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Imagine a retirement-savings well that never runs dry, no matter how long you live. If that's the dream of future retirees, why are annuities, which make that very promise, such a minuscule part of our collective nest egg?
This so-called annuity puzzle has baffled academics, policymakers and financial advisers for decades. Now, as more retirees shift their focus from accumulating assets to spending them, solutions to the puzzle may finally be emerging.
In exchange for a lump sum, annuities guarantee retirees regular payments for the rest of their lives. Sounds attractive, but investors have long shunned annuities, citing high fees, low returns and the inability to bequeath the money to heirs. Worst of all, there's the "bus" risk -- that is, the chance of getting hit by one, or meeting some other untimely demise and not getting your money's worth.
"I've explored all the perfectly rational reasons people don't like annuities, and I've concluded there's something more fundamental," says Jeffrey Brown, a finance professor at the University of Illinois. Namely, he says, we're trained to think in terms of accumulating wealth, with a focus on rates of return, market risk and the like. As an investment, an annuity just doesn't stack up.
But if your objective is to ensure enough money to live on no matter how long you live -- think consumption instead of accumulation -- then an annuity is a no-brainer. "I just tell clients that they're buying their own pension," says financial planner Jim Saulnier, in Fort Collins, Colo. "That grabs their attention."
In a world with fewer corporate pensions, longer retirements and substantial 401(k) balances, annuities should loom large in most retirement plans. Borrowing from the playbook of the 401(k) industry is the way to make that happen, says a group of researchers at the Retirement Security Project in Washington, D.C. The group is pitching a plan to employers that would let retirees "test drive" an annuity by automatically channeling a portion of 401(k) assets into one at retirement, similar to the way many workers are automatically enrolled in 401(k) savings plans at the start of their career. After two years, retirees could opt out.
Specifics -- such as how much to put into which type of annuity -- would vary. In general, Saulnier suggests putting no more than one-fourth to one-third of your portfolio into an immediate annuity, or just enough to cover required expenses. He rarely chooses inflation protection because the monthly payout is so much lower it takes years of inflation adjustments to catch up. He does recommend a "period certain" feature -- meaning that if you die before a certain cut-off date, your heirs will receive annuity payouts until the cutoff. Check annuities and their prices at www.immediateannuities.com.
If you designate less for an annuity -- say, 10% to 15% of your portfolio -- then a longevity annuity may be a better choice, says Jason Scott, of Financial Engines. Because payouts don't start until later in life, perhaps in your eighties, longevity annuities cost less to purchase. Plus, with the worry of outliving your money off the table, these annuities let you spend more freely in retirement. And isn't that what we're all saving for?
POSTED BY: NJMC_CFP (September 07, 2008 11:58 AM)
With the exception of Jason C, most of the comments here are nonsense. The simple (& low cost)immediate annuity (not any VA or EIA with their high costs and commissions)is the perfect product for most of the fixed income portion of a retirees portfolio. It's simple, an 8 - 9% payout on the annuity beats your common garden variety Treasury or Corporate bond for cash flow hands down. That cash flow enables you to have more stocks in your portfolio and not be forced to sell them for cash flow when the market is down. This combination has proven successful during all of our great bear markets ('29, 73-74+ and 2000 to 2002). If one wants to have a better chance of a long & succcessful retirement spending 5% of assets instead of 4%,(25% more), use immediate annuities. If not, don't buy them and hope for the best. Its your choice. For me buying 3 SPIAs (limited to $150K for state guarantee funds)combined with a pension with "retirement" in '99 allowed me to coast thru the '00-02 bear market and be up in assets and income by 50% since then. Don't knock something until you have researched it in detail. These academics have no axes to grind and they agree with my experience and research.
POSTED BY: hm (September 09, 2008 08:06 AM)
Like others I have always seen annuities as a great way for insurance companies (and their agents) to bilk the public. But it occurs to me now that for people like me who haven't had the advantages of IRAs, 401Ks or other tax sheltering plans, the tax treatment seems helpful, maybe going some good way toward making up the difference between the annuity's low return and the return you would get in a conservative portfolio of other investments. If this thought is wrong, I would be happy to hear why. It occured, too, that outside of relying mostly on bonds, it would be clumsy trying to sort out an even monthly income stream. I assume that there are funds that do this, but I don't think there are many, and from what I've seen they don't pay very well either. So it seems like if you want to keep the larger portion of your investments in equities, the annuity could provide regular income without the need to sell small tranches of assets, and again saves creating tax events.
POSTED BY: DW (October 06, 2008 02:11 PM)
NJMC_CFP - I generally agree with your comments and, in fact, have long planned to employ that sort of strategy for retirement. However - I do have a question - do you really have strong data supporting the strategy from the 1929 period? Or are you employing hypotheticals? Thanks.
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