Question about annuities (annuity, bond, judgement, fund)

[HawaiiLover]

I have some money that I'd like to invest, but not sure which way to go. One thought is buying two or three $100,00 fixed annuities to generate more income for about 25 years. (I am 63 and want to start the extra income at age 65) I will still have more money to invest in my 401K that is already monitored by Fidelity. Or, should I put all the money in my 401K, which is at low risk. I have been doing pretty good in the stock market this year, but, that could change at any time. Any thoughts?

[Pilgrim21784]

I don't have a perfect answer for you (big surprise ) but some considerations might be helpful:

1) The current, extremely low interest rates (IR) mean that annuity contracts will be priced with very low payouts (in the context of being compared to previous higher interest rate levels not too long ago). Annuities are constructed based off the IR levels current at the month of purchase - low rates means lower payouts.

The last annuity rate index I came across in recent months was at 2.125% - thats REALLY bottom of the barrel. Given the presumption that QE will have to taper off (as repeatedly announced by the Fed) over the near/midterm period and consequently likely create rising IRs, its generally a no brainer to hold off purchasing any annuity contract(s) until we see what the end of QE does to IR levels.

2) My comments in 1) above are not based on opinion, just derived from current factual information. What follows IS my opinion, just that, no promises or warranties :

Whether you should alternatively dump the assumed $300K into your 401K is a judgement call. Personally, I wouldn't, based on the presumption that the end of QE will create some as yet unknown level of froth in the markets and I wouldn't want to risk funds I had designated for secure income streams. That is, as noted - JMO.

3) Whether annuities make sense to you is obviously a personal decision. IMO, they can possibly be useful in some limited circumstances but I'm not a huge fan of them. Most especially with anything other than a very plain vanilla, fixed variety with inflation adjustment features from a rock solid company.

I'm much more fond of simply using personally calculated, item specific inflation adjusted* cash stashes to cover BLEs (basic living expense items) for multiple years. It simply removes one from having to consider market risk, annuity company risk and related considerations.

* I calculate a rolling five year price increase factor for each of my major BLEs (RE taxes, food, utilities, insurances, etc.) and use it to establish a cash stash to cover those anticipated expenses for X number of years. Its certainly not perfect but is much more accurate than using a unitary CPI measurement which doesn't have much relevancy to my actual experienced costs.

My BLE expense increases have been increasing at way more than double the official CPI measurements in most cases since I retired in 2007. (Actually, they've been doing that for many years. The CPI is useful for macro economic analysis but not of much use for real world personal expenses projections.)

The foregoing is probably a bit obtuse - think of it this way: my RE taxes are X, in the previous five years they have risen at an annually compounded rate of Y. I want to set aside a cash amount that will cover the annual RE tax costs for Z number of years. Simple math gives me a useable value to designate a cash chunk to cover that expense.

Is my approach a plan that maximizes my future income streams? Nope. Does it allow me to ignore the market/company/etc. risk factors? Yep. Its based on my intent to minimize the attention to I need to pay to managing retirement resources going forward.

My non-BLE "fun money" is in the market. If things go well, I've more to spend on travel, etc. as well as move profits into my BLE cash accounts and extend the number of years where I don't care what the markets are doing. If things don't go well, I've no need to care about covering our basic living costs. It works for me .

Hope the foregoing has been of some use to you.

PS - I'd rather be Makawao myself, but its just too pricey for me. The Maui burger at the Stopwatch was probably the best dead cow I've ever eaten.

[mathjak107]

immeadiate annuities work best around age 70. not only are the mortality credits much larger but rates should be much higher by then.

another thought might be longevity insurance later on .

you can spend much more now while you are young without fear of overspending down.

if you live you can have the insurance kick in around 78-80 and if you die before , well dead is dead .

it is much cheaper than an annuity product and i have to admit it looks interesting.

[MrWillys]

Annuties are only as good as the company you purchase it from. If they go under so does your cash. If you contact Fidelity about bond laddering you could spread that $100,000 out over 10 companies, and bonds would mature annually, so they can be reinvested t higher rates as interst rises. I just see it as spreading out the risk in the most secure way. If one company goes under you've only lost $10,000 instead.

Plus you leave money to heirs, and not insurance companies.

[mathjak107]

that is not true at all, annuities are guaranteed up to certain maximums by every state. you can click and see what my own state ny covers.

http://www.dfs.ny.gov/insurance/ogco2008/rg080206.htm

there is a whole load of myths and mis-information out there about annuity products.

while im not for or against annuities they do offer advantages that you can not do on your own. for one thing the payouts are higher than any bond your are going to get . in fact they can be 35-50% higher. you can get a 5.89% draw today that can be passed to a spouse. a 30 year bond is 3.69% . you have to go out to 30 years to see that too..

you are also still held at the mercy of markets and interest rates if you go about it on your own . annuities give you diversification into something you can't buy on your own, DEAD BODIES.

THATS WHY NO HIGH QUALITY BOND YOU CAN BUY CAN COMPETE.

As crappy as things are out there in can be many years before a bond ladder plus what was given up while waiting equals that annuity.

What happens over years when rates cycle and fall again as bonds get renewed.

you also get to shed some of that market risk onto a 3rd party .

in effect you are buying a pension and that can help stabilize things as well.

the disadvantage is liquidity and giving up your money when you or you and your spouse die.

a combination of 25-50% immediate annuities and your own investing has been shown to leave you with not only a much higher success rate of not outliving your money but with more money left at the end for your heirs then if you didn't buy the annuity.

that was in a landmark paper called Making Retirement Income Last A Lifetime" by Ameriks, Veres, and Warshawsky published in the Journal of Financial Planning in 2001.

more recent research by two of todays foremost researchers dr wade pfau and michael kitces took another look at annuities . v the study was completed just the last few weeks.

interestingly enough they showed that to duplicate the annuity's effect when combined with your own investing you would have to increase your allocations by 1% a year on your own to end up with the same balance left over.

if you took an annuity to cover your basic spending and left your equities to grow and used them to cover inflation adjusting you would have an amazingly high chance of not only not running out of money but even after purchasing that annuity you would still have more money left over than had you not bought it.

not many retirees are going to increase equity allocations as they age so in a nut shell the annuity coupled with your own investing will beat your own success going at it on your own.


anyway here is the current study and don't listen to anyone who just shoots from the hip as to what they belive is true.

http://www.kitces.com/blog/archives/...inability.html

[mathjak107]

I just wanted to add an explanation as to why the annuities and your own investing will leave you with more money then if you didn't buy it.

When you buy enough annuities to cover your basic bills you are leaving your equities to grow. In effect the annuity is like a pension . If you put 50% in equities and 50% into an annuity you would have a 50/50 mix.

As you got older and older the annuity would get closer to stopping,we can assume by age 100 it will end . By age 80 you can figure that annuity as 20% vs equities which may be at 80% at this point.

In reality you have increased your allocations to equities by spending down the annuity. It is that increased allocation through the years to equities that grew your money.

You could do the same thing dr pfau and michael kitces said by spending down bonds and cash first allowing allocations to equities to rise by 1% a year.

That is in contrast to spending down evenly from a 50/50 mix of equities and bonds and trying to maintain that 50/50 relationship through retirement.

That left less money at the end and had a higher failure rate then increasing stock allocations by spending down cash and bonds first.

If anyone thought this stuff is easy to figure out you were very wrong.

It is a lot more complex to get right then buy an annuity or buy a bond ladder.

There are retirement researchers like pfau and kitces that devote their lives and brain power to crunching endless numbers and data to set the structure for the financial planning industry.

[mathjak107]

one thing i want to caution about the bond ladder is the first five years of a retirement are the most crucial to the entire outcome. 15 years seems to have set the die totally as to whether a retirement will fail and run out of money.

getting hit early on with bad markets can be one of the worst things that can happen to a new retiree.

the much higher payouts early on of an annuity compared to a bond ladder can add years of sustainability to your portfolio with the higher cash flow.

in later years after your portfolio has gone through some market cycles and built up a cushion the sequence of bad markets has much less of an effect.

if it looks like i have had quite a bit to say about annuities it is because they have always been of interest to me as to whether they are still the red headed step child of investing.

in a nutshell older ones were terrible and even some of the newer ones can be expensive . while vanguard and fidelity offer lower cost ones the devil is in the details as far as what you are not getting that makes them so low cost compared to others.

looking at the fidelity growth and income variable annuity as an example there is no guaranteed minimum death benefit. they guarantee you 6% of your highest value a year . sounds great right ?

well fees take away 2% so now we are at 4%.. add minimum value death benefit protection for .75% and we are down to almost 3% as a guarantee.

buying an immeadiate annuity has made things simple. it is like buying a pension . if you like the draw rate then that is the entire deal.

whether it is for you is another story.

to be honest if you are just going to throw your money into one without a goal or reason then i would say no.

if you are using it as a strategy to improve your portfolio success rate and or to leave more money for your heirs then yes i think they can be worthwhile.

it is not the product that is going to decide if it is worth it , it will be your own usage of it.

[MrWillys]

Please keep in mind that an insurer can go broke, and have gone broke. Anyone ever heard of AIG? While there are state funds in case of such a situation. None are funded like the FDIC. Not to mention, when you pass the insurance company gets the money. I'm not against annuities, and have some short term ones myself, but I would avoid going all the way where the salesman is drooling over his commissions.
The premise of the above argument against bond laddering is based solely on another economic collapse such as what occurred in 2008. With the current money printing that's been going on, how many of you think interest rates will drop to the record lows we saw in the past year? I've recently created 5 year ladders that return 4% with nothing lower than AA, A1. As they expire, and rates rise, you buy into more with even higher returns.
I just pointed out laddering as an option of consideration, and especially now with annuities having such low rates. Laddering can work upwards as rates rise, but the annuity is what it is. Buying one now just seems foolish. Remember, Investments are only what you can afford to lose.

[mathjak107]

no one lost a penny to date in any insurance company and that is all that counts not even AIG. in fact insurance companies that operate in most states must agree to accept the clients from any failed insurance company and honor their plans. any companies that went belly up had their clients absorbed.

you are also wrong about the laddering and that the results were based only on 2008.

i suggest you read the data in the study as it was back tested through many many time frames all with the same results. the ladder produces way less income the first 5 years in almost all cases. that reduces the need to spend from the equities bucket and thats where the annuity mix with the equities takes off.

in fact you can read this interesting study by dr pfau

.http://www.hullfinancialplanning.com...wade-pfau-cfa/

[Willy702]

Originally Posted by mathjak107

no one lost a penny to date in any insurance company and that is all that counts not even AIG. in fact insurance companies that operate in most states must agree to accept the clients from any failed insurance company and honor their plans. any companies that went belly up had their clients absorbed.

you are also wrong about the laddering and that the results were based only on 2008.

i suggest you read the data in the study as it was back tested through many many time frames all with the same results. the ladder produces way less income the first 5 years in almost all cases. that reduces the need to spend from the equities bucket and thats where the annuity mix with the equities takes off.

in fact you can read this interesting study by dr pfau

.Do You Need Bonds in Retirement? An Interview With Wade Pfau | Hull Financial Planning

Money has and will be lost from poorly rated insurance companies. AIG is a bad example to discuss because they are a conglomerate of lots of companies, some riskier than others. The part selling derivatives which blew up wasn't tied into the same pool of funds which covered homeowners insurance for example. The basic types of insurance every one has are generally always safe and not something to worry much about. States regularly review their reserves and if they get risky they will shut them down. These are the ones who will get picked up by others at the same terms.

Life companies are different and this is generally where annuities go. They aren't out selling derivatives to my knowledge, but bad underwriting could bring them down. Few have gone down in recent decades because lifespans have been extending. This has offset the costs to pay off customers who got much higher contract rates on their money. Going forward who knows what might happen, if some major epidemic kills a quarter of the population lots of life policies are not going to get paid.