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July 26, 2011

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Immediate fixed annuities seem to have the right place in many retiree's portfolios.

Let's put it this way. If you're 65 and you believe you shouldn't take more than 4% of your portfolio adjusted yearly to inflation, and that 4% is less than you'd like to spend, and an inflation adjusted lifetime immediate annuity pays you 6% (effectively increasing your income by 50% on that money over a 4% draw), then it makes sense to shift the risk to the bank. You do obviously have to keep a very large emergency fund if you do this.

I think I may compare my social security payments to my basic stripped-down budget. Whatever not covered by SS maybe I get enough of an annuity to cover. The rest I try to grow to raise my SOL and what I get to pass on to others...

I think Steve is on the right track here with the appropriate use of an annuity (and type). Mike at Oblivious Investor has written some great articles discussing this topic as well.

I like Steve's idea as well. Shifting risk out of my portfolio is a big appeal of an annuity to me, but the practicalities and barrier to entry in finding a trustworthy broker and the right vehicle make me reluctant.

I am considering getting a fixed annuity when we retire, but it will just be a small portion of our retirement portfolio. Depends on my health too. If I am sick, then obviously I would never consider an annuity.

I agree Immediate fixed annuities can have their place in retirement but you have to be ultra careful that you are really getting what you think you are getting.

Also I believe the state insurance board will cover some amount of insurance if the issuing company goes bankrupt- so if you are going to have a lot in annuities you should get them from multiple insurers... thus complicating the process even more!

-Rick Francis

I invest with Vanguard. If I were thinking of buying an annuity, I would look into their low-cost annuity products.

It seems likely that one reason people don't like annuities is that they prefer to leave a large inheritance to their families.

FMF,

you said: "Delaying Social Security" -- depends on how long you think you will live (I know, hard to determine).

This is very common thinking amongst those considering when to take social security. I think it is the predominate factor for the majority of people. Will I get my "money's worth" if I wait. I would like to offer a different way to look at it.

Social Security for people who really need the money is their pension for the rest of their lives. It might be the sole thing that determines how well they can live in retirement. Even if its only 1/2 of their money (for many its more than that), the difference between getting 1000 a month and 1500 a month can be huge. When people are thinking about it from a standpoint of I might die early and then won't get to draw as much money out, I would submit they aren't really thinking correctly. Here is why.

If you work a little longer and use other sources of income and wait longer to draw and then die early, its correct that you didn't get as much out as you could have. However you will be dead and thus you won't care that you didn't get to draw as much out. And your kids won't either because they don't get to keep extra money if you drew out more money because you will have needed that to live on and will have spent it.

However if you do live long, well into your 80s, you will draw far more money by waiting and you will have a much bigger draw which will make living in those years much easier than if you are on a very meager draw because you took SS at the age of 62. That is something you will care very much about unlike dying early and not getting out the maximum you could have before you died.

I have watched multiple of my relatives and friends of my parents who have meager means make the 62 decision using either that logic or the logic that they want to slow down and take it easier. I fear greatly that they will regret this decision deeply when they are in their late 70s, and either have to continue to work 3 days a week or can no longer work and have to scrap by on the most meager of means.

People who draw at 62 are why we hear stories about having to decide between medicine and food. Obviously not saving enough is a big factor but if they had waited to draw to 66 or 70, they would have a much bigger SS check and that would make all the difference in the world.

Now for someone who is well off and doesn't really even need SS then the decision of will I live long enough to maximize the amount drawn is a far question to ask because if you have a smaller draw in late life it won't really matter. But for those of meager means, I think drawing early is usually one of the biggest mistakes they make.

Apex --

Personally, I'm in the group that won't need SS to retire well -- and I hope most FMF readers get to that point well before they stop working too.

@FMF,

Yup, I assumed that. This topic of annuities seems to be most important for those that aren't well off financially though. I personally doubt I will entertain annuities because I won't need to. It's basically insurance where you give up ownership for the benefit of never running out of money. With the lost of ownership comes the lose of options, many many options. It also comes with the risk of having a large nest egg that you could have left to your kids that is now gone or at least partially gone. If you have little risk of running out of money I don't see any reason to purchase the annuity insurance and take on the extra costs and risks it brings to get the mitigation of a risk that you don't really have. For those that have the risk of running out of money its an entirely different calculation.

However with social security since there is no ownership to give up, you are getting the benefit by waiting without much of any additional cost or risk. I will probably wait as long as possible to draw social security. Probably until I am 70 (if they haven't means tested it by then). To me taking the larger annuity in Social Security versus the smaller one seems like it is almost always a prudent move unless you pretty much know you will not live long.

The annuity question however is not something I would think makes much sense for people who are well off enough to not have to really worry about outliving their funds. It would be interesting to find out if the super wealthy buy the kind of annuities that pay you money until you die and the company keeps any funds if you die early. I suspect they do not.

Annuities have been given a bad name. "Today's" Annuities, particularly the Variable annuities have some wonderful riders and options that can provide a great deal of financial security. I sold MYSELF a VA that guarantees a 7% W/D rate for life, an annual step up, and a principal guarantee. BAck @ S&P 1525 it was a gret decision. For deferred monies (that are taxed as ordinary income) and a portion of your portfolio they can be a great addition. You WILL pay for them with higher expenses but, mostly the "guarantees" that keep you ffrom losiing money are the winning points. Shop 'em well ass the large, strong insurers have some great ones. Fixed annuities shine a bit better when interest rates are higher but, also are a great addition for must need income!

I think annuities can be a good choice in retirement to give you some level of guaranteed lifetime income. Seems to me that people dislike annities because of perception that they are giving over all their money and have an expectation that they can do better managing their money with stocks (yet most can't). Also I do think that some of the annuities like the variable annuities can be rip offs so this has clouded the image of annuities in general. A good annuity is a good financial instrument but a bad annuity is a ripoff.

I wonder if those that were not able to make wise enough investments to provide sufficient income (without touching principle) will have the ability to make the right choices on annuities.

The drum beat of financial advisors has been annuities are bad. This started way back in the 90's when the stock market was riding the tech bubble and people are convinced that they are bad. In some ways they are too complex for the average idividual to understand. Personally I do not full understand them so I can't comment intellegently. Could they be a good hedge? Possibly. But right now I don't trust alot of what people say.

If I were to go the annuity route with some of my money I would look to have several. I know the Knight of Columbus have annuities for as little as $25k I have not looked at vanguard because right now I am not shopping of an annuity.

My curiosity took me to the FAQ of vanguard and here are items that I saw that helped me.

Financial advisors usually recommend that you consider a deferred annuity only after you've contributed the maximum to other tax-favored retirement accounts, such as 401(k)s and IRAs. That's because annuities typically have higher costs than other retirement savings options.

Advantages of a deferred annuity compared with an IRA:

No IRS-imposed cap on how much you can contribute.
Not subject to the IRS requirement that you start withdrawing money after you turn age 70½.


Ponder this more I shall.

I dont get how an annuity is less risky or somehow more guaranteed than an asset allocation investment portfolio invested in stocks, bonds, REIT, bonds, and money instruments. The insurance company charges you a bunch of fees to take your money, then invest it right back in its own portfolio of stocks, bonds, REIT, bonds, and money instruments. So, there is no less real risk taken with the pool of money; its just that you a betting that you will outlive enough of the insurance companies other clients as well as the insurance company itself. perhaps one like jeffwestern wrote of might not be a bad gamble with that 50% or less of your investment portfolio, but as FMF points out, I know more people that have been burned by annuities than i have by someone who invested their assets in an asset allocation plan made up of stocks, bonds, REIT, bonds, and money instruments, or in mutual funds using a similar allocation plan.

First, nothing in your write-up mentions the type of annuity, but it is obvious the subject is immediate annuity and not variable annuity.
Second, it was mentioned "very few 401(k)’s offer a specific annuity option". Why would one put an annuity in a 401K? Not the place for them.
I wouldn't want an immediate annuity, but many years ago I opened a variable annuity with Fidelity and it has done better than any other investment I have: I picked the right fund. Their fees are much lower than the norm for annuities.

I've worked as an actuary in the variable annuity industry for nearly a decade. While the products aren't for everyone they do offer peace of mind that you will always have a minimum lifetime income stream to supplement social security. Diversifying the issuing companies (i.e. purchasing from multiple insurers) is also an import consideration to maintain this peace of mind.

However, the products aren't without their faults. The complexity and lack of transparency are two of the fundamental problems of the annuity industry. It is ridiculous to expect a consumer to read a 200 page prospectus for each product they are considering - let alone expect them to digest and make sense of this information.

To address these issues, I've created a free, unbiased website that provides reviews of the different products on the market. I actually read and digest these prospectuses and provide visual summaries, while pointing out some of the fine print to be aware of. If you are interested, these can be found at www.NoBullAnnuities.com - any feedback is appreciated!

I don't have a head for finances at all and hope y'all can help me out. Between my husband and I, I "hold the purse strings" and I am doing my best to save for our retirement. My situation is this:
1/ My husband does not know how to invest.
2/ He is a spender, not a saver, and I truly doubt I will ever get him to change or learn anything different.
3/ The men in his family live to a ripe old age (90+ easily) while I will surely die before him, I predict, in my 80s if I am lucky to live that long.

I know him well enough that when he sees all the money in our accounts after I die, he will just spend it without 'pacing' himself and will also not try to invest (or do so poorly) any savings we do have. My question is: is an annuity(ies) the way to go so that I can set up an account for him for the deposit to go into and that will be his biweekly "paycheck" (all other accounts can be with a different bank so he won't "see" it)? If it is not, what other options do I have?

@Grace,

If you want to ensure he can't blow through the money, an annuity seems like a pretty good way to do that. Another option would be a trust where ownership is given to someone else, kids if you have them, and then the terms of the trust would be such that the kids cannot touch the principle while he is alive. I believe it could be setup so that they could authorize him to draw down principle but the default would be that just the earnings are thrown off to him each year and not the principle. After he dies the kids or whoever the ownership was transferred to would get the remaining asset.

Either way, if you truly want to stop him from raiding the funds then you have to take ownership of the principle assets out of his control.

Here's a link to an essay written by the Wharton Financial Institutions Center on the importance of having at least some money invested in an annuity; http://fic.wharton.upenn.edu/fic/policy%20page/whartonessay18.pdf

@apex
Thanks! I'll keep your suggestions in mind as I continue to plan for our future.

I read all of these comments with great interest. I sell annuities and go to great length to make sure clients understand why annuities give them better value and stability. I think a lot of the bad press is caused by less than ethical sales people. Many of the comments here will help me teach my clients better so they can make a more informed choice. I still think many well known advisers do their readers a disservice by dismissing annuities as scams.

The best thing for any individual is to go talk to a licensed financial professional you can trust and let him develop a strategy for your specific situation. While there is some very valuable information on the internet, a lot of people take these opinions as gospel even though they have never met the author of these articles. Again, find someone you can TRUST and make sure that they'll be a good ally for the long haul, not just as a transactional broker.

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