On Retire Your Way Radio, I talked about annuities and how to decide whether or not to include them in your retirement portfolio.
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I'll be discussing two articles about annuities.
The first is an article from Advisor Perspectives called Should Consumers Annuitize at Normal Retirement Age? It summarizes the results of two studies that examine retirement withdrawal strategies and how annuities may fit in with those strategies.
The article starts with a study of the 20-year period from 2000 to 2019. This period included the bear markets of 2000 to 2002 and 2007 to 2008.
The 20-year period studied is NOT considered to be a worst-case scenario because bond yields during that period were higher than what they are now, and especially higher than what they were a few months ago.
In this situation, some researchers are suggesting using annuities to transfer some of your investment risk to insurance companies as a way to guarantee a stream of income for life.
Single Premium Immediate Annuity (SPIA)
The second study reviewed in the article focuses on adding a Single Premium Immediate Annuity (SPIA) to your portfolio starting at age 65 and looking at a 30-year retirement time horizon.
To give you a basic introduction, a SPIA is generally purchased from an insurance company with a lump sum of money. Then the insurance company agrees to pay a regular income based on the terms of the contract, usually starting within a month of purchase, which is what makes it immediate.
In general, I am not a fan of annuities, because they are often a black box of high fees, but a Single Premium Immediate Annuity (SPIA) can be a good substitute for a bond portfolio for some people.
Here is a summary of a few main point from the two studies:
1. SPIAs are more attractive to singles than to married consumers. Single retirees who purchase an SPIA at age 65 can get their principal back after 17 years, at age 83, while for couples, it can take 21 years, up to age 87.
2. Fixed SPIAs are more attractive than SPIAs that have a 3% cost of living adjustment (COLA). COLA annuities start with a lower monthly payout than fixed annuities. Since retirees tend to value the earlier years of retirement more than later years, the lower payout makes them less appealing.
On top of that, according to the annuity study, the monthly payout of a 3% COLA SPIA doesn’t exceed that of a fixed SPIA until age 79-80, and the total return doesn't surpass that of the fixed SPIA until annuitants are in their early 90s.
3. The decision to annuitize at age 65 is often optimal in cases of extreme longevity (age 90+) or in prolonged environments of poor stock and bond returns, as bad or worse than historical conditions.
Neither of these are situations that we can predict.
However, within a normal 30-year retirement and a less than ideal investment environment, most retirees will be better served by maintaining control of their own portfolios.
But there is no guarantee with the stock market.
So basically, it’s a personal choice whether or not to include a single premium immediate annuity in your investment portfolio.
It is important to note, the studies in the article only considered SPIA contracts purchased by 65-year-old retirees. The results may be different when looking at other types of annuities, such as deferred annuities, index annuities, buffered annuities, and variable annuities, and also when looking at other age groups.
Other Annuity Income Strategies
The second article is called Annuities are Not Alchemy from Morningstar.
It starts by stating that retirement plans across the country are adding more annuity options, but their research suggests that this may not be the right option for everyone.
The reason they are starting to do this is a lot of lobbyists for insurance companies and people that sell annuities have been pushing congress to allow annuities in retirement plans.
Overall, the researchers found that annuities do not add much value when an investor is already well-prepared for retirement. They also do not help much when Social Security or other guaranteed income sources already cover the majority of anticipated retirement expenses.
None of the annuity-based strategies could compete with delaying Social Security claiming, especially when there is high inflation.
Lifetime Income Strategies
They looked at 5 lifetime income strategies:
- Portfolio only. Use Social Security benefits, claimed at retirement (which we assume is at 65), and systematic withdrawals to fund expenses in retirement.
- Social Security bridge. Delay claiming Social Security until age 70, taking larger withdrawals to fund retirement expenses before Social Security benefits start. (I am a fan of this strategy. I like to frame Social Security as an insurance policy.)
- Fixed single premium immediate annuity, or SPIA, at retirement. Purchase a fixed SPIA with a portion of wealth at retirement and use Social Security benefits and portfolio withdrawals for remaining expenses.
- Qualified longevity annuity contract, or QLAC, at retirement. Purchase a QLAC with income starting at age 80. Use Social Security and portfolio withdrawals to fund remaining expenses.
- Deferred variable annuity with guaranteed living withdrawal, or GLWB, rider. Contribute to a deferred variable annuity before retirement and start guaranteed living withdrawals at retirement. Use Social Security and the investment portfolio to cover remaining expenses.
Benefits of Social Security Bridging
They found that Social Security bridging offers more generous payments than private annuities, for the following reasons:
- Social Security has no profit margin requirement.
- The benefits are based on life expectancies of the United States population, instead of the above-average life expectancies used by insurance companies.
- The benefits are indexed to the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W).
The research showed that partial allocations to annuities can help some investors, but not others. And for those who can benefit from annuities, again, they found that they should consider Social Security bridging before private annuities.
Another thing to consider with annuities is that many types of annuities end when you die. There may not be legacy options with an annuity like there are with other forms of retirement savings, such as IRAs and 401(k)s that you can leave to your heirs.
If you want an annuity for whatever they are guaranteeing, then you should get one, but beware of all the fees often charged by variable annuities, because you often pay a high price for those guarantees.
But often other strategies could be more efficient for you. The most important thing is to be open to adapt and focus on controlling what we can control, and over the long-run, a properly diversified and managed portfolio is optimal for most retirees.
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