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Be Like Burt?

Dennis Friedman

I RECENTLY HAD LUNCH with four friends I’ve known since the seventh grade. Because of the pandemic, this was the first time we’d all seen each other in more than a year. Every time we’re together, I’m reminded of how important my friends were in helping me start a new life when I left home for the first time. Our continuing support for each other is probably the reason we’ve stayed close for 57 years.

At lunch, we spent a great deal of time talking about our health. It seems that’s the way it goes when a bunch of 70-year-old retirees get together. Burt, who is overweight and loves his beer, might be the healthiest of the group. He doesn’t take any medication and jokes that his diet consists primarily of junk food.

After a while, the conversation veered off into a discussion about money. Burt tells us that he doesn’t think he’ll run out of money. I don’t doubt what he’s saying. Burt worked in the aerospace industry and earned an above-average wage with excellent benefits.

You might assume he’s careless with money because of his undisciplined eating habits. But Burt was a good saver, which I’m sure was important in helping him achieve financial security. He and his wife still live in the same two bedroom, 840-square-foot house they bought in 1977. They raised two boys in that house, who shared the same small bedroom until the oldest left home.

Listening to him, what I found so fascinating is the amount of money he has in annuities. He’s a multimillionaire who has about half his money in income annuities and the other half in stocks. He has no bonds in his investment portfolio. With this strategy, he’s confident he’ll never outlive his money, while leaving a legacy for his children.

That got me thinking: Should my wife and I put our retirement money in income annuities rather than bonds? With a lifetime income annuity, you give money upfront to an insurer, which then provides you with guaranteed income for life. The insurer might start paying that income right away or at a predetermined date in the future. The payments are fixed. The amount is based on your current age, the age at which you start receiving income, your gender and the amount of money you invest.

Two of the most common annuities are immediate fixed annuities and longevity insurance. These are the two types that Burt and his wife own.

An immediate fixed annuity, sometimes referred to as a single premium immediate annuity (SPIA), is the simplest annuity you can buy. Based on how much money you give an insurer today, you receive a monthly stream of income for life.

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Longevity insurance, also known as a deferred income annuity (DIA), is designed for people who want income starting at a predetermined future age. The initial investment might be made up to 40 years before receiving income.

I would never do what Burt did and have all our fixed-income money in annuities. I wouldn’t want to lock up that much of our retirement money in something that’s illiquid and doesn’t provide a high rate of return. That said, I could see buying an annuity that would bridge the gap between what we get from Social Security and what we spend on nondiscretionary expenses that we couldn’t live without, such as housing and food. That way, our basic retirement expenses would be covered for as long as my wife and I live, while allowing us to invest more heavily in stocks.

There’s another reason I think an annuity could play an important role in our investment portfolio. If we bought a qualified longevity annuity contract (QLAC), we could reduce the taxes we pay on our required minimum distributions (RMDs). A QLAC is a type of deferred income annuity that can be funded using an IRA or other pretax retirement savings plans.

Using IRA money to fund a QLAC reduces the balance subject to RMDs, resulting in lower taxes. Also, you don’t pay any taxes on the annuity money until you start receiving the income payments, thereby allowing you to continue deferring taxes.

I think these are good reasons to own an annuity. Still, after thinking it over, I wouldn’t buy one. I made one bet on my longevity by delaying Social Security until age 70. I’m not willing to place another bet by buying an annuity, especially when I’m convinced our stock and bond funds will provide us with a lifetime of income.

Dennis Friedman retired from Boeing Satellite Systems after a 30-year career in manufacturing. Born in Ohio, Dennis is a California transplant with a bachelor’s degree in history and an MBA. A self-described “humble investor,” he likes reading historical novels and about personal finance. Check out his earlier articles and follow him on Twitter @DMFrie.

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Michael Meyer
Michael Meyer
24 days ago

I really like QLAC’s because there is no loss of principal meaning if the QLAC does not pay out fully the difference goes to your beneficiaries (if you die) and you reduce your tax base (reduce RMD’s in retirement) and can be used for income later in life. This is the only annuity product that has made sense to me for the future.

Olin
Olin
1 month ago

Nice article Dennis. I’m always in the fog about annuities. Since Burt has two sons and wants to leave a legacy to them, would he need to have a Death Benefit clause in the annuities which has additional fee’s? Without a DB clause, doesn’t the insurance company then become the beneficiary?

Jonathan Clements
Admin
Jonathan Clements
1 month ago
Reply to  Olin

While you can get income annuities that pay something to heirs, that’s generally not the best way to go. Instead, with the “Burt strategy,” the goal is to use the annuities to create a lifetime stream of predictable income — and that you frees you up to invest your remaining money in stocks, which then turns into a substantial legacy for your kids, despite the money “lost” to the insurance company. This is a strategy I’m personally considering.

Rick Connor
Rick Connor
1 month ago

I spoke to an RIA recently and she said many of the firms she dealt with were getting out of annuities, or discussing it. Then I saw Principal is stopping selling LI and annuities.

https://www.google.com/amp/s/www.wsj.com/amp/articles/principal-financial-to-divest-business-of-selling-life-insurance-to-u-s-consumers-11624897984

Bob Wilmes
Bob Wilmes
1 month ago

Accord to this website (June 2019) for financial advisors, there is only one company in the United States that sells an inflation-indexed Single Premium Immediate Annuity (SPIA) and that is Principal Financial.

https://www.advisorperspectives.com/articles/2019/06/17/which-annuities-offer-the-best-inflation-protection

When I purchased a SPIA (a few years back), I found that the cost and monthly income are extremely sensitive to US Treasury 10 year bond yields.They can vary dramatically each day of the week.

You should consider that some portion of your retirement income will be indexed by Social Security COLA, and compare that portion to the portion coming from your SPIA. It doesn’t hedge the total income stream, but it will help.

Another option would be to purchase a qualified life annuity contract (QLAC) which reduces your RMD’s from a 401K/IRA, while deferring a higher income stream possibly later in your life when you need the additional income to offset inflation in the out years of your retirement.

Helpful Neighbor
Helpful Neighbor
1 month ago

Dennis I always enjoy your posts.

Philip Stein
Philip Stein
1 month ago

Immediate fixed annuities can provide greater income than similar bond investments because of mortality credits whereby annuity holders who die earlier than their life expectancy, fund higher payouts to those who live longer.

However, if insurers no longer offer inflation-adjusted, immediate fixed annuities, your guaranteed income today might be insufficient in the future if we experience a significant period of inflation.

Is it better to consider purchasing immediate fixed annuities when you’re in your seventies to mitigate the inflation threat?

mytimetotravel
mytimetotravel
1 month ago
Reply to  Philip Stein

I am in my seventies, but I am planning for another twenty five years, so I’m not ready to buy a SPIA. Certainly not in today’s environment.

parkslope
parkslope
1 month ago
Reply to  Philip Stein

You can purchase annuities with an inflation adjustment. You typically have to select a 1%-5% annual increase when you purchase the annuity so the increase may not correspond to inflation.
https://www.fidelity.com/annuities/immediate-fixed-income-annuities/compare

Another strategy to protect against inflation would be to purchase a series of annuities with different periods of delay.

Last edited 1 month ago by parkslope
Philip Stein
Philip Stein
1 month ago
Reply to  parkslope

I should have mentioned that I was referring to immediate fixed annuities with inflation adjustments tied to the Consumer Price Index. I believe these are no longer offered.

You’re right about annuities with payouts rising at a fixed percentage each year. But these don’t track the measured inflation rate so inflation protection is not assured.

mytimetotravel
mytimetotravel
1 month ago

One big problem with SPIAs – no inflation protection. I already have a pension with no COLA, I don’t want to compound the problem. I just read Wade Pfau’s book on annuities and it seems there are very few available with any kind of inflation protection.

R Quinn
R Quinn
1 month ago
Reply to  mytimetotravel

My pension is without a COLA as well. I hedge my bet by having dividend paying stocks and municipal bond funds I will be able to tap for additional income as needed. So far being retired 11 years that has not happened.

R Quinn
R Quinn
1 month ago

I’m guessing all those folks convinced their investments will provide a lifetime of income would avoid turning over a pile of cash to buy an annuity. It’s a tough call, but as someone living on a pension that more than covers my basic expenses, that stream of income is a good feeling.

Buying an annuity with a portion of investments is the opposite of taking a lump sum in lieu of a pension. I’ve seen that lump sum go wrong too often.

The reality in my view is that the less sophisticated investor who could benefit most from an annuity probably is also least likely to want to give up the cash.

I would like to see some form of an annuity accumulation fund within 401k plans where a portion of savings- perhaps only employer match – buys an annuity gradually over the years. Thus avoiding the need to make the cash payment decision.

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