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Like many HD contributors, I don’t own a Single Premium Immediate Annuity (SPIA). Social Security and pensions cover most all of our spending, I don’t need no stinkin’ SPIA.
Or do I? I’ve done the math. The calculators tell me I’m in good shape. But I know this sense of security I feel is precarious. There are any number of things that could blow up my plan. Lengthy care in a nursing home, victim of fraud, catastrophic market events are all examples of things that could upset my applecart.
In a perfect world I can make lots more money in the market than by purchasing a SPIA. Sadly, this world isn’t perfect, and a SPIA can guarantee my income will last as long as I do. Yes there is a cost to be paid, just as there is with insurance for my health, home, cars and life. I’ll probably never need the insurance, but then again, I might.
If I do end up buying, I’ll get one with a return of premium, or a period certain that guarantees my beneficiary at least gets back the unused portion of the premium. The moral of my story is to keep an open mind about SPIAs.
Another postive of annuities not yet mentioned: for those naive enough (ie me !) on their financial journey to have been talked into buying a whole life insurance policy, doing a 1035 exchange of the insurance policy to an annuity, allows one to access the built up cash value of the insurance policy without any tax consequences.
This allowed me to 1) stop paying a huge annual premium to maintain a death benefit no longer needed and 2) have access to the cash value. Maintaining the insurance policy allowed me the “privilege ” (sarcasm intended) to access MY money, at the low, low, interest rate of 5% !
I bought a SPIA, 10 years certain, so that it will completely pay out prior to me having to take take RMDs. And if I die within the 10 years, my wife/heirs will continue to receive my monthly benefit until its all paid out.
Dan: In the late 1990’s, when I was the Owner of a Nationwide Insurance & Financial Services agency, I sold a fair number of annuities to retirees.
Almost without exception, they were SPIAs with Period Certain. Like you mentioned, most often the client would ask me how long it would take to “make his money back,” and that usually became the Period Certain.
When my turn came, I opted for FIAs with Income Riders, Joint Life, with LTC Benefits…because while I have a great LTC Insurance Policy, my wife couldn’t qualify for one. Like you, financially, we didn’t “need” an annuity, but the peace of mind and certainty was worth consideration.
Had you come to me in those days, based on what you have shared here, I would definitely recommend the Period Certain over the ROP. The Period Certain benefit will almost always be greater than the ROP benefit, and with Period Certain, you know your survivor will still receive the benefits, whether you are her or not.
Continued Good Luck in Retirement.
Cannot a person invest in the same thing(s) that insurance companies invest in to back their annuities? Rather than handing over one’s money to an insurance company, why not build your own annuity?
Yes, you could buy the same sort of investments, but it’s a less appealing place if you’re the only person in the risk pool! One of the attractions of an immediate annuity is the “mortality credits” — the fact that those who die relatively young effectively subsidize those who live longer and who, as a result, enjoy far larger monthly checks than they could generate on their own.
So an annuity is sort of a bet? Is it possible to get more back in payments than was put in to fund the annuity in the first place?
Every investment is some sort of a bet. In the case of an immediate annuity, a key aspect of the bet is that you’ll live a reasonably long time. And, if you do, you can get back far more than you paid for the annuity.
It’s possible to get various guarantees — that you’ll get, say, 10 years of payments or you’ll get back total payments equal to at least what you invested. I would think twice about such guarantees because there’s a price to be paid in the form of lower monthly payments. If I’m going to buy insurance, I prefer to buy “pure” insurance.
To illustrate your point about guarantees, I looked at the immediate annuity payments I would receive from the money I have accumulated in my TIAA 403(b) account. Adding a 10 year period certain guarantee would reduce my monthly income by 8.7%, while adding my wife as a joint lifetime survivor would reduce my income by 18.6%. Adding both options would result in a 19.6% reduction so, at least for our ages (75 & 77), it wouldn’t cost much to add a 10 year guarantee to a joint annuity.
The issue isn’t that the options have a cost associated with them, the issue is you are facing uncertainty. The question is, “How would you like to handle that uncertainty?’
Sure, you can opt for the life only, highest payout on an annuity, if you are willing to accept the risk that if you die before you have received your investment back, the balance will go to the insurance company, to be used to fund morality credits.
The insurance companies offer options because that is what people want. They also employ some of the world’s smartest mathematicians, called actuaries. The insurance company is not in business to lose money, so if you want guarantees, you can have them…for as price. The actuaries know exactly what the risk is and they price for it accordingly.
Only insurance companies have the skill and ability to do what they do.
I’ve been thinking about this too.
I think you’re hitting on a very important part of how to consider an annuity, which is, what are my actual unfunded cash flow risks?
I think you also have to spend a good deal of time thinking about the legacy/estate goals you have.
I may do a more robust analysis, thinking about what one can do simply, with a small number of choices, and how an annuity might make sense, just to put my own thinking to the test. (I like researching the opposite of my inclinations).
One thing I don’t like about the annuity discussion is the security aspect without considering exactly how much inflation risk you’ve bought in that annuity. I’m far more concerned that we have some stagflation than a deflationary period. So I’m less worried about a 50% drawdown than I am about losing 50% of my purchasing power. (100% certain this is because I matured in the 70s)
Dan, I was in the “never an annuity camp” for ten years but eventually bought a SPIA 2 years ago to supplement soc security income. The combination provided a “guaranteed income(eg monthly paycheck)” that covers our basic expenses. Aside from the quantitative arguments for and against annuitizing part of the investment pie, I would recommend that folks consider the psychological/emotional/behavior dimension of having a certain level of guaranteed monthly income coming in. Before I purchased the annuity, I presented the pros & cons of annuity to my wife and her short answer was “I like the security of having a monthly paycheck. It gives me emotional peace”.
And therein lies another dimension – emotional behavior – that is a very important factor to consider as well. One last point, if in 2034 Social Security income payouts are reduced to the Trust fund depletion, what’s one’s response that? Reach for a more aggressive asset allocation in an attempt to increase one’s Rate of Return to makeup for the Soc Sec shortfall when we’re in the late season of our life. Just sayin ……..
Two great points Ray. Studies support your feelings on the emotional support provided by having guaranteed income.
I’m among the throng of people who express certainty about our legislators fixing Social Security funding before it is too late, but with every year of inaction I fear that we may be suffering from a severe case of denial. I sure don’t think that economic growth alone will rescue the trust fund.
Dan, I would also agree that I’m in the camp that Soc Sec will get fixed eventually. One last point that made me consider an SPIA was death of a spouse and it’s impact on the surviving spouse’s RMD depletion of IRA withdrawals. I was the executor of my parents’ will and assisted in managing their investments. When my father died in 2016, he had the largest IRA balance which my mother inherited. However, the scenario of moving from a joint RMD schedule to a Single RMD schedule quickly accelerated the withdrawals that she had to take from my father’s IRA. This forced her to liquidate the IRA quicker than she needed, caused higher tax bills because she had more income(than needed) and her tax filing status changed from married to single, and also created more emotional angst that she would run out of money.
Having witnessed this, I decided to use my part of my IRA as the funding source for the SPIA. Why
1. To remove the emotional angst of outliving your money
2.Spread the tax hit over a potentially longer timeframe
3.Created a “paycheck lifestyle” that made my wife feel more comfortable assuming I checked out earlier then her
Food for thought that should also be considered in purchasing an SPIA or not.
Excellent Points and glad you made them.
There are many, many aspects of annuity ownership that rarely get considered by folks, because they are not aware of things like you just mentioned.
Far too many articles present negative reports concerning annuities, many containing misleading and erroneous information, especially about “Terribly High Fees.”
The press tends to treat annuities like they are a monolith product, when in fact, there are combinations and permutations of annuities, that would stymie the brightest among us, at times.
Your comment makes a great point about the importance of getting sound advice when considering one’s retirement income, and providing for survivors.
Good topic Dan,
I have also thought about an annuity but I have been considerting a Joint with Right of Survivorship qualified longevity annuity contract (JWROS QLAC).
Per investopedia –
A QLAC allows distributions to be delayed until a predetermined payout date but no later than the person’s 85th birthday. A QLAC also allows a spouse or other party to be a joint annuitant where both named individuals are covered with the same conditions regardless of how long they live.
To me there are two key positive factors of a JWROS QLAC.
One is the cost of a QLAC inside of my traditional IRA is excluded from the asset base used to determine my RMDs until the lessor of my age when I elect to start the annutity payments or when I attain my age 85, and
Two, the key feature of an annuity is the mortality credit. For those not familiar with the term a simple explanation of a mortality credit is the extra payment that annuitants receive because others in the pool have died sooner than expected.
Going against my deciding to buy a QLAC are the annuity costs such as commissions and the profit the insurance company has to make.
For now I have decided to postpone taking any action on a QLAC until my age 80.
William:
You said, “Going against my deciding to buy a QLAC are the annuity costs such as commissions and the profit the insurance company has to make.”
I have a question…When you go to a lawyer or a physician with a problem for which you are seeking a solution, do you focus on their costs and fees, or the fact that these folks offer the solution you need?
I say that because the rest of your message is 100% sound reasoning. Waiting until age 80 to purchase a QLAC is a great idea, and I don’t say that simply because I intend to do the same thing.
The fact that the insurance company “makes a profit” or that the annuity sales persons earns a “commission” on a sale are not concerns I share with you, because neither affects the fact that my problem has been solved.
That makes sense William.
One thing that has influenced my decision is the possibility of the insurer being unable to pay. Bankruptcies or insolvencies don’t happen very often, but if they do it is my understanding that the state’s Guarantee Association will step in. Coverage is determined by the present value of future annuity payments but there are limits which vary from state to state. In my state protection is limited to “$250,000 in the present value of annuity benefits, including net cash withdrawal and net cash surrender values.” However, it can also take years to resolve. For example, when Colorado Bankers Life Insurance Co. ran into difficulties it took four years for partial payments to resume to policy holders. By the way, these state managed guaranty associations also cover long term care and life insurance insolvencies, but limits vary.
True Norman, and I think some states only protect to $100K, so one would want to spread the risk over several high rated companies.
That risk is very low. The few bankruptcies are among small insurers most people never heard of, not major insurers like Prudential and MetLife.
It took $180 billion from the federal gov’t to prevent AIG from collapsing. Not exactly a small insurer.
And how much did the auto industry receive? Do you still drive your car?
AIG’s potential demise was based on their forays into businesses other than life insurance and annuities, specifically questionable mortgage instruments, as well as illegal activities by officers of the corporation.
NONE of their annuity recipients went unpaid.
True, it can happen, but there is always risk, but the markets weren’t do well then either. The good news is the Feds made $22 billion in the end.
Still, the odds are heavily on your side. A few years ago my former employer took $2 billion and bought annuities that matched the former pension for about 1500 retirees from one division that was sold. The retirees panicked so I spent some time researching the topic.
Bill Bernstein, who I admire greatly, shares your concern. After strongly recommending TIPs ladders in his Four Pillars of Investing update, Bernstein states that he would consider an immediate fixed annuity with the following caveats. First, annuities carry the credit risk of the issuing insurance firm…Second, no annuities with true inflation protection are available (pages 160-161). In addition to expressing doubts about the adequacy of state government reserves during a severe financial crisis, Bernstein also says that the soaring US debt/GPD ratio raises doubts about whether the federal gov’t would save annuitants like it did when AIG failed in 2008.
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State Insurance Guaranty Associations are funded primarily through assessments levied on member insurance companies licensed to operate in that state. These assessments are designed to cover the cost of paying claims when an insurance company becomes insolvent.
SS and pensions cover most all of our spending- same for us. But if that is your situation too, you must have investments to buy an annuity.
‘’My question would be won’t the investments generate additional income and wouldn’t the value of investments be available for large emergency type expenses if needed?
if your purchased an additional income stream would that be sufficient to deal with they catastrophes you mention?
You seem to make the case you don’t need an annuity. Isn’t your income already guaranteed?
To be clear, there’s no ambivalence about what events may cause me to buy a SPIA. The purpose of the post is to try to explain to the “never an annuity” crowd, that there may well be a future problem that could be solved using that “A” word.