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Why Accountants Have Trouble Understanding Annuities

Written By: Larry Klein in Walnut Creek, CA

I am a CPA (inactive) and fortunately also able to think outside the box.

Many accountants think of investments only in terms of their Internal Rate of Return (IRR). The IRR for an investment takes into account:

  • The amount you receive over the period you own the investment
  • The amount you get back at the end

Life annuities do not have any payment at the end as the payments cease at death.  The IRR of a typical life annuity is not very good, maybe 2% annually and for this reason, is disfavored by accountants.  But they don’t get it.  Life annuities have the highest cash payout of any investment offering the same level of safety.  Depending on age at inception, life annuities have typical annual cash-on-cash payouts of 6% to 10%.  No other investment offers this combination of guarantee by the insurer and the high cash payout.

The only time that life annuities fail to be attractive is at death as the payments stop.  But I have not yet met anyone who will need cash when they die.  So unless an investor has a very significant need to put their heirs above themselves in their financial picture, I suggest that life annuities be given a very strong look to help the underfunded retirement plans of millions of retirees.

About the Author: Larry Klein is a retired financial advisor, retired CPA (inactive) and holds an MBA from Harvard Business School.  He is an author, retirement expert and publisher of the Retirement Blog for people age 50+ and the Wealthy Producer for financial professionals.  He speaks frequently at industry events.

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12 Comments

  • Tom Grainger says:

    I certainly agree that CPAs almost never get it when it comes to annuities. I have several relatives that are CPAs and they don't get it either. They tend to buy in to the Mantra "A diversified portfolio of Stocks and bonds… Yada, yada,yada" Ive seen too many cases with massive losses in retirement portfolio could have been avoided with the addition of a significant allocation into Fixed Indexed Annuities coupled with Lifetime Income Rider. This would have provided much better protection for the client.. One recent industry study shows very clearly that the best portfolio was a mix of Stocks with fixed annuities with a lifetime Income guarantee.
    I can always sleep well at night because I don't risk my clients money!

  • John Olsen says:

    Larry, you nailed it! While the interest rate used in setting annuity payout rates may be 2%, the mortality credits can add a lot to the implied return – which can be, as you said, in the range of 6% – 10% (the older the annuitant, the higher the cash on cash payout.

  • Tom Grainger says:

    The attached article explains why many CPAs don't understand the benefits of Fixed annuities with lifetime income. it also helps explain how they think generally. I'd be surprised if 2 out of 100 really understand the great combination of safety, features and security that todays Fixed Annuity products offer. I am working with a couple of CPAs that do understand it.
    I'd be happy to talk with a CPA that does want to learn more about the current generation of products and the difference between the Variable Annuity product which get a lot of negative press and the Fixed Indexed Annuity products.

  • Larry Klein says:

    Thank you John. It's a good thing some of us get it and the good thing about CPAs is that while they may be mistaken in their views, they are typically logical and will readily digest a well prepared factual presentation.

  • Larry Klein says:

    You might want to develop a CPE class for CPAs (co-presented by one of the CPAs who get it) "Multiple Misconceptions CPAs have About Annuities for Retirement Security."

    • Laura Hisey says:

      I am a CPA who works with a seller of fixed indexed annuities. I had no clue about them before I began working with them. We have discussed offering some sort of seminar for CPAs that will educate them on the value of this product to many of their clients. If you develop such a CPE course, I would love to get more information on it.

  • Rob Klein says:

    If I had a dollar for every time I said, an annuity is about the cash flow – today, tomorrow, or way off in the future. It is not an investment. Yes, I know FINRA regulates the variable annuities. Some broker-dealers treat fixed index annuities as securities, even though they aren't. But annuities were created to be the opposite of life insurance. Life insurance protects your heirs if you die prematurely. Annuities pay you if you live to a ripe old age.

    Most people don't have a pension. They didn't plan well for retirement. An annuity, in addition to Social Security, may save many seniors.

  • Rob Klein says:

    If I had a dollar for every time I said, an annuity is about the cash flow – today, tomorrow, or way off in the future. It is not an investment. Yes, I know FINRA regulates the variable annuities. Some broker-dealers treat fixed index annuities as securities, even though they aren't. But annuities were created to be the opposite of life insurance. Life insurance protects your heirs if you die prematurely. Annuities pay you if you live to a ripe old age.

    Most people don't have a pension. They didn't plan well for retirement. An annuity, in addition to Social Security, may save many seniors.

  • There is a big "however." Most annuities are extremely vulnerable to inflation.

  • Rob Klein says:

    You aren't buying the annuity for inflation protection, although some have benefits to address that. Annuities are for the cash flow. You also don't put your entire nest egg in an annuity. The equity markets, real estate, metals, etc. will be the place to look for inflation protection.

  • Drew Denning says:

    I’m a bit disappointed that CPA’s are being painted with such a broad brush on not understanding annuities. As John points out in his message, mortality credits have a definite impact (especially for individuals purchasing one at a more advanced age). After a 2 minute conversation, my wife (a CPA) understood the concept. However, it has been more difficult to explain this to individuals who just sell stocks/bonds as there does not appear to be any recognition (my personal opinion) of what mortality credits are.

    • Larry Klein says:

      No intention to use a broad brush except when warranted. Having been a CPA, I find that many reject ideas without fully understanding them. Additionally, having been an advisor, I know that many advisors are fearful of ever involving CPAs as they are prone to nix ideas that are knew to them. So my comments in the post were just reflecting my experience and the experience that others have shared with me.

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