Jeanie wasn’t a planner. She had a Master’s degree in education and could have settled down with a career in teaching. But adventure called and, instead, she spent her twenties and early thirties as a waitress on a cruise ship. After that, she took a more conventional job managing large apartment complexes. Jeanie was good at it, was making decent money and expected to retire with her third employer. Unfortunately, when Jeanie was 55, her owner/employer died suddenly and his son, who inherited the property took over. Jeanie had never bothered to become proficient with a computer. She had always left tasks involving technology to her younger assistant manager. The son, having recently acquired an MBA, was all into efficiency. He fired Jeanie and promoted the computer-savvy assistant to Jeanie’s position.
Jeanie tried to retrain, but she was never able to regain fulltime employment and soon found herself dipping into her meager retirement savings. By the time she was 65, her health had deteriorated and she was no longer capable of working a 40-hour week, even if she could have found a job. Desperate to provide an income stream to supplement her Social Security, at age 69, Jeanie took almost half her savings - about $32,000 - and purchased an annuity. The annuity paid her $162.00 a month.
Six months later, Jeanie panicked, believing she had made a mistake. She figured she would have to hire a lawyer to get out of the annuity and was worried how much that would cost. What should Jeanie do?
Should Jeanie Hire a Lawyer?
Jeanie doesn’t need to hire a lawyer to get out of the annuity. She doesn’t even need a financial planner to determine whether or not she has made a good decision in purchasing the annuity. First, she needs to read her annuity contract and determine what the penalty would be for canceling it. Then she needs to do a bit of math.
What Return Will Jeanie Receive on the Annuity She Purchased?
First of all, Jeanie should calculate how many years it will take to recover her $32,000 at $162.00 a month or $1,944.00 a year. Jeanie figured it will take 16.46 years, at which time she will be 85. Next she needs to determine her potential life span. Her father died at age 98 and her mother lived to age 103. Her mother was extremely healthy, but her father had some significant health issues, including diabetes. The actuarial tables indicate that, statistically speaking, Jeanie is likely to live to be 100. If she does, she will have earned $25,272.00 more than the annuity cost her.
What Return Would Jeanie Receive on a CD Over the Same Period?
Jeanie then needs to estimate the amount of interest she could make on the $32,000.00 if she purchased a certificate of deposit (CD). Currently, she found could earn 2.35% annual interest on a 5-year CD. Using the Bankrate interest calculator, Jeanie gauged she would earn $8,367 in 10 years, giving her a total of $40,367.00. During that time period the annuity would have paid $19,444.00, but she would have no cash in hand, only the potential continued income stream of $162.00 a month.
If Jeanie earned the same 2.35% annual amount for the next 20 years, her 30-year return on the CD would be $25,101.00, which is just shy of her return on the annuity for that period. If interest rates rise over this time period, Jeanie would fare better than the annuity. And the biggest difference is that she will still have her initial $32,000 as well with the CD.
What Other Factors Must Jeanie Consider in Choosing An Annuity Versus a CD?
In her twenties, Jeanie was something of a spendthrift. If she has not changed her habits to spend more prudently, she may be better off with the annuity. With this investment, she would be protected against impulsive expenditures that would shrink her nest egg and, thus, reduce its return. If she chooses the CD, she will have to be disciplined or her investment will disappear. Of course, she will have to take out some of the money over the years, so she has to consider that. However, if the money is in an IRA, she will not be penalized if she takes the Required Minimum Distributions (RMD) each year from the CD.
Many Seniors Face This Decision
Many seniors are faced with the same annuity versus CD decision. Whether the amount of savings is small, as were Jeanie’s, or much larger sums, the analysis is the same, and the decision just as hard to make. Neither outcome is perfect. Had Jeanie planned better and been able to save more, she might have had more options for investment. Given her meager savings, stocks and bonds, which fluctuate in value, would not be a wise option for her. She will need every penny.
Sandra W. Reed is an attorney with Katten & Benson, an Elder Law firm in Fort Worth. She lives and practices in beautiful Somervell County, near Chalk Mountain