Do annuities fit into an ER plan? (SWR-related)

[lwbarry]

Hi everyone,

I’ve lurked for a while on this board, even before I started grad school. Now I’m a grad student in financial planning and I’m writing a paper that discusses SWR, among other things. I have a question that I’m hoping people here could shed some light on.

Discussions of SWR seem to focus on investments, not insurance products like annuities. In other words, discussion focuses on what % of one’s investment portfolio one can safely withdraw each year. My background is squarely in investments, as opposed to insurance, so an investment-focused SWR discussion makes sense to me. However, the insurance industry spends a lot of time and money marketing products like annuities as a guaranteed way not to outlive your money. As an investment person, I admit I tend to be skeptical of the insurance industry (suspicious that the fees outweigh the benefits). As a future financial planner, though, I at least need to educate myself more about insurance, regardless of how often I ultimately recommend it once I understand it better.

My question is: Do you think it is desirable to use insurance products to meet some or all of one’s retirement income needs? Why or why not?

Thank you for any discussion this generates. I’ll check back regularly and respond to any posts.

Best, Leonard

 

[MasterBlaster]

I hope this isn't a sales pitch !

Perhaps one could make a case to fund an immediate annuity with part of your stash so that you have a "Can't Starve" income stream.

I think that for someone that is not an investor (or a good investor) an immediate annuity could be worth while.
I have thought about having my estate purchase one for the wife should I go to the other side.

My concern(s)/comments are:

1) Is the insurance company going to be around ?
2) Are their fees so high that I could do better on my own ?
3) Who knows what inflation will be like decades down the road so do I want to lock into a very long term inflexible commitment ?
4) In a way this is kind of like the defined Benefit pension plan(s) that are being discussed so much lately. Would you rather have the cash in hand, or the promise from an insurance company to pay you. There is a trust issue here.
5)The products that I have seen don't impress me much. They seem to benefit the sellers and the insurance company more than the buyer.

 

[haha]

My question is: Do you think it is desirable to use insurance products to meet some or all of one’s retirement income needs?  Why or why not?

I am too much of a risk seeker to be attracted to annuities. But a genuine expert with no axe to grind who sees a strong role for annuities is Prof. Robert Shiller of Yale University. Look at his website to see where he is going with the concept of insurance.

Ha

 

[free4now]

The consensus seems to be that annuities will result in a lower SWR and lower average terminal value than investments would.  

Also, the longer the time frame, the more investing beats annuities.  Since early retirement implies a long time frame, again annuities are not the ideal vehicle for most.

However, they do offer security and protections that you can't get from being in the market.

I subscribe to the Hulbert newsletter, and he recently had an article that made a very convincing case that buy and hold is not an easy strategy to execute.  In fact many people who say they are buy and hold investors end up bailing out when the chips are down, and often at the worst possible time, losing a significant portion of their nest egg in the process.

As you get older and less mentally there, I think there is something to be said for getting out of the investment game in your later years.  There is a reason that con men prey on old people.

 

[REWahoo]

lwbarry,

At the risk of being rude, I've just got to ask this question:

Since you've lurked here for a while, you know this forum doesn't hold financial salesmen planners in very high regard. I'm just curious as to why a "financial planner in training" would come to this forum and ask for our assistance in helping you write a paper?

Are you trying to gain intelligence on how you can overcome objections for your future annuity sales career?

 

[free4now]

I think it's great that you're trying to learn the real facts rather then just learning to regurgitate sales pitches. Don't let REWahoo or anyone scare you off these boards (well at least not until you start trying to sell!)

 

[BigMoneyJim]

Heh, we're touchy about potential sales pitches, but lwbarry seems legitimate enough to me so far. He has a couple of posts back in 2003.

He's not an FP yet, so he may not be evil yet.

However, the insurance industry spends a lot of time and money marketing products like annuities [. . . .]

I wonder why they spend a lot of time and money doing that? Who pays for the marketing? At least in mutual funds they show up as 12b-1 fees.

Anyhoo, my take is that they believe they'll come out ahead on the deal most or all of the time, and that alone is enough to make me run away screaming. I might eventually consider an annuity if I find the situation really fits or if I'm leaving income for a dependent who doesn't have investing confidence, but for now I steer clear of them.

 

[unclemick]

Yep

I'm getting old - I love con men.

My annuity - I call SS.

heh heh heh heh heh heh

Only wish my rinky dink pension was COLA'd.

Do they provide ' a core budget' for my frugal/survival mode?
Right now at 62/63 yes - ?in twenty years should the mental go or Mr Market turn against me - don't know.

Prior years (49-55) - real estate income plus stock dividends.
age 55 - 62 - small non cola pension plus dividends.

So I have sympathy for a 'core/backup/secure' income base - however an individual ER chooses to construct it.

Past heartburn has always been with the expenses charged by many annuities.

 

[lwbarry]

Thanks everyone for your replies so far. I don't even like to use the terms "financial planning" or "financial planner" because they are so associated with salespeople instead of people who are actually in business to help clients. By "people who are actually in business to help clients," I mean fee-only planners who receive no commissions whatsoever. While there are some ethical salespeople (is that an oxymoron?) in this world, there are just too many conflicts of interest in the commission-based business model for it to make any sense to me, or for me to be ethically comfortable with it.

I've spoken with a couple of fee-only planners I respect who have told me that the best way to break into the business is to go work somewhere like American Express (now Ameriprise) to get the experience, even if you don't stay with a firm like that for the long term. My response to that has been, and still is, "if the choice is getting into the business that way or not getting into the business at all, I don't want to be in the business."

The professor for the class I'm currently taking has an insurance background. To his credit, I don't think he's pushing insurance over investments, but we had a few handouts this week on annuities. I thought that even after a few insurance classes, I'm still not as knowledgeable about annuities and such as I'd like to be, precisely because I'm an investing, indexing, buy and hold low cost funds kind of person. I lurk on this forum, read the Retire Early home page, lurk and post on the Vanguard Diehards forum on Morningstar's web site, etc. etc. I'm currently rereading Bernstein's 4 Pillars of Investing. I have many years of self-taught investing background and precisely no experience with insurance other than buying auto and home policies. So when I see something like an annuity, I'm skeptical for all the reasons that MasterBlaster mentioned. But I also want to at least understand them better. Frankly, I doubt I could ever recommend an annuity to very many people, because I'm so firmly on the investing side already, again for the reasons that MasterBlaster mentioned. But when there is something that I feel I don't know enough about, I want to at least understand it better. So I posted here because I know that people on this forum come from the investing mindset that I respect, but might also be able to comment on why or why not something like an annuity would make sense. One might ask, why not post on an insurance forum, but those forums are populated with insurance salespeople, so the so-called benefits of insurance are self-evident to them and their responses would not be valuable to me, nor would they generate discussion that would be useful to me or anyone else.

I hope that helps clarify the reason for my post. I hope this thread generates more discussion.

Best, Leonard

PS One final note is that I'm not in business now as a "financial planner" and probably won't be for a while. If and when I am in business, you won't hear any sales pitches. I respect forums like this too much for that.

 

[azanon]

Leonard,

I dont like annuities because on average you lose (compared to not using them). This is why i dont like any insurance really. If you didn't lose on average, the insurance companies wouldn't make money. This is not to say i dont have insurace though. I have medical (feds pay 75% of the bill), minimal auto insurance, and property insurance (the bank insists on it). I never, ever buy insurance on consumer items.

Annuities: they take your money, invest it, give you a portion of the profits and keep the rest for themselves. After you die, they also keep the entirity of the principle.

Honestly, the most amazing thing to me is anyone that finds that even potentially appealing since it is so obviously a scam.

If the appealing thing is cause you get a payment for the rest of your life, well hells bells, hand a million dollars over to me and i'll gladly agree to pay you 30K a year for the rest of your life. I will even sign the contract with my blood.

Azanon

 

[brewer12345]

Leonard:

Don't let the grouches here scare you off.  I think its great that you are planning on going the fee-only route.  There are a lot of people out there who need more help than most of the posters here, and the more fee-only ethical advisors there are, the better, IMO.  Have you looked at the Garrett Financial Planning Network or Ayco as places to work/start a business?

In answer to your question about annuities, I think it depends on the type of annuity and the investor in question.  Most variable annuities that have guarantees (minimum withdrawal, minimum death beneft, etc.) are a horrendously bad deal and typically have annual expense ratios in the range of 3+%.  Very low fee variable annuities (like those sold by Vanguard and TIAA-CREF) might be applicable for investors in very high tax brackets.  For portfolio survival, most people concentrate on payout annuities.  I have seen fairly convincing studies indicating small positive and negative effects on overall survival and maintenance of standard of living, which leads me to suspect that the effect is likely minimal or neutral.  Since you give up a lot of flexibility and take substantial credit risk by plunking a big chunk of money into a payout annuity, it doesn't seem like it is worth the risk.

Please keep posting here.  I find that financial planners who keep up with the literature usually run across interesting stuff to share.

 

[cute fuzzy bunny]

Use the Force lwbarry. Dont be drawn to the Dark Side.

 

[unclemick]

Hmmm

Way, way beyond my area of knowledge. But I suspect, don't know for sure - that there is a large pool of people where annuities have a role - in preventing them from having to make financial decisions of any kind(I looked into this a little for Mom and the SO at one time), a need to have minimal assets for political/legal reasons estate and qualification wise for various forms of assistance and older people with a relatively small portfolio who want to party harder until they croak.

This gets very complex - very fast - because of the variety of scenarios possible.

I'm at a loss - as to what kind of strawman to set up for a pro and con analysis.

A toss out: My mom in the PacNW - age 72, widows SS say 1k/mo plus 100k in Vanguard Lifestrategy Income. No nursing home insurance - bad arthritis in the hip, high bp - could still get around. The 100k in assets caused heartburn in the eyes of government for various forms of assistance - logic is not their strongpoint.

So 1k plus whatever 100k can earn VS my guestimate of 1.5k average expenses with no reserves at all.

I looked at annuities and passed. Sold the house and brought her to live with us in LA - for personal as well as financial reasons. She died at 89.

I have no knowledge of population groups in age brackets, levels of education and current government reg.'s - but they continue to piss me off when it comes to assets as an income generator. FEMA being the latest.

Me and the Norwegian widow may stop voting someday.

Heh heh heh heh

This forum is the wrong place - but there is a vast pool of 'people' out there - who have no clue, don't know what in the world you are taking about, and could care less.

WARNING! This be my first cup of coffee post - I slept in!

heh heh

 

[cute fuzzy bunny]

Just a thought without even a moment of further consideration...wouldnt an all-tips/ibonds portfolio be just as safe and produce as much income as an annuity, and for just as long?

Way too far out for me to have given it more than a passing glance, but like some other discussions we've had recently, anything that only looks good if you live longer than you're supposed to and provides a great income when you're in those final years vs a stronger balance sheet/income stream when you're younger almost automatically gets the gong.

A lot of folks point to the depression or the 60's/70's 'stagflation' period as reminders of how grim things can get...stuff that makes annuities look like a good idea. I think you have to consider that in periods like that, a disciplined person with the sort of financial standing that would be considering an annuity as a portion of their portfolio is still going to be well enough off financially vs 'everyone else' as to be in pretty good shape.

I guess its as simple as that old joke where the two hunters are charged by a grizzly bear. One stops to take off his boots and put on his sneakers. The other says "Bob! You cant outrun that bear!". Bob says "I dont have to outrun the bear, I just have to outrun YOU!".

Chances are pretty good that even in a really tough economic period, we're going to be Bob's.

Of course, if you're holding a shitload of debt and investing it like a margin loan, and you're arbitraging all sorts of stuff and rolling six figures of credit card money by flipping 0% deals and/or depending on low interest rates...you might be the bears lunch instead.

Two sides to this equation...making sure you have a certifiable income stream...or making sure you dont really need much of one.

 

[brewer12345]

Just a thought without even a moment of further consideration...wouldnt an all-tips/ibonds portfolio be just as safe and produce as much income as an annuity, and for just as long?

Maybe. The difference is that the insurance company that seels you an annuity is taking on the risk that you will outlive the tips/i-bonds portfolio.

 

[Nords]

Maybe.  The difference is that the insurance company that seels you an annuity is taking on the risk that you will outlive the tips/i-bonds portfolio.

I don't have a problem with annuities-- I think they're great.

But I object to their high costs, high expenses, and limited liquidity. I wouldn't buy a loaded mutual fund and I won't buy an annuity either, because there are too many other low-risk ways to achieve the same goal without having to wear both belt & suspenders.

 

[brewer12345]

I don't have a problem with annuities-- I think they're great.

But I object to their high costs, high expenses, and limited liquidity.  I wouldn't buy a loaded mutual fund and I won't buy an annuity either, because there are too many other low-risk ways to achieve the same goal without having to wear both belt & suspenders.

Umm, but are you mixing up products here? Variable annuities do indeed commonly include obscene expenses and/or commissions. Fixed and immediate annuities don't include explicit ones (although the insurer generally pays the agent a commission that gets reflected in the rate paid to the policyholder). You can buy the annuity version of a no load mutual fund from several companies. Annuities are like any other investment oroduct: caveat emptor. But like any mutual fund, they may be suitable for some people.

 

[Peter]

there are too many other low-risk ways to achieve the same goal without having to wear both belt & suspenders.

I've heard this said by a number of people on this board. But the #1 feature of annunities, at least from my perspective, is that there is an income stream that will go on forever.

Yes, there is a small risk of insurer default, and yes, there is inflation to be considered, but AFAIK there is no other product that offers the same guarantee.

Unless, of course, you are the recipient of a government pension ...

Personally, I wouldn't put all my money into annunities, but I don't think it's right to condemn the concept in blanket fashion.

Peter

 

[73ss454]

No one is condeming the concept just the fees.

 

[ats5g]

Leonard,

Here are some articles to ponder:

From William Reichenstein Critique of why some believe annuities are better than mutual funds

From William Bernstein: A Limited Case for Variable Annuities

From John Ameriks, Robert Veres, Mark J. Warshawsky: Making Retirement Income Last a Lifetime - discusses adding annuities to a portfolio and SWRs

From Moshe Milevsky and Peng Chen: Merging Asset Allocation and Longevity Insurance: An Optimal Perspective on Payout Annuities

Thus, in some sense we are advocating a classical economic “separation theorem” argument. We claim that the first step of a well-balanced retirement plan is to locate a suitable mix of risky and risk-free assets independently of their mortality-contingent status. Then, once a comfortable balance has been struck between risk and return, the annuitization decision should be viewed as a second-step “overlay” that is placed on top of the existing asset mix. And, depending on the strength of bequest motives and subjective health assessments, the optimal annuitized fraction will follow.

Remember that if one believes that one can use stocks and REITs, in addition to bonds, to "fight inflation in retirement," one can still "purchase" longevity insurance by annuitizing stocks, REITs, and bonds in a variable payout annuity. So one doesn't have to chose b/w only using a fixed immediate annuity and no annuity.

I can certainly use Vanguard's "balanced annuity" for an immediate variable annuity. After all this "balanced annuity" is just VWELX wrapped into an annuity, for only 0.56%.

- Alec

 

[lwbarry]

Thanks all for the replies. I'm glad this thread generated more discussion.

Brewer: I'm familiar with the Garrett Planning Network but haven't heard of Ayco. I'll look into it. Are you familiar with the Cambridge Advisors? cambridgeadvisors.com It is a network of planners that seems sound to me so far. They focus a lot on tax work, more than most planners do. That is something I'm considering, although I haven't looked into it seriously.

You mentioned studies of annuities. Do you have cites or links for any of those? I understand if not--I myself tend to come across things and read them but not keep good enough track for later.

When you say "payout annuity," are you talking about an immediate annuity, where you put money in and then immediately start receiving payments?

Peter: AFAIK insurance companies are the only non-governmental entities that can use the term "guaranteed" with their products. As you note, there is still default risk and inflation risk, but regardless, insurance companies can use the term. I do grant that the default risk is small if you choose a reputable and highly rated company, but it's still something to make me think twice if I were to buy an annuity. In today's rapidly changing business environment, how can one be sure that any company will be around in 30 years to meet its obligations?

Alec: thanks for the cites. I'll check them out. I am really interested to read some well-written articles on this topic. Often, if you're an investment person, it ends up being an article of faith that investments are better, and vice versa if you're an insurance person. I want to read good articles so I'm equipped to discuss these issues intelligently.

Best to all,
Leonard

 

[Gone4Good]

Annuities have there place, but probably not for early retirees.  I plan to retire around 40 and I doubt I could find an attractive annuity to "guarantee" lifetime income for me and my wife over the next 60 years.  

Default risk is also more of a concern then you may think and is probably improperly priced into the annuity.  I don't have the study handy but I think the 20 year cumulative default rate for 'Aaa' rated companies is around 2% - probably more than double that for a 40 year period.  Try selling a product that supposedly "guarantees" life-time income while simultaneously disclosing that the "guaranteed" income stream has a 1 in 25 chance of dropping to zero at some point before the recipient dies.  

 

[cute fuzzy bunny]

I can certainly use Vanguard's "balanced annuity" for an immediate variable annuity. After all this "balanced annuity" is just VWELX wrapped into an annuity, for only 0.56%.

Probably a good pick. Just for those keeping score, using this fund option for me and my wife 44 years old, joint with 100% survivor, inflation adjusted (cpi-u), per $500k you'd get a little under 16k a year. SWR on a similar mix held in a taxable port would be $21,500 @ 95% survivability for 40 years per firecalc.

So you're paying roughly...what is that...about 22% premium for the 'safety', sub off the odds of the insurer (looks like vanguard is using AIG? Thats what the link to give the online quote started with), sub off or add in the odds that CPI-U will over or understate actual inflation, and sub off the odds that you'll live past the 40 year run I did for firecalc.

Doesnt completely suck. I'd rather do that than hold a 100% tips port or sit in cash for years waiting for the correction...

 

[brewer12345]

Yrs and I have had this discussion before, but lets just say that not all Aaa-rated insurers are created equal. Prudence dictates that one should not have too much exposure to any one credit, but I would have few qualms about buying an annuity from the largest, most highly-rated mutual and fraternal insurers, assuming I ever could be convinced that such a product made any sense foe me (it doesn't).

 

[greg]

Leonard:

As a future financial planner educator of people in or preparing for retirement, you should certainly spend a decent amount of time examining annuities. Many people, including me, like the security of knowing that certain amount of money will arrive in their checking account every month no matter what. It's not just soothing, it is a habit that has been acquired over many years of working. People here because they have been planning for retirement for many years already have a comfort with retirement products and carefully managing their own money. Others oftentimes just want to go into retirement with things remaining exactly like their work years but without the work . It's your job to discern where the client student is coming from and how to make their dreams or security real.

Sometimes the extra fees involved with some annuities are well worth that good feeling or knowledge of a check coming in every month. Not everyone wants to hash out whether or not 1-2% in fees each year is justifiable. This annuity issue also becomes more important as older type defined benefit plans decrease in availability, and people need a replacement product. I think your job should be to understand these changing environments (e.g. people's psychological changes and differences, the market's financial products, the changing world of monetary policy :, etc.) Continuity and stability are important factors in retirement. So a portion of monies transformed into a steady stream of checks should not be underweighted in your thinking. Nor overweighted.

My own plan lately has been to build a bond/CD ladder about 5 years out for this steady supply of income. As I age and wither away , I suspect this will be replaced with 5 to 10 year fixed, immediate annuities so that my financial decisions decrease in importance over time and also are reduced in frequency. Unless I'm still sharp as a tack, then I might apply for Warren Buffet's job. Part of his job description is eating cheeseburgers and playing bridge, isn't it?

--Greg