We talk with a lot of people who come to us seeking advice about using annuities.
We get why annuities can be attractive: they’re usually presented as being low-risk, reliable sources of retirement income. In the not-too-distant past, people had pensions through their employers — monthly income they knew they could count on when they no longer earned a paycheck. As pensions become less common, annuities have become a popular way to replace that income stream. But for most people, they’re a terrible idea.
First, let’s look at how annuities work: When someone buys an annuity, a vendor (typically a large insurance company) contracts to pay the purchaser a stream of cash payments for the remainder of their life, usually beginning at retirement. The annuity may be level, may increase at a fixed rate, or may be linked to an inflation index. All of these options are, of course, reflected in the annuity’s initial pricing.
Some financial advisors push hard for their clients to purchase annuities. One reason for this may be that annuities pay notoriously high commissions to the advisor who sells them. Even if they tell you they don’t charge a fee for an annuity, they are most likely making a commission on it. And why are annuity vendors willing to pay such high commissions? It could be because they’ve calculated their odds and believe they’re going to make money on the deal — which means they believe they’ll make money off of you.
There are two primary reasons someone might be tempted to put their IRA dollars into an annuity. First, they can take advantage of annuitization, which is that stream of income that is guaranteed to last a set period of time, sometimes for life. Second, if they put their IRA money into certain variable annuities, they may be able to get a death benefit guarantee.
However, there are strong arguments against putting IRA money into an annuity. First, both IRAs and annuities are tax-deferral mechanisms. If you are already deferring taxation by setting up an IRA, you gain no further tax advantage by investing in an annuity. It’s kind of like using an umbrella inside your house when it’s raining. Second, with annuities, you are required to pay a mortality and expense fee (generally one percent of your investment) along with an annual contract fee. These fees are in addition to any fees you may be paying for your IRA itself. The resulting combination of fees eats substantially into the growth of your investment over time.
For Muslim investors, there’s an additional reason to avoid annuities. Ultimately, annuities are insurance contracts, which contain two features that Muslim scholars have deemed impermissible: excessive uncertainty and gambling.
Gharar (excessive uncertainty): People purchasing annuities generally do not know how much longer they will live (known as “longevity risk”), nor do they necessarily understand the details of the exchange. Scholars say that both of these factors represent gharar.
Maysir (gambling): Longevity risk also introduces a level of risk that could make the purchase of an annuity a form of maysir. In a sense, the annuitant is betting that they will live longer, while the issuer of the annuity is betting on early death.
The uncertainty and gambling aspects offer financial arguments against annuities that may resonate with many people, regardless of their religious affiliation.
We hope you’ll keep these points in mind the next time someone tries to talk you into an annuity. And if you have any questions, feel free to give us a call at 888.86.AZZAD. Our financial advisors are available to walk you through halal options that can help you enjoy a comfortable retirement.