but if you die first, the cost-basis is stepped-up for your heirs!   Hmmm.

Insurance companies can go out of business, too!  I like the Treasury `guarantee’ better –  I use quotes only because the word `guarantee’ doesn’t appear anywhere on a Treasury or any other government note, bill, or bond.  The wording is, `backed by the full faith and credit of….’.   Nevertheless, it’s a better guarantee.  We’re not Greece, yet.

Now, my little strategy discussed above does not take into account taxes or inflation – the latter being the huge, hidden tax ignored by too many people.   So, you shouldn’t pursue this, or any other, strategy without discussing this with your advisor first.

Okay, so why would someone want to buy an annuity when they could just do it on their own?  There might be one good reason.   The insurance company will do it and often the investor won’t.  What I mean by that is individual investors often lack discipline.  They’ll begin a strategy, but they don’t stick with it.  They hear a new story or investment idea and are prone to change horses prematurely.  The insurance company will see it through; and will likely charge the investor a surrender charge for leaving early – sometimes those nasty things do serve a purpose.

The drawback:  Investors shouldn’t purchase anything unless you know how it fits-in with an overall plan!   

Success always begins with a plan.   I’m here to help and I hope I can help you; but, if you want to find someone else, you might be able to find the right professional here.



Jim Lorenzen is a CERTIFIED FINANCIAL PLANNER™ and in his 20th year of private practice as Founding Principal of The Independent Financial Group, a fee-only registered investment advisor with clients located in New York, Florida, and California.  He’s been a headline speaker at conventions throughout the United States, Canada, and the U.K. and has appeared in `The Journal of Compensation and Benefits’, as well as in The Profit Sharing Council of America’s `Insights’.    Jim has also appeared on American Airlines’ `Sky Radio’, heard on more than 19,000 flights.  IFG does not sell products, earn commissions, or accept any third-party compensation or incentives of any description.  Nothing contained herein should be regarded as tax or legal advice and the reader is urged to seek competent counsel to address those issues.   The above represents the author’s opinion and should not be regarded as investment advice which is provided only to IFG clients upon completion of a formal financial and investment plan.   For questions or comments, you can reach Jim at 805.265.5416 or through the IFG website, http://www.indfin.com.