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IN A RECENT ONLINE discussion, I compared the benefits of an immediate-fixed annuity with the 4% retirement-income rule. The 4% rule suggests that investors can withdraw 4% from a well-balanced investment portfolio in the first year of retirement, and then add annual inflation adjustments without fear of running out of money over a 30-year retirement.
Using the NewRetirement annuity calculator, I found that a 65-year-old man could purchase an immediate annuity for $1 million, with a 3% annual inflation adjustment, and receive initial income of $54,000 a year. This annuity would continue monthly payments to our 65-year-old’s heirs if he died before getting back the entire $1 million through annuity payments.
Compare that with the $40,000 initial payment he’d receive on the same $1 million using the 4% rule. While the 4% rule allows withdrawals to increase each year to offset inflation, it still offers less income and less certainty than the annuity. For many, I believe, the annuity’s guaranteed and growing income should be more attractive than accepting the risk that the 4% strategy won’t pan out.
But most people in the discussion group disagreed with me, and strongly so. The response—often repeated—was, “The insurance company may go bankrupt.” Yes, that could happen. But the fact is, only three to five annuity-issuing insurance companies have failed over the past 10 years. These were small companies you’ve likely never heard of. The exact number of failures is unclear because some of the insurers in question are still winding down their operations.
But while everday investors may worry that annuity insurers will fail, large corporations seem unconcerned. Several years ago, IBM bought $16 billion in annuities from Prudential Financial for its employees’ pensions. My former employer did the same this year for $2 billion. It’s fair to say that the chances of bankruptcy, if you stick with large insurers with a high rating for financial strength, are negligible.
The comments that really fascinated me were those who claimed that, by using the 4% rule, they’d never run out of money, even when retiring in their 50s. Some even claimed they would eventually have more money in their accounts than when they began withdrawals.
Dave Ramsey says you can withdraw 8% a year from a diversified portfolio with no problem. He bases this on his claim that the S&P 500’s long-term average annual return is 12% or so, which is a bit of a stretch for most historical periods. Then he subtracts 4% for inflation’s bite, giving him his 8%. Simple, right?
YouTube financial commentators jumped on Ramsey’s advice, calling out its flaws. It’s risky to assume you’ll get average returns when both inflation and stock market results vary each year, often significantly. Ramsey didn’t take into account what’s called sequence-of-return risk, the chance that consecutive losing years will put a big dent in a portfolio’s worth, even as your withdrawals continue unabated.
If an 8% withdrawal rate is a nonstarter, how about 4% instead? I recently spent a fun afternoon viewing YouTube videos about the 4% rule from a variety of “experts.” Youza. Many claimed the rule is no longer valid.
It should be 3%, or 5%, or 6%, these experts say. Just tweak your investment mix to achieve a higher return percentage, some claim, and then you can withdraw more. Meanwhile, a new Morningstar study says the 4% rule is viable once again. Interestingly, the IRS’s required minimum distribution rate also works out to about 4%. I guess that’s convenient at least.
It’s the unknowns that make projections of the right withdrawal rate about as accurate as the fortune teller in the carnival kiosk. The unknowns include your age at retirement, the market cycle during your retirement, the rate of inflation you experience and the results for your individual investment mix. There’s a reason they call these retirement success projections a Monte Carlo simulation: You spin the wheel and you take your chances.
How to cope with these unknowns? One person in the discussion group said he wouldn’t take withdrawals during a down market, but rather pull money from cash reserves. He said his cash assets are sufficient to pay for five years of his expenses. Sounds like a good plan, just not in the real world. While HumbleDollar readers may have five years’ worth of expenses stashed in money market funds and certificates of deposit, I doubt most retirees have that sort of cash sitting around.
One thing not mentioned by anyone is the discipline needed to follow the 4% rule or a similar approach. For instance, you aren’t meant to pull out a lump sum when, say, the old car irretrievably breaks down and you need to buy a new one.
Based on my experience working in retirement benefits, I tend to think in terms of average folk. These are the kind of people who at age 65 have $280,000 saved for retirement and no earthly idea what their Social Security benefit will be. Is this large segment of society equipped to manage a complicated withdrawal strategy? Do average folk understand the risks of having 100% of retirement investments in an S&P 500-index fund or—for that matter—100% in bonds?
If you’re going to bet your 30-plus-year retirement finances on averages and assumptions, I think more than one strategy is necessary. Here’s my suggested mix of approaches:
Richard Quinn blogs at QuinnsCommentary.net. Before retiring, Dick was a compensation and benefits executive. Follow him on X (Twitter) @QuinnsComments and check out his earlier articles.
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I do have an annuity. I bought it in my 20s. Too bad I didn’t have more money to invest back then! It was a charitable gift annuity and my wife still receives the payments.
As I read the article and numerous comments, it strikes me that buying an annuity has many things in common with hiring an investment advisor, with the exception that company providing the annuity is taking the risk (for guaranteed or fixed annuities.)
As Richard and others have reminded us, many people either hire an investment advisor, buy annuities, or both, and they have good reasons.
For me, surprise, surprise, annuities are like their cousins, insurance–something to buy only when I can’t manage the risk myself, since the broker/dealer/company has to make a profit to do it for me.
With that in mind, one disadvantage (okay, once in a while it’s an advantage) is that once purchased, annuities can’t (easily) be sold. They are lifetime contracts. My father, however, used this to our benefit (maybe accidentally?) by purchasing annuities when he was dying. Fortunately they guaranteed return of principal, so we got that back (and annuities are usually guaranteed issue, no health exam required.) Whether it was the cancer or the cancer meds, he was especially susceptible to sales pitches in those terrible years.
I could not disagree with this article in stronger terms. Annuities are sold, not bought. Anybody is the business knows that. That’s why insurance companies have glass towers in the toniest areas of major metropolitan cities.
In addition, all you need to do is look at late 08 into 09 to see what can happen to insurance companies listed on the NYSE. Many were on the brink of insolvency, AIG by far the largest. Just google how many insurance companies have declared bankruptcy. You’ll be surprised. If they go under, you lose all of it.
The S and P has returned 7.9% over the last 30 years, and 7.2% since 1957. If you feel the need to play it extra safe, keep a combination of bonds and cash. I have not held bonds until recently, it was a loser as an investment. I keep 2 years of cash on hand.
Many people will lower their spending in a down year. I prefer having 2 -3 years of cash on hand. I do understand many are not able to do this.
I would like Humble Dollar to take a poll of writers on this site who are registered brokers and ask their opinion of annuities. The only people I know who recommend them are people who sell them.
https://www.atlas-mag.net/en/article/bankruptcy-of-insurance-and-reinsurance-companies-in-the-usa
Based on this article, your premise is off base. The vast majority of Insurance Companies having filed for bankruptcy in the past 30 years have NOT been annuity issuing Life Insurance Companies. Instead, they have been Property & Casualty companies.
Your statement, …”if they go under, you lose it all…” is either misinformed or purposely misleading, indicating a lack of knowledge or understanding of the purposes for State Guaranty Associations. All 50 states have such an association and most states protect individuals for up to $250-$300K in annuity holdings. A smart consumer will buy their annuities from strong carriers with substantially histories of claims paying and fiscal stability, and will kept the amount purchased from a single carrier under the state maximum.
As to the return historically, of the S&P…
The average investor regularly fails to benefit from investing in the S&P because of behavioral finance miscalculations. When the market is volatile, the average investor retreats to the “safety of cash,” a critical mistake. See the following breakdown of the S&P and its performance. The longer the period of time, the greater the likelihood of positive performance by an investment in the S&P, as long as you stay invested. Timing the market is not an option if you want to realize the best results from an investment in the S&P.
https://www.capitalgroup.com/individual/planning/investing-fundamentals/time-not-timing-is-what-matters.html
Now…as to the viability of annuities as a part of a retirement portfolio…
There are NO…repeat NO…investments that can guarantee a stream of income, with or without a COLA…in the investment arena, except for annuities. And even then, technically annuities (unless they are Variable annuities) are not investments. Annuity are insurance products, and the only products that have a feature known as morality credits. If you understood annuities, your comment would have been more nuanced. You may choose to hold annuities in distain, but that is your choice, and based on the sales of annuities in 2023, there are millions of Americans who decided to make a different choice than you have.
I was one of them, and again, contrary to your stated opinion, “The only people I know who recommend them are people who sell them.” I do not sell them. I have authored/edited a text book on annuities (among others) however, and I recommend them frequently. But then again, you don’t know me, and you did say “The only people you know…”
Annuities are financial tools. NO OTHER FINANCIAL TOOL can do what they do. They have been around since the days of the Roman Legions, and millions of Americans cash annuity checks everyday. You are entitled to your own opinion, but not your own facts, and the facts are simply that annuities are the only financial tool that can guarantee a stream of income for the rest of your life, or for a specified period, depending on which of the many different kinds of annuities you decide to own.
We are talking immediate annuities only here. I don’t think your views are supported by relevant facts with regard to those types of annuities.
Great article, Dick. In addition to the suggestions you outline for implementing this plan, I’d add that it may be appropriate for the investor to adjust their asset allocation (reduce fixed-income holdings while perhaps increasing risk-asset/equity exposure). That’s because the annuities are effectively a never-ending bond ladder.
Someone I know in the DC suburbs of Maryland was making around $110K when they retired at age 65. They get about $32K a year in Social Security and found they needed only to draw $10K/year from their $1 million IRA to live without scrimping.
This was possible because their mortgage was paid off. Housing typically accounts for over 40% of total expenditures in the Consumer Price Index.
Now they have to take RMDs and their income is $70K. What they don’t spend gets saved in a taxable account.
I believe the greatest factor in determining what percentage of your income that SS will replace is based on when you decide to claim your benefit. Per the Social Security website if you claim at 62 vs 70 your benefit will be reduced by 43.5%. They give as an example $700 vs. $1,240 per month.
While an annuity may be right for some people under certain circumstances, no one should ever sink $1 million into one.
State guaranty associations protect annuity owners if the issuing insurance company becomes insolvent. Most states have annuity coverage limits of $250,000.
If you are foolish enough to sink $1 million in an immediate annuity, split it up between four insurance companies, so you are covered even if all four of them went bankrupt.
It’s funny how people worry about insurance companies going under but will invest their money in companies like Vanguard, Schwab, and T. Rowe Price where there is no insurance to protect you if they go kaput.
Regarding Vanguard, Fidelity, Schwab, etc.
isnt that what SIPC is for? My understanding is that my holdings (not their value) is covered by SIPC insurance.
A TIPS ladder can offer a secure source of inflation protected investment.
https://www.morningstar.com/personal-finance/how-build-tips-ladder
Here is a great website to help build a TIPS Ladder…
https://www.tipsladder.com/#aW5jb21lUmVxdWlyZW1lbnRLaW5kPUF2ZyZmaXJzdFllYXI9MjAyNSZpbmNvbWU9MjAwMDAmeWVhckNvdW50PTIxJmJvbmRDaG9pY2VGb3JHYXA9TmVhcmVzdEJvbmQmYm9uZENob2ljZVdpdGhpblllYXI9QmVzdFlpZWxk
Thanks for this link! Very helpful.
Split it up indeed, but $1,000,000 is not crazy depending on total assets. The amount depends on total assets.
Thanks for the thoughtful article, and I’ve also enjoyed the lively discussion in the comments.
William Bernstein’s name comes up a few times in these, and having both listened to his latest interview from the Bogleheads conference and read the newly-published revised edition of “4 Pillars of Investing” I agree with his argument that a TIPS ladder is far superior to annuities of any kind for most investors.
Morningstar’s John Reckenthaler has written about this a good deal of late, and IMHO this article by him, which discusses combining a TIPS ladder with a modest allocation to equities, ought to be required reading for anyone considering fixed immediate annuities. Yes a TIPS ladder requires more work to set up (though the tipsladder.com tool makes it do-able in an hour or so), but once in place there are zero worries about the things that any annuity investor has to be concerned with for the rest of their lives (namely inflation and the viability over several decades of the insurer to whom they’ve surrendered their life savings).
https://www.morningstar.com/bonds/high-tips-yields-are-retirees-best-friend
Social Security and IRA/Pension distributions are not taxable in PA. Several articles and the state website led me to believe that annuity payments are taxable. Do you have information on this issue?
The PA state website has updated information now.
This is what I found:
If you invested in a retirement annuity that is not part of an employer-sponsored program or a commonly recognized retirement program, you have Pennsylvania-taxable income when you begin receiving annuity payments. You must report the difference between the amount you receive and your previously taxed investment as taxable gain on a PA-40 Schedule D, Sale, Exchange, or Disposition of Property. If you receive periodic payments, you use the cost-recovery method to report the taxable gain.
AIG is not a tiny company none of us know about. The gov’t bailed them out to the tune of $180B. What if they weren’t bailed out? But I don’t know if they were responsible for retail annuities. But it does make me worry as more than half our retirement $ are in a single annuity due to a work retirement plan. We hope Prudential is too prudential to fail.
On the other hand, my parents bought an annuity in 2013, as you suggest, when interest rates dropped. They missed the run up in the stock market, but my mom has gotten monthly payouts that exceed anything she could have gotten anywhere else.
Annuities are definitely a major piece of a retirement package. Don’t stop promoting them.
Great discussion with very intelligent thoughtful people.
I can still invest in Vanguard Federal MMF at 5.32% compounded. I will ride this horse a little longer waiting for the World to go Mad again to re-invest.
I have a personal story that illustrates a benefit of immediate annuities that I rarely see discussed.
My grandfather was a hard worker and a saver who lived frugally and accumulated a good amount of retirement savings that he self managed. He made emotional decisions and pulled his money out of the market in the crash of the early 2000s. He then became convinced thought investment newsletters that the market would continue to collapse and “shorted”, which shrunk the account even more as the market rebounded.
Mostly out of frustration, he took what was left and put it into a couple of fixed immediate annuities with a monthly payout.
Fast-forward a few years, while in the early stages of Alzheimers he began to fall victim to scammers who phoned him constantly, asking for increasing large amounts of money. He eventually drained his checking and saving accounts, and it was only brought to light when he returned home angry after a teller at his bank refused to process a cash advance on his credit card.
Lots of lessons here, but a big one is that I shudder to think what would have happened if he had access to the funds that were locked up in the annuity. These were essential for his eventual long-term care and kept my grandmother out of poverty when he passed.
No matter how intelligent and wise a person may be in their prime, a good portion of retirement planning should be spent on protecting you from yourself.
Very thought provoking comment
Agree. To me this is a big benefit of an annuity.
The piece mentions Social Security without addressing a key point-Timing of Social Security claiming and, if married, coordinating claiming strategies-THE best annuity, backed by the US government, is Social Security which comes with a real COLA rather than an annual “adjustment” in an annuity with a lower starting payment, and maximizing the SS benefit for at least high earner by delaying to 70 can be a good plan, recognizing that each decision is personal. This can work for average folks too, particularly if they are able to work a bit longer, and can keep it simple without the need for an additional annuity. For more affluent folks it can also be a good first choice in a retirement plan and a basis for determining gaps between retirement income and expenses and how to address them which can be done by a number of means, simple annuities being just one of several options for a portion of the portfolio, usually no more than 20-30%.
A fixed immediate annuity will always have a place and there are enough companies available to lower the risk of bankruptcy. They wi limit their own risk against excess longevity by not keeping the entire risk themselves. I would not have a concern with many of the annuity companies.
where did you find a 3% inflation benefit?
What is more commonly available these days is a straight “COLA” at 2 or 3% (rather than being pegged to the CPI) and it comes with a lower starting benefit amount than if you don’t elect to take it. So you can buy a fake “inflation” benefit that may not be more cost effective than a straight annuity.
For the NewRetirement link given in the article, if you fill out the info, it gives adjusted payout rates for 0%, 3%, and 5%. (After you fill out your info, see the buttons at the top to adjust.)
I haven’t created an account, so I’m not sure how one would actually buy them at these rates, because it doesn’t show who is selling them. (Presumably unless you create an account.)
I looked at several, but I think it was Fidelity site.
Thanks to William Perry for mentioning the recent interesting Bogleheads Q&A between Jonathan Clements and Bill Bernstein (https://www.youtube.com/watch?v=Itv2RkFC1yI), which ranges over ideas like market timing, keeping 20 years worth of your portfolio in safe assets, value investing, self-worth and happiness, experiences vs. possessions, how money buys time and autonomy, and more.
Regarding this thread’s topic of annuities, I especially liked Bill Bernstein’s remarks at 31:40 on why a retiree who will have a spending burn rate of 4, 5, or 6 percent (vs 1 or 2 percent) as they move through the decumulation phase should consider building a TIPS bond ladder in the sheltered part of their portfolio. That is what I am considering as a no-fee, more liquid pension “floor” alternative to an insurance annuity in my retirement portfolio, and it was nice to hear Bernstein’s boost for it.
But my favorite part of the conversation was when Jonathan spoke about how carefully he moderates the comments on HumbleDollar, weeding out any personal attacks. He said, “The tone in the HD comments section is remarkably civil and I am bound and determined to keep it that way.” This is a main attribute of this site and I appreciate the time and cultivation it takes.
Another fan here of Bernstein, TIPs ladders in retirement vs annuities (we have one) and Jonathan’s work.
Thanks for this article Richard. Deciding if I should buy an annuity is a topic that I, and apparently many others, are thinking a lot about.
I recommend the Friends Talk Money podcast from their Season 8 titled “Annuities for Retirement” where the co-hosts Pam Krueger, Terry Savage and Richard Eisenberg interview and discuss with Stan Heithcock annuities. I consider their podcast ( or the YouTube video link if you drill down into the show notes) to be a frank Annuities 101 class that helped my thinking. It can be found at –
https://friendstalkmoney.org/
Unrelated to this topic I am also currently watching the 2023 Boglehead’s conference recordings which are excellent and were posted five days ago. They include a segment of Jonathan Clements and Bill Bernstein in Conversation, a must watch for me.
Excellent article.
While you correctly noted that RMDs are ~4% for folks in their 70s, they increase a small amount each year. For example, the RMD for an 80 year old is 4.95% and the RMD for an 85 year old is 6.25%.
Richard, I resisted purchasing a SPIA for 10 yrs and really didn’t foresee myself allocating resources to annuities. However, at 70yo, I joined the “dark side” and recently purchased 2 annuities(kept under the State Guarantee levels) from Mass Mutual & NY Life for the following reasons:
So, those were my reasons and I sleep well at night. I believe Jonathan had posted previously that he was considering a similar strategy. Anyway, your mileage may vary but those were my reasons.
Ray:
As read your comment it could have been me writing it.
In anticipation of retiring in January 2024, in July 2023 I purchased 4 Fixed Indexed Annuities, with Income Riders. 3 from my funds and 1 from my wife’s funds. 3 were funded with Roth Dollars and 1 with Traditional IRA Dollars.
If we let these annuities remained deferred over the next 7 years, when we “turn them on” in July 2030, they will produce $59,000 in income, 89% of which will be income tax free.
What if we need cash in the next 7 years? We have over $500K in Vanguard VTI/VXUS (80%-20%) from which we are not taking withdrawals and do not plan to. We also have $178,000 in cash/CDs Short term Treasuries (roughly 2.5 years of our social security benefits.) And most important, we have Social Security Benefits that provide 111% of our retirement living expenses, including 10% charitable giving and $10,000 annually for travel.
Because we have the annuities, 100% of our Vanguard funds are in Equities. Our annuities represent our “bond allocation.”
Another feature of our annuity holdings is the ability to collect double income for up to 5 years, in the event my wife or myself needed long term care. While I have a tremendous LTCi Policy, my wife was not able to secure coverage, due to underwriting issues. These annuities required no underwriting. Should the annuity values drop to zero, because of the doubler benefit, the annuities revert back to their guaranteed payments for the rest of our lives.
One additional benefit you can add to your excellent reason/benefits outlined, related to the Simplicity item, is assisting a surviving spouse should the financial manager in the family experience cognitive decline. The checks will simply keep coming, monthly.
As you humorously stated, “…your mileage may vary…” but this is our plan.
From my point of view, exactly right, #2 is a winner.
It’s difficult to argue your numbers. Well done. Forgive me for dumbing things down to my level.
I just can’t get past this: I give the insurance company a lump sum. Then each month they give me back some of my money. An opportunity for them, an opportunity cost for me.
As they well know, odds are that I’ll adhere to a mortality schedule that works well for them. I’m not likely to get back all my money in my lifetime. My heirs may get the portion I didn’t collect, but (like me) they won’t recover the opportunity cost.
I don’t expect this to hold up against thoughtful numbers, It is just a gut feeling that puts me off annuities.
M,
You said…”I just can’t get past this: I give the insurance company a lump sum. Then each month they give me back some of my money. An opportunity for them, an opportunity cost for me.
How is this different from, “I place my money in a stock and bond mixed portfolio, in the market. Each month I withdraw a percentage of my portfolio to live on. I don’t know, in advance, how much it will be, because I do not know month to month, what the market will do. Whether my wealth increases or not, it’s an opportunity for the portfolio manager, and a cos to me to have them managing my money to me, regardless of performance.”
Many folks have a hard time in retirement spending what has taken them a lifetime to amass. Taking a portion of your nest egg and giving it to someone for a promise to send you checks for the rest of your life is challenging. But the choice you have if you don’t elect a guaranteed income stream is… what? Maybe having a favorable market that allows you to draw 3-5% of your portfolio in good times and 0-2% in times of market turmoil? The market provides no guarantees and sequence of returns risk is real.
Some folks elect TIPS Ladders or Bond Ladders vs. annuities and my response is good for them, as long as a planner guaranteed income. Personally, if I were doing it again today, I would have put a portion of my annuities into Multi-Year-Guaranteed -Annuities. Today 10 Year MYGAs are paying 5.4%. 3 year and 5 year MYGAs are paying 5.5 to 5.8%. And unlike TIPS, MYGAs allow you to collect your interest as you go and recovered 100% of your principal at maturity. MYGAs are paying higher rates than CDs and many Bonds, and again, unlike TIPS, your principal is not consumed.
Isn’t it great to have choices?
You reflect how many people feel, but the other side of the coin is you manage your money and you may do okay or not, the market may be good or not, but every year you think about your income for next year. Can I take what I need? Any risk I can get in trouble?
On the other hand, an annuity sends you an amount of money each month with minimal risk.
May receive little in payments? You worked your whole life and paid SS taxes and may receive nothing or as in my case, many, many times more in benefits than paid in taxes, but some people still think they could do better investing the taxes.
I would point out that $280K is double the median retirement savings of Americans at 65, according to the Federal Reserve Survey of Consumer Finances. I look at the median rather than the “average folk” numbers since averages are skewed by high-wealth people.
Interesting that a large segment of your clientele had reached 65 without ever checking their Social Security benefits.
Who knows the accurate number? I just reviewed several sources from, Vanguard, Fidelity, the fed and they all have something different, but the point is, it’s far from enough.
I don’t worry over-much about large insurance companies going broke (just as well, as my pension is now an annuity). I do worry about the effects of inflation, especially as my pension, now annuity, has no inflation protection. It wouldn’t take many years of 5% or 7% inflation to make an additional fixed annuity a mistake.
First, you can add an annual adjustment to an annuity. My pension calculated in July 2008 now requires $1.41 to buy what started at $1.00 in 2008. Why is it any different than an annuity?
And what about the bonds or CDs you might buy instead of that annuity? Wouldn’t inflation also make those a mistake?
Probably I am missing something, but if I buy a short term CD I can reinvest the proceeds at a higher rate if inflation hits and interest rates go up, no? I have to see how my finances work out over the next year, but I don’t think I need much in the way of income from my portfolio at this point. Maybe 1.5%.
Also, I don’t understand the reference to an annual adjustment. If buy an annuity that pays $x/year, with no COLA, it always pays $x/year, doesn’t it?
Conventional bonds and CDs leave you vulnerable to inflation, just like an immediate fixed annuity. Yes, you could take your CD and bond interest and reinvest it at higher rates. But you could also do that with your annuity income. Meanwhile, while there’s no true inflation-linked annuity, you can purchase immediate fixed annuities where the payment rises, say, 2% or 3% a year.
My overall point: Folks raise constant objections to immediate fixed annuities — financial salesmen are scum! inflation! interest rates could rise! the issuer could go belly up! — and yet these same objections are equally valid with other financial products. The net result is that folks are being frightened away from a product — immediate fixed annuities — that could be useful to them.
Let me add that I’m no fan of variable annuities and index-linked annuities. But I’m also no fan of load mutual funds — but that would never stop me from recommending index mutual funds.
I didn’t mean the interest. I keep seeing references to CD ladders. When the three year CD I (theoretically) bought at a derisory interest rate in 2021 matures, I can reinvest the capital at the new, higher interest rate. I have no access to the capital I might use to buy an annuity. While 2% is certainly better than zero, it’s not much help when inflation is 5% or 7%. (Perhaps I am still spooked by the 70s.)
You can include a fixed percent annual adjustment. I’ve seen 2% or 3% recently.
The various annuities available are so nebulous that I suspect the average holder of one doesn’t understand it or is unable to explain the topic clearly to anyone. People I know 10+ years older than me say they have annuities because their financial advisor highly recommended them. When I ask why, they’re unable to explain or even tell me what kind of annuity they have. All they know for sure is how much income they are receiving.
I have tried to educate myself about annuities due to my late parents horrible experience of having been persuaded into several variable annuities with the same mutual fund that had high expense fees because they trusted the sales person. The financial sales person also put them into poor performing investments.
I’m aware readers of HumbleDollar do have, or are considering annuities, and I respect those who make an informed decision. For me, whenever I hear “annuity” I feel the rumble of that train that’s a coming and hear the whistle blowing, but I do keep an open mind and will listen to other opinions.
Think fixed, immediate annuities, don’t mix that up with any other type.
Advice to think only fixed is probably solid, but wouldn’t say think only immediate. A QLAC that pays later could also be okay, as insurance against running out of money late in life as opposed to the often discussed bridge to SS.
https://humbledollar.com/money-guide/longevity-insurance/
Good point
With annuities, there is an interest rate market timing issue that isn’t mentioned in this article. When the Fed had rates near zero, annuity quotes were much less desirable than today. And, if a few years if they go back down they will again be less desirable.
In my neighborhood there were quite a few long term Boeing employees who retired at the end of 2022 because the cash value of their Boeing pension was going to decline dramatically in 2023 due to the increase in interest rates.
Yes, there’s an interest-rate timing issue, as there is when buying bonds, but arguably the issue with immediate fixed annuities is less than it is for bonds, especially if you’re older. Remember, the payout on an immediate fixed annuity depends not only on interest rates, but also on your life expectancy. The older you are, the less important prevailing interest rates become, and the greater the influence of your ever-shrinking life expectancy.
This is heavily dependent on your income and expenses. If you are retired, and your expenses are significantly below your income, then you can actually continue to invest your excess income, and don’t have to worry about running out of money.
If, on the other hand, things are very tight, and you can barely cover your ordinary expenses, then an annuity might make sense. The biggest problem then would be unexpected inflation.
Inflation, of course, isn’t just an issue for immediate fixed annuities. It’s also a problem for certificates of deposit, fixed pensions and fixed-interest bonds.
A pension is an annuity purchased with deferred compensation, it has risk based on adequate funding and the ongoing viability of the plan sponsor. A worker may never recoup that deferred compensation.
It is only partially insured.
Who doesn’t want a good pension if available, so why not an annuity?
Thanks, Richard. Solid advice.
Your note about the IRS’s RMD amounts piqued my curiosity about a stretch IRA that I inherited fifteen years ago, prompting some calculations this morning. The IRA is conservatively invested – 60/40 stocks to fixed income. Over this time, the RMDs have averaged 3.7% (and are now near 5%) and the account has grown 46%. That represents an annual growth of 0.5% above inflation and after withdrawals. So yes, in my experience a 4% withdrawal rate seems viable. But an annuity seems simpler and more predictable.
The saying goes, Annuities are sold, not bought, but something to ponder. Unfortunately insects get a bad rap by selling lots of bad annuities like variable and fixed indexed.
It’s an enduring frustration to me that folks hear the word “annuity” and immediately freak out, without bothering to understand there’s a huge difference between an immediate fixed annuity on the one hand, and products like variable annuities and index-linked annuities on the other. Why do folks disdain immediate annuities and yet love traditional pensions, when both are effectively the same thing? If immediate annuities are supposedly so costly, why don’t commission-hungry insurance salesmen flog them endlessly? Hint: The commission they’ll earn is tiny compared to those offered by variable annuities and index-linked annuities.
Good article, Dick. This topic is squarely in the recurring discussions with my wife as we consider just how to switch from work to retirement.
Thanks, Richard. As always, advice worth considering.
The one bone I’ll pick is with:
“But while everday investors may worry that annuity insurers will fail, large corporations seem unconcerned.”
Large corporations are, almost by definition, unconcerned. “Everyday investors” have skin in the game, very personal skin in the game.
Large corporations, in moving away from pensions and in transferring existing liabilities to insurers are simply looking at their bottom line, not expressing concern for individual retirees.
I’d like to be wrong here. Tell me where I am. I worked for WorldCom at the end of the dot-bomb bubble, so perhaps I’m too jaded?
You’re certainly correct regarding the transferring of liabilities. No company (large or small) wants pension liability on its books.
States have guaranty funds to help protect against an insurance company going belly up that work similar to the FDIC. The limits of protection (I believe) vary from 100 to 300k, so you may need to use multiple companies to protect your annuity.
Yes, they make the move to improve the earnings look, but they have a fiduciary liability as well, many have to deal with unions and then there is the PR aspects if things go wrong.
In some cases the employer may be doing workers a favor as the insurance company may be more stable than the pension fund.
Also, in the entire discussion about the value of pensions often overlooked is the fact the value in a pension is longevity with the employer. If a person works for a company for 4-5 years, as is mostly the case, there is no value.
How many workers could earn a pension today based on 35-40 years of service or nearly 50 as I did? How many want to?
My issue with the change is that my state’s guarantee is much lower than that from the PBGC.
That depends on age, pension level and age at retirement. Hitting the PBGC limit under ER is not that hard.
What is the real risk of buying an annuity from a major good rated insurer. However, I understand the hesitation turning over a few hundred thousand dollars. On the other hand, an income stream is mighty calming.
Yup.
Over a 38 year career (retired this month) in tech I averaged a job change every 3.1 years, not counting the internal job-function shifts. It’s been a fast ride from just-before PCs to the Internet to the brave-new-AI world.
And my wife is getting a *small* pension from Nationwide Insurance, having spent about 5 years as Certified Employee Benefits Specialist means testing corporate contributions to pension plans 🙂
Thanks.
Enjoy your new chapter!