Retirees: Don’t Overlook Annuities. Really.
September 21, 2018 by Steven Goldberg
Most investors have grown to hate annuities. Hate them too much, in my view. In fact, if you’ll read on, I think you’ll agree that annuities make abundant sense for many retirees.
My inbox used to be flooded with offers from annuity providers: “Sell these to your clients,” the advertisements boasted, “and earn fat commissions, often as high as 8%.”
But the word is out. Most annuities are far too expensive, far too complex and mostly just bad products to be sold to investors.
Nobody wants them anymore.
ut here’s the thing: For many seniors in retirement, one simple type of annuity – an immediate fixed annuity – can help solve their retirement income problems.
The Immediate Fixed Annuity Explained
An immediate fixed annuity is the most straightforward kind of annuity. You give an insurance company a lump sum and they send you monthly checks for life. “Those have been around now for thousands of years,” says David Blanchett, head of retirement research at Morningstar, and an advocate of annuities.
Here’s an example. If a 70-year-old retired man invests a lump sum, say $100,000, into an immediate fixed annuity with an insurance company, the insurance company will pay him about $7,740 annually for the rest of his life. If he waited and started at age 75, he could earn about $9,348 annually for life.
There’s a catch — of course.
Suppose our annuitant signs up for his lifetime income, then drops dead the next day. His family doesn’t get a nickel of his $100,000. The insurance company pockets the whole hundred grand.
Insurance companies have tinkered with annuities to come up with something more appealing to investors. Most annuities now come with payouts guaranteed for at least 10 years — even if you die sooner. Others guarantee payouts for as long as either you or your spouse is alive.
These make immediate annuities easier to sell. But they also decrease the size of your monthly annuity checks. Most people, I think, should just buy the simplest immediate annuity — and take care of family members with other funds.
Other Ways to Use Annuities
The insurance company, in figuring how much it can pay you in an immediate fixed annuity, considers two things: long-term bond yields and mortality tables.
When you buy an annuity, the insurance company buys bonds to cover its lifetime obligation to you, but the total payout depends on how long you live. I think it’s helpful to think of these annuities as reverse life insurance: The longer you live, the bigger your return from an immediate fixed annuity.
For most investors, annuities may make sense for a portion of their fixed-income investments. Blanchett says you should consider how much of your retirement income already comes from defined benefit plans, such as Social Security and pension plans. The less you have in such defined plans, the more sense it makes to put a significant amount into an annuity. After all, annuities pay a lot more than all but the riskiest bond funds.
But income annuities also can make good sense for retirees who are at risk of running out of money. Typically, retirees are advised to withdraw 4% annually plus an annual cost-of-living adjustment from their investments. But for many folks, that’s not enough to live on. That makes the higher guaranteed returns from annuities extremely attractive, although most don’t offer cost-of-living increases.
There’s still another good way to use annuities: longevity insurance. Typically, financial planning software (and planners) estimate how much you can withdraw each year to live on in retirement based on your living to age 95 — even though most people won’t live that long.
With a longevity annuity, you typically invest a lump sum at age 65, then begin receiving payments at age 85. Because the money has 20 years to grow, and because many people don’t live to 85, a relatively small investment in a longevity annuity can make a big difference if you live into your late 80s. And if you don’t, you’ll have been able to spend more money from your investments while you’re alive — because you don’t need to budget for living beyond 85.
A 65-year-old man would need to invest just $40,000 to guarantee $12,000 in annual income for life starting at age 85. A 65-year-old woman would have to invest a bit more than $45,000 to guarantee the same lifetime benefit. Women, of course, live longer than men, on average.
Steve Goldberg is an investment adviser in the Washington, D.C., area.