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choosing annuity or investing is never the best choices . there are cons enough to both that both can end up not ending well.
the real power of an annuity , especially a cheap immediate annuity is its ability to work together with your own investing and let investments grow longer or even with higher allocations to growth vehicles then they can do on their own.
A number of retired relatives are financing most of their retirement through Annuities. They are guaranteed a certain payout for a certain period, or the rest of their lives. The trouble is they are only getting about 4% of their principal each year in the annuity and once they die there is nothing left for their kids.
A more logical approach, with just slightly more risk, is putting the majority of their assets in stocks in the ten highest yielding Dividend Aristocrats. The stocks in the Dividend Aristocrats have never cut their dividends historically dating back over 25 years or more, regardless of the stock market and economy, and have instead, increased their dividends on an annual basis even during the worst bear markets and economic crisis periods. (Such as the blood baths of the 2000-2002 and 2008-2010 bear markets.)
Sure, the main value of these stocks in the Dividend Aristocrats Index, will go up and down, but that is just noise because they allow you to live on the dividends. As long as the dividends keep paying at the historical rate, you are not concerned about the day by day price of the actual stock in that index, you will never sell it in your lifetime.
Lets assume you live for twenty years after retirement, the value of the stocks you buy that are part of the Dividend Aristocrats could be higher or lower than when you purchased them- at your death, but there is a 99% chance they are worth something for your kid's inheritance, which is much more than ZERO for annuities.
If you have kids then an annuity is not the place to put your money. They'll get nothing of that annuity.
Also most annuities wind up paying between 0% and 5% (very best case scenario) over an entire lifetime.
Finally, yes a retiree needs more high dividend and "safe" stocks like consumer staples, but most of their portfolio should be bonds. They may not pay much in the next few years as interest rats rise, but that just means that stocks will do well. Money always goes to one or the other. Then you keep re balancing.
this is where you would be wrong if combining the annuity and investing .
if you use the annuity to replace cash,bonds and dividends then over time you would be spending down the cash and bonds bucket to zero anyway as well as pieces of your equity's with each dividend payment not reinvested but spent . .
trying to pull 4% or more INFLATION ADJUSTED will require spending down principal to keep up when cash is near 1% , bonds are 2 to 3 % and dividends in effect if you spend them are like selling off equity value and the higher the dividend pay out not reinvested the more it is prematurely pulling value out of the equity bucket cutting long term compounding on that money .
in effect you are selling stock whether you realize it or not and depleting to zero your spending bucks of cash ..
so 15 or 16 years down the road the money for spending will need to be refilled from equitys as it will be gone regardless whether used to buy the annuity or spent down to live on because you didn't buy one ..
the annuity is merely utilizing the same money you would have spent to zero anyway from your cash bucket .
in both cases the amount left will be zero in that spending bucket .
only with the annuity the income never stops so when you go to refill you need a lot less equity selling down the road since you always have the base income flowing .
historically using more bonds in retirement then equity has resulted in more failures where over the worst time frames the money ended before you do , it has resulted in lower incomes and less for heirs so anything under 40% equity's has failed to many times to be acceptable unless 2% inflation adjusted withdrawals are used .
compared to 4% withdrawals that would be a 50% cut in pay.
the optimum allocation for best results has been a 50/50 mix for the highest success rate or for never a failure ,50% equity's /25% bonds /25% single premium annuity .
the more conservative the portfolio the more the annuity benefits you .
to see how the various asset allocations would have failed in the past this chart is a summary . anything higher than 10% failure rate is unacceptable .
these are results using a single premuim annuity
Last edited by mathjak107; 08-23-2015 at 03:40 AM..
keep in mind when rates rise those retirees loaded up on bonds are going to freak when they see those losses . just like we saw in july where every bond fund had negative returns when bond rates rise that is what will happen.
we never had a long term bond bear market before as even the blip upward we had were really just bumps in the road in a 40 year bond bull market .
but once we start to go back toward historical norms bonds will be a losing deal and unlike equity's which tend to recover fairly quick you may not live long enough to see an interest rate cycle they take so long .
you can see for 40 years bonds really had a great ride before bottoming out last feb and climbing upward.
My simpleton view is that comparing just percentages is near worthless. If an annuity pays 5%, then I need to know 5% of what, and how much if that is taxed. The same for dividends. While it sounds great that a T has traditionally paid a 6.5% dividend, it is 6.5% of what? If you are drawing it as income, and the amount isn't required to meet needs, but you just want to maximize, you have to look at the after tax amount. When dividends are declared quarterly, you have to look at what the stock cost you, and the amount you are getting, and how it is taxed. The OP started with one question, paraphrased, "relatives funding their retirement with annuity should use blue chip dividend payers instead", then changed it to "when I die, I want the investment potfolio to be worth something, and make more money along the way".
Two totally different objectives. The first is "retirement income" vs the second, which is "growth for accumulation". Duh, no one buys annuities for growth for accumulation! Of those two choices, everyone wants the second one. Reality is, what is the TOTAL worth of the two, untouched after taxes, after X years is what matters, IF YOU DON'T need it for income. If you don't NEED either one to generate income, but instead just let each accumulate, you could be cost average buying equities with the annuity income vs the same for the dividends of the blue chips. In the long term, after taxes which has the higher probability of the greater net worth? Not the annuity, or everyone would take that safe and sure path to success. And vise versa. If for retirement income, all anyone needed to do was buy the 10 best dividend paying stocks, then there wouldn't BE any annuities, because what would be the point?
Do you actually think you are coming up with an original "ah ha" moment ? It is ALL risk vs reward. There is no way to minimize risk and maximize reward or everyone would do it. There is role for each, depending on your income needs, and amount saved and net worth. It is the simple reason the very rich continue to get richer, as the income need is far less than the wealth generating stream, so time averaging allows them to ride through poor times, and maximize the good times. If your i come needs reduce that generating stream appreciably, them growth generation is not as efficient.
exactly , which is why the integrated strategy generated higher income day 1 in retirement 100% of the time and more left over for heirs almost 70% of the time in hundreds of scenarios run vs just trying to buy term and invest .
it is the blending of all three that reduce sequence risk which is the biggest risk retirees have as well as reduces the need to sell equity's preserving them longer to grow . because of the initial higher cash flow .
all the numbers are in the study if anyone wants to read them . in fact the paper contains just a few of the scenario's . i believe all the data is on the website since it is a huge amount of figures .
just buying those dividenfd paying stocks will leave the retiree 100% in equity's.
Chip you are absolutely correct. I am assisting my brother-in-law with investing. He was set to retire Feb 28th when we started talking investing about the first of the year. Because his company (he only worked one place his entire career), had been bought out partway thru his career, his retirement packages were offered to him in 2 parts, both with the same options.
In both cases he could elect to take a lump sum, or an annuity that did not adjust for cost of living. He is widowed so income for his surviving spouse was not an issue.
We made a Solomon-like decision and opted for the security of annuity on the slightly larger package and took the second one as a lump sum rolled into an IRA invested in dividend paying stocks. The annuity WILL offer a greater initial payout unless you have the world's worst annuity.
Making a straight line comparison to the annuity at this point is hard/impossible for a few reasons. For one, he has decided to reinvest his dividends for the time being, so he is not withdrawing anything yet. Secondly he did already have about $14,000 of his own money in the IRA before we started, and initially the plan was not to invest that money. However since we started, and as the total monthly income creeped ever closer to the dollar figure he would have received from the annuity, he became interested in matching that dollar figure, and has since invested $10,000 of his original $14,000, and sent me an email Friday about buying $4,000 worth of stocks on Monday.
I have been pleasantly surprised by his understanding of the fact that we were buying at the top of the market and there was an excellent chance the market would be going down. Which is exactly what has happened. We are down over $10,000. We bought $28,000 work of oil stocks, and they are down a bunch as you might imagine.
But the IRA income stream is working exactly as we planned, it's creeping up month by month. He made a purchase on August 7th and his yearly income after the purchase was $8,353. Today it's $8,412. He benefited from a 8.7% dividend increase by Altria yesterday but it was $8,378 before that raise. And other than the Altria raise this was a pretty typical month.
The raise from Altria pushed him over the hump and he now earns more from his IRA then he would of from his annuity. And he still has the vast majority of his invested money. His other annuity still chugs along at his initial payout, never to increase and the money that funded it is completely gone.
I fully expect at some point 5 years down the road to be asked "Why in the world did we take that one money as an annuity?"
If you don't want to talk about it, don't, but don't speak for others!
I think mathjak is concerned that he will have to teach the OP all of Finance 101 and 102 in order to be understood.
Briefly, annuities provide a guaranteed income for life and cannot be exhausted, because the beneficiaries who die young help pay for those who live a long time. The insurance company selling the annuity arranges this transfer, while also removing a profit for themselves.
Dividend-focused investing is just individual investing, and has no feature allowing you to get other people's money when they have died and you are still alive. Thus, you can run out of money. There is no guarantee. mathjak is correct in saying that it is not appropriate to make a direct comparison between the two.
I recommend blending annuities and conventional investing as described in my Financial Analysts Journal article here: http://www.cfapubs.org/doi/pdf/10.2469/faj.v69.n6.4. Brief summary: 85% in conventional investments dominated by a TIPS ladder as you get older; 15% in a *deferred* annuity that begins payouts at age 85.
bernstein also had a strategy using cd's ,tips, short term bonds and an an annuity for longevity .
he said only up to 2% is bullet proof and then qualified it even more saying that while it is a good strategy it is a poor time to put it in to action with the tips rates negative and negative returns on short term bonds .
A number of retired relatives are financing most of their retirement through Annuities. They are guaranteed a certain payout for a certain period, or the rest of their lives. The trouble is they are only getting about 4% of their principal each year in the annuity and once they die there is nothing left for their kids.
A more logical approach, with just slightly more risk, is putting the majority of their assets in stocks in the ten highest yielding Dividend Aristocrats. The stocks in the Dividend Aristocrats have never cut their dividends historically dating back over 25 years or more, regardless of the stock market and economy, and have instead, increased their dividends on an annual basis even during the worst bear markets and economic crisis periods. (Such as the blood baths of the 2000-2002 and 2008-2010 bear markets.)
Sure, the main value of these stocks in the Dividend Aristocrats Index, will go up and down, but that is just noise because they allow you to live on the dividends. As long as the dividends keep paying at the historical rate, you are not concerned about the day by day price of the actual stock in that index, you will never sell it in your lifetime.
Lets assume you live for twenty years after retirement, the value of the stocks you buy that are part of the Dividend Aristocrats could be higher or lower than when you purchased them- at your death, but there is a 99% chance they are worth something for your kid's inheritance, which is much more than ZERO for annuities.
For what it's worth, I think you are correct. Except in extremely limited cases annuities are almost always a bad idea for most people. Complexity, inflexibility, hidden fees conspire against their unwitting buyers. The Dividend Aristrocrats is an excellent way of delivering current income and protecting against inflation.
Your thinking is cogent and clear. I defy anyone to understand what the math guy is talking about with respect to annuities. Investing should be clear, simple, and understandable. Annuities possess none of those characteristics.
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