Convert my 401(k) into an annuity?

[papadad111]

HELP. Was just looking at mega corp pension web site. For grins and running some numbers. Plan to FIRE next year in mid 40's.....

It shows a tiny little pension available to me. It also shows that I can take my entire 401K and turn it into an annuity starting right now.
The math says that the annuity pays approx 5.6% annually.. Just for grins, I ran some numbers - eg a $500K balance will return $2300/month (28K/yr) for life starting at age 46 . But No cola!! There are a few survivor options as well which will be considered for DW's benefit.

What might a rule of thumb be to determine what percentage of savings should be annuitized? I like the idea of being able to access money now in mid 40's via the annuity that I would otherwise not be able to be accessed til age 59.5 as a 401K .....at least, that's what I'm thinking. Is that how it works? Presume this is a form of 72T ...

The drawback of course is pension stability (going concern risk, but it's a well funded mega corp pension). Also the money is no longer growing tax deferred in equities. 5.6% is relatively low compared to long term historic stock market returns. That seems to be an average annuity rate today. Nothing special there... Aside faster access to 401k money ... (Not sure on that though).... There is no COLA feature, once locked that;s it. Inflation hopefully stays low for at least the first decade of FIRE. ?

The positive is annuitizing a percentage of retirement income now..at a younger age..and being able to use it now for FIRE... and therefore reducing risk associated with a black swan of a "long and protracted market down turn in the early years of retirement" by reducing overall total asset exposure to equities. Also I fear regulatory changes to 401K's... and of course tax rates could change in the future.

The monthly annuity payout covers ~ 30% of current estimated post - FIRE budget (pre tax). Remainder ~60% of expenses would be funded near term via post-tax account via annual withdraws (@ 3% SWR), and the remaining 10% expenses via rental income. Longer term, I woudl expect to cover inflation increases using IRA/Roth IRA withdraws (starting as early as 15 years from now) and then take SS @ 70. Finally for late life expenses/ longevity , would sale rental condo and primary residence and/or draw down of taxable asset accounts (SWR 4%-6%).....(leaving no inheritance as worst case scenario is an option too)...

Tell me what questions i need to ask, what am I missing, what is a reasonable percentage of total income to annuitize for an early retiree mid 40's (exclude SS since it's so far off) and am I crazy for going with a 5.6% return (hopefully many many years) vs keeping lump sum in the market and letting it ride....

My gut tells me that I have enough in taxable accounts that having some annuity "security" in addition to social security is a good, risk averse/safe approach.

Please chime in. thank you all.

 

[pb4uski]

I think the likelihood of a period of high inflation is more likely than a black swan event so I would not annuitize.

I think what I would do is to run annuitization vs not through firecalc and any other retirement planning tools I use and see which alternative results in higher success rates.

If a black swan occurs and you need access to your tax-deferred funds you can always 72t. Can you annuitize later if you wish to? I would think so.

 

[jerome len]

If you can leave your money tax free in the 401k I'd leave it in relatively safe investments for the next couple of years. Then, interest rates will increase, eventually, you'll be older and you'll get much more than the 5.6% they are offering now. On the other hand, if the security of $2300 month along with SS give you a secure feeling, do it! To me, life is good when I feel secure and financially worry free. It's your choice, each has its advantages.

 

[gauss]

Does the 5.6% payout rate vary with time as market interest rates change (if you were to delay). This is how normal annuities work. When market interest rates are low, annuities are expensive. When market interest rates are higher, the cost of an annuity decreases for the purchaser.

With interest rates likely to increase over the next 5 to 10 years, perhaps it would make sense to hold off annuitizing in this current low interest rate environment.

-gauss

 

[papadad111]

I think the likelihood of a period of high inflation is more likely than a black swan event so I would not annuitize.

I think what I would do is to run annuitization vs not through firecalc and any other retirement planning tools I use and see which alternative results in higher success rates.

If a black swan occurs and you need access to your tax-deferred funds you can always 72t. Can you annuitize later if you wish to? I would think so.

Thanks. Firecalc seems to point to slightly higher success rate by not annuitizing but I run it over a very long period. 40yrs +.

I do believe I can hold and annuitize later.

 

[papadad111]

Does the 5.6% payout rate vary with time as market interest rates change (if you were to delay). This is how normal annuities work. When market interest rates are low, annuities are expensive. When market interest rates are higher, the cost of an annuity decreases for the purchaser.

With interest rates likely to increase over the next 5 to 10 years, perhaps it would make sense to hold off annuitizing in this current low interest rate environment.

-gauss

Thanks. Yes I believe the rate of return of the annuity will rise as I grow older AND as rates rise.

I view this more as opportunity in buying an insurance policy at FIRE to lock in some assurance vs maximizing total asset returns at the cost of increasing risk.

 

[papadad111]

If you can leave your money tax free in the 401k I'd leave it in relatively safe investments for the next couple of years. Then, interest rates will increase, eventually, you'll be older and you'll get much more than the 5.6% they are offering now. On the other hand, if the security of $2300 month along with SS give you a secure feeling, do it! To me, life is good when I feel secure and financially worry free. It's your choice, each has its advantages.

Ya. It's more about that peaceful easy feeling than about maxing return. I think my other assets will be enough to live on UNLESS we see major down market issues, inflation beyond what market returns can generate etc. in those cases having a portion of total needs met with an annuity seems to make sense and 5.6 percent certainly is more than the 30 year long bond pays ...

Good thoughts.

Am still totally on the fence running the numbers and the emotional aspect of "security".

 

[brewer12345]

I would also carefully consider your tax position. If you have significant IRA assets that will need to be converted to Roth, withdrawn, etc. getting a pension going will likely "fill up" much of your 15% bracket that you might otherwise want to use to convert these assets.

 

[papadad111]

I would also carefully consider your tax position. If you have significant IRA assets that will need to be converted to Roth, withdrawn, etc. getting a pension going will likely "fill up" much of your 15% bracket that you might otherwise want to use to convert these assets.

Thanks brewer. I have little IRA assets outside the 401k. Most all other assets are taxable and thus would be at either dividends or LTCG rates.

This raises another question about how I might do a backdoor Roth and how that might apply here versus annuitizing the 401k

I think you all have talked myself out of an annuity thinking I can beat 5.6 percent over an extended period - and with about 15 years before touching that money it should do better than the current option. Also a 72 T could be used later if needed and instead draw from taxable accounts first and let the 401k just ride til the annuity value looks better. Just feels like a whole lot riding on the stock market but a revised more conservative AA could mitigate some of that risk.

 

[Chuckanut]

I would also carefully consider your tax position. If you have significant IRA assets that will need to be converted to Roth, withdrawn, etc. getting a pension going will likely "fill up" much of your 15% bracket that you might otherwise want to use to convert these assets.

Good advice. My pension pretty much means half of my planned Roth conversions would be in the higher bracket. Not so good.

On the other hand, it was the last time anybody was going to offer me a DB plan with a partial COLA. So I bought a few more years to balance my income sources. It seemed the right thing to do back then and still does.

 

[haha]

Ya. It's more about that peaceful easy feeling than about maxing return. I think my other assets will be enough to live on UNLESS we see major down market issues, inflation beyond what market returns can generate etc. in those cases having a portion of total needs met with an annuity seems to make sense and 5.6 percent certainly is more than the 30 year long bond pays ...

Except that your annuity will likely be worse off than a balanced portfolio in a period of strong inflation. IMO, current conditions are so unusual that it is complete folly to imagine that it is possible to forecast inflation rates. There is no security there, only an illusion of security.

Ha

 

[papadad111]

So back to original question-- how much as percentage of total portfolio should be annuitized ? Is there a rule of thumb. Eg. If total swr is 3.5 percent, 1 percent should be from annuitized assets ??




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[nun]

So back to original question-- how much as percentage of total portfolio should be annuitized ? Is there a rule of thumb. Eg. If total swr is 3.5 percent, 1 percent should be from annuitized assets ??




Sent from my iPhone using Early Retirement Forum

I'm looking at a similar situation myself, but I'll only be annuitizing 25% of my assets. Wade Pfau recently had an analysis of pension success replacing bonds with an annuity.....so maybe you should annuitize whatever percentage on your portfolio you had allocated to bonds and leave the rest in equities.

 

[papadad111]

Thanks. Helpful. Was following your post before Nun and was the genesis of my exploration on this.

I am thinking 20-25 percent of assets is a reasonable amount -- provides a degree/ level of security without jeopardizing a huge chunk of total investable assets. That would also exclude social security which, once eligible, would add to the annuitized percentage of portfolios ...

 

[38Chevy454]

Are you missing something in that if you stick with 401k and the company pension, you get the (small) pension and still have all your 401k savings. If you convert to annuity you have much less 401k and a non-COLA'd annuity.

Make sure you are comparing the pension plus full 401k potential income vs the annuity plus reduced 401k potential income.

I also agree that inflation is probably more likely than a huge market fall. Once you buy the annuity, you lock in the amount and no chance for increases.

 

[Cobra9777]

DW and I both have DB pensions that we took as annuities. The combined lump sum value represents 29% of our investment portfolio (including the lump sums). However, the annuities cover about 55% of our initial expenses. That percentage drops over time, as one of the pensions has no COLA, but then kicks back up with SS.

DW and I are very comfortable with those percentages, as a balanced approach to generating retirement income. There's definitely some inflation risk, so we may drift heavier on equities over time. And as others have mentioned, pension annuities are fully taxable as ordinary income, which is higher than CGs and QDs, and also has negative implications for Roth conversions and/or ACA subsidies.

Definitely a lot to think about when annuitizing a portion of one's portfolio. For us, it's about balance and diversification. I remember in the late 90s, Megacorp offered a one-time opportunity to switch from DB to DC with significant matching. It was the go-go days of the internet bubble, and I was one of the few who stayed with the DB pension. Reason: balance and diversification... I wanted some reasonable portion of my portfolio to grow regardless of what happened in the stock and bond markets. That worked out pretty well for me, so it seemed reasonable to stick with that strategy after retirement.

 

[Midpack]

So back to original question-- how much as percentage of total portfolio should be annuitized ? Is there a rule of thumb. Eg. If total swr is 3.5 percent, 1 percent should be from annuitized assets ??

There isn't a rule of thumb, and you should ignore anyone who provides one. The right answer is unique to each retiree and their circumstances. Just Google and read.

If you choose to annuitize at all, there are several schools of thought. Here's a poll that shows less than half annuitize more than 30% of their assets http://www.bogleheads.org/forum/viewtopic.php?t=66116. Several experts have recently suggested that retirees annuitize enough to cover their essential or "floor expenses" for life (after Soc Sec or other pensions, annuities), which is considerably more than 30% for most retirees - Pfau, Bernstein (recently), Otar to name a few. Otar goes as high as 100% if you're in his "red zone."

Whatever ever else, I would not annuitize now if I could avoid it, rates/payouts are at historical lows so it's a relatively bad deal right now. I'd leave the money in a 401k or roll it into an IRA for now, and preserve the option to annuitize later when rates improve. Once you annuitize, there's no undoing it...

 

[Chuckanut]

I'm looking at a similar situation myself, but I'll only be annuitizing 25% of my assets. Wade Pfau recently had an analysis of pension success replacing bonds with an annuity.....so maybe you should annuitize whatever percentage on your portfolio you had allocated to bonds and leave the rest in equities.

Didn't Dr. Pfau's study of a few years ago show that a SPIA and stocks combination was superior to the stocks/bond asset allocation we normally use?

 

[zinger1457]

I would agree with the others that with today's low interest rates now is not the best time to purchase an annuity. When/if the time comes to purchase an annuity do some research on the different insurance companies selling SPIA's, their ratings, and what options they have to offer. You can get annuities with an inflation option but the initial payout will be much less. Your current 401K custodian probably deals with only one insurance company and you might be able find a better deal with another company. It also might be a good idea to split up the amount you want to annuitize among several insurance companies. The chances of an insurer defaulting is probably pretty slim but if it does happen most states will only cover loses up to about $150K. When I looked at annuities a few years ago most recommended that no more than 25% of ones portfolio be invested in an annuity.

 

[68bucks]

I was curious about something that wasn't really clarified in this discussion. Can you annuitize a tax deferred account (IRA or 401) and draw from it before age 59-1/2 without the 10% penalty? That's what the OP was talking about doing here and I'm not sure if that is correct.

 

[zinger1457]

I was curious about something that wasn't really clarified in this discussion. Can you annuitize a tax deferred account (IRA or 401) and draw from it before age 59-1/2 without the 10% penalty? That's what the OP was talking about doing here and I'm not sure if that is correct.

Yes, an annuity as described meets the 72t requirement of substantially equal periodic payments over ones lifetime.

 

[unno2002]

[FONT=&quot]For federal employees, the equivalent of a 401k is the "Thrift Savings Plan" (TSP). Prior to and shortly after retirement I ran a TSP annuity estimate. If at my retirement I had chosen that option, and allocated $77,500 to it, and wanted an annuity for my lifetime and which would continue for my wife's lifetime, TSP would only have offered a FIXED annuity of $306 per month ($3,672/year). No inflation adjustment. If Julita and I both died (say in the same car accident) the daughter would have inherited nothing. [/FONT]
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[FONT=&quot]When you do the TSP annuity, it is locked in. You cannot increase or decrease the taxable payout to you.[/FONT]
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[FONT=&quot]As soon after retirement as was possible, I rolled my TSP money out into a privately managed account. What I did was a little move involved, but if you run a web search for “checkbook IRA” you’ll see the basics…[/FONT]
[FONT=&quot]
[/FONT]
[FONT=&quot]In early 2013 that account purchased as an asset owned by the account a house for $77,500. It is a 2 bedroom, 1 bath, 1 car garage, red brick structure, about 3 mile from the college. It is rented for $805/month. After tax, insurance, etc. it’s dumping around $7000 a year ($583/month) tax-deferred into the account. If we need it we can withdraw it, otherwise it can accumulate. I've been putting it back into improvements in the house. [/FONT]
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[FONT=&quot]$306/month locked-in taxable payment from the "guaranteed" annuity, principle guaranteed to disappear on the second death of myself or my spouse. [/FONT]
[FONT=&quot]
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[FONT=&quot]Or[/FONT]
[FONT=&quot]
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[FONT=&quot]$583/month taking the risks of rental real estate, the money falling into a tax deferred account to be withdrawn if needed. The asset remains owned hopefully appreciating, with potential for higher rents, and inheritance by heirs.[/FONT]

 

[brewer12345]

Thanks. Helpful. Was following your post before Nun and was the genesis of my exploration on this.

I am thinking 20-25 percent of assets is a reasonable amount -- provides a degree/ level of security without jeopardizing a huge chunk of total investable assets. That would also exclude social security which, once eligible, would add to the annuitized percentage of portfolios ...

Look up the work of Prof. Moshe Milevsky (Wade Pfau is his evil twin). His work suggests that something like 25% of assets is about the right proportion to maximize utility/consumption.

I expect to annuitize a 401k that is ca. 15% of my assets down the road. My ex-employer allows the use of 401k funds to supplement the payout of the cash balance pension and that is what I will do.

 

[nun]

Didn't Dr. Pfau's study of a few years ago show that a SPIA and stocks combination was superior to the stocks/bond asset allocation we normally use?

Yes, given the assumptions he used for his model....

 

[nun]

Look up the work of Prof. Moshe Milevsky (Wade Pfau is his evil twin). His work suggests that something like 25% of assets is about the right proportion to maximize utility/consumption.

I expect to annuitize a 401k that is ca. 15% of my assets down the road. My ex-employer allows the use of 401k funds to supplement the payout of the cash balance pension and that is what I will do.

Well my state DC plan is almost exactly 25% of my retirement savings and I like being able to start the income stream at 55...the one drawback is that I won't be able to rollover much from my IRA to my ROTH without going into the 15% tax bracket. Still the $20k COLA pension and $15k from rental income will cover my expenses; I'm on track to spend $32k in my first year of ER. Heck when SS and my UK state pension start I'll be in serious accumulation mode again.