This post is about using a Single Premium Annuity in combination with mutual funds, other investments and income streams (e.g. Social Security) to have adequate money in retirement.
I've given some thought to this question, but would like some advice and comments from members of MFO.
The simple explanation of a Single Premium Annuity: Think of it as a pool of people who make a one-time contribution to a pool of money. Each person periodically receives money from the pool of money. Persons who die early give up their income stream for the benefit of those who live longer. Truly a game of "You Bet Your Life".
QUESTION 1: What lifestyles are possible in retirement?
I have three general categories:
1. Live a steady comfortable life.
2. Die poor, but live rich.
3. Die rich (leave a big legacy to heirs) but live poor.
QUESTION 2: How long will I live?
This evolves into the probability I will still be living at age X. The basic rule-of-thumb is your probability of dying during a given year doubles every 8 years. (That is, your probability of dying at age 80 is twice the probability you will die at age 72.) This is a consequence of "Gompertz's Law of Human Mortality". (There's an Irish song "Isn't It Grand Boys" that has a line "the longer you live the sooner you'll die".)
REFERENCES:
http://gravityandlevity.wordpress.com/2009/07/08/your-body-wasnt-built-to-last-a-lesson-from-human-mortality-rates/http://www.marketwatch.com/Story/story/print?guid=D24EE7A4-BFAF-11E1-98EF-002128049AD6http://www.ssa.gov/oact/STATS/table4c6.htmlhttp://www.northwesternmutual.com/learning-center/the-longevity-game.aspxMY REQUIREMENTS:
I want to withdraw more money in the early years to enjoy travel and experiences.
MY PHILOSOPHY:
Life is a bunch of probabilities; our problem is to manage uncertainty (the probabilities).
IN CONCLUSION:
1. Will a Single Premium Annuity help me solve the problem of outliving my money?
2. What strategy should I use to front-load my withdrawals during the first 20 years of a retirement starting at age 65? (Assume collecting Social Security and other income streams.)
Comments
I am convinced that I can achieve a better return than the 4% that the annuity will pay me. I will have my spouse as a contingent annuitant and she would receive 70% of my annuity upon my death. I will choose a zero annual cost of living increase. I will make that choice because I really don't need the monthly annuity to live on and will almost certainly invest it anyway and, again, achieve better returns than the cost of living adjustment.
I believe that we live in a fairly special time in investing history in the U.S. where investors are still able to invest in "accidental high yielding" investments because so many stocks have not yet recovered to their pre-recession trading levels despite the bull markets that we have seen since 2009 (with a correction here and there).
I have a portfolio of open and closed end funds, ETFs, ETNs, and stocks and am receiving a +10% dividend yield that I believe is sustainable over the long run. Of course another massive recession could change that and that is why people invest in annuities, I think. You know you'll get your annuity payment every month regardless of a second or third great depression.
But I have investments that paid consistent dividends through 2007-2009 and continue to pay dividends at that same rate and have good earnings today and their share prices are increasing.
So I am disappointed that I will be forced to annuitize 65% of that pension account I mentioned because I am persuaded that I can beat the annuity rate. I also recognize that as I age I may lose the mental capacity to manage my investments as I do now. Although some question my current mental stability for making what they believe are risky investments. But that is another matter. I have friends and family who kind of dismiss me as a somewhat weird old guy who likes to "play the stock market." That's really all they know about investing. If you manage your own investments then you're "playing the stock market" and they think that is very very risky. Many of them sock their 401K or other retirement funds into CD's, money markets or bonds and leave them.
So, this is a too lengthy reply, to your situation. In summary, for me, I would choose investing in a diverse portfolio of funds and stocks weighted towards dividend income over an annuity any day.
You noted: "Of course another massive recession could change that and that is why people invest in annuities, I think. You know you'll get your annuity payment every month regardless of a second or third great depression."
Lincoln National & Hartford Financial need TARP funds
During the market melt I happened to follow Lincoln National. Through some fancy work and the chance that they were able to buy a small bank or savings/loan failing in Indiana, allowed them to qualify for TARP relief monies. My recall is that the request form was filed about 18 hours before the cutoff period. One may hope for such a program in the future if there were to be another melt to protect the insurance companies who were not part of the required TARP funding for some banks; whether they chose to take the money or not.
As to whether one would receive a future annuity payment under duress monetary circumstances has yet to be discovered; but the possibility exists. At the least, one could be in line for some amount of payment via state programs; which would be overwhelmed by a serious system failure.
The lender of last resort, being the Federal government/Treasury may only guarantee a certain amount of product under the worst circumstances.
While none of this may present itself during my lifetime; I believe not too many folks realized just how serious some of the non-banking sectors were being hit on the liquidity side of the 2008 event.
Not unlike the ability of banking and related institutions to flow "your" money to you as they choose during a financial crisis; I fully expect similar language is buried somewhere inside of many insurance products. Of last resort, of course; is the full ability of the U.S. President to engage presidental directives for whatever purpose may be necessary to facilitate a smooth and functional system.
Regards,
Catch
Hi Catch,
You are absolutely on target that we now know that even annuities are not necessarily as certain as most had once thought. I am guilty of thinking of my own pension-based annuity on this one as the pension fund that backs the annuity that I will receive is just about as certain as any investment could ever be. Nevertheless, you are right. We really don't know for sure what would happen if an annuity vehicle went belly up.
Fred
I am of the opinion that annuities should be thought of as insurance, not investment, and should be evaluated accordingly. Of course the annuity's yield is lower than what a competent investor could expect to achieve -- that is how the insurance company makes their money after all. You are trading off the potential total return for insurance against the risk of losing your investment and/or outliving your savings.
If you have enough money that an insurance company can guarantee you a steady comfortable income, for as long as your life lasts (don't forget about inflation), then I would go for it. You have a limited time in this world and, assuming you have a comfortable income, is the extra 5% or so of potential return really worth the risk of another 2008 event (or worse)? Of course there is the risk that notwithstanding the guarantee, the insurance company will still default in some extreme circumstances, but in that scenario surely you are still better off than the equity/bond investors who do not have that extra layer of protection.
Unfortunately because the annuity yields are necessarily lower than expected market returns, most folks will not have enough money to guarantee a comfortable retirement for the duration of their life. That's really where retirees need to make a tough decision between risking their retirement vs. guaranteeing a subpar lifestyle vs. a mix of both.
I have never been a fan of annuities, especially the type where you never see your principal again. But playing around with the numbers in the link and a retirement age of 70 1/2 shows a 10.64% annual return. That's almost tempting to give up at least a small portion of my capital. I wish I could retire now and I can financially but not emotionally. I have this thing about watching my account compound tax free over time. But I figure at 70 and 1/2 where I will finally be forced by Uncle Sam to begin drawing down on my IRAs is as good a time as any.