Annuity—or not?
I recently attended a conference in Washington on the question of retirement income—how baby boomers will generate income from their 401(k) accounts once they retire.
The issue is this: Current workers are more likely to have 401(k)s (or similar accounts) for retirement than monthly pensions. 401(k) accounts pay out a lump sum benefit, which most workers roll over into an IRA at a bank, brokerage firm, or mutual fund company. So, without any monthly pension check, how will future retirees create a regular income stream from their nest egg? The question is so important that the government recently issued a public “request for information” for answers.
Why is the government interested? Put on your public policy hat for a moment. The federal government provides tax incentives to 401(k) accounts to encourage retirement savings. Washington is worried that some (many?) aging retirees might mismanage their savings and run out of money altogether. That would lead to higher old-age poverty—a social problem in and of itself—along with demands from impoverished seniors for more governmental assistance.
Much of the discussion at the forum focused on ways to encourage Americans to purchase more guaranteed annuity income with their 401(k)s. By buying an immediate income annuity, you have the option to hand over a chunk of your capital to a private insurer, who promises to pay you (and/or a survivor) a guaranteed income for life, no matter how long you (or the survivor) live. Annuity contracts solve a central problem for the government: They minimize the risk of older retirees running out of money. And they’re helpful if you are looking for guaranteed income on top of Social Security.
The problem is that Americans by and large are uninterested in purchasing income annuities. (Investors buy lots of variable and fixed deferred annuities, but as investment and tax-deferral vehicles, not as sources of income.) With the traditional annuity, you lose permanent control of your assets in exchange for the guaranteed income stream. And you run the risk that the private insurer might fail to pay (though failures have been rare). According to recent insurance industry statistics by LIMRA, Americans have only bought about $15 billion of income annuities in recent years—versus hundreds of billions of dollars rolling out of retirement plans each year.
So, on the one hand we have the retirement experts, who are looking to promote annuities, and on the other hand there is the broader public, largely uninterested in them. Supporting the experts’ point of view is longevity risk—none of us knows how long we will live. Even if you plan your finances through age 95, you might be the one person in your family to live to age 100. Supporting the broader public view is the idea that most everyone has Social Security as a backstop, albeit a modest one. Combine that with the fact that only a small percentage of Americans will ever make it to their late 90s, and the argument for annuity income is hard to make.
For the moment, one thing is true: The attention on this issue by government and industry is likely to grow. Investment companies and advisors are working on educating clients about techniques to spend down savings sensibly (without resorting to annuities), while providing non-guaranteed income streams from various types of portfolio or fund investments. Insurers are promoting the traditional annuity, while creating new types of hybrid annuities that combine portfolio elements with insured income. The marketplace is generating many new ideas.
It will probably be a year before the government formulates any specific plans around retirement income. My guess, though, is that even if policymakers decide to tilt the scales, even if only slightly, toward annuity contracts, it will have little impact.
The fact is, for most of us, “retirement security” is more than having a guaranteed monthly check. It is also having a pool of savings as a form of financial security—to be used in a flexible way as our life evolves in retirement. If that is true, many Americans with 401(k) savings may have only limited interest in guaranteed income streams on top of Social Security. Check back in a decade, and we’ll see.
Notes:
- Product guarantees are subject to the claims-paying ability of the issuing insurance company.
- Variable annuities are long-term vehicles designed for retirement purposes and contain underlying investment portfolios that are subject to investment risk, including possible loss of principal.
I plan to retire sometime in the next 10 years, and have often thought about an annuity. What stops me is concern about the long-term viability of the insurance company. One possible solution – though I doubt the politicians and lobbyists would let this happen – is to allow the Social Security Administration to sell annuities. I would be willing to take a smaller monthly payout in return for an annuity backed by the US government. And perhaps this could help stabilize the trust fund.
As one who has considered annuities, I just cannot understand how I can turn a large amount of money over to a private financial institution for some 25+ years and feel confident in their solvency. Without something equivalent to the FDIC, the risks seem disproportionate to the advantages.
Good income annuities are difficult to find. Vanguard has some decent products and USAA as a variety of great fixed annuities. Some people think that only military personnel may invest in USAA annuities but anyone can.
If your finances permit waiting, deferring social security to age 70 seems like the best way to address longevity risk. It’s inflation adjusted and less costly than a private annuity; also no risk that the issuer will go belly up.
Give me a break! This is a sales pitch for annuities. First defined benefit pensions were trashed, now the 401(K) for retirement is being bashed! What are we supposed to do?
I like my chances making my own decisions about how and when to spend my money. I am lucky- I should have SS, a modest defined benefit pension, and 401K savings. I like the diversity. I accept the risk in deciding what to do with the 401K nest-egg in this case.
I believe I will be better off handling my expenses myself, and I believe I would think this way if I only had 401K (and SS) for retirement.
One form of this investment is fixed indexed annuities. If I understand this vehicle, your money is tied to a specific market index or a group of funds and one receives a fixed income (systematic withdrawal) for a period of time and the total value of the may rise or fall dependent on market conditions. I qualify this input because I have not due dilligence on this subject.
For me, a major problem with fixed annuities is that they are fixed. I well remember the inflation of the early ’80s. Any annuity I purchase will need to have inflation protection. My personal approach is to plan to withdraw 2 to 3 percent per year and hope the yield on my mix of stocks and bonds lets the principal keep up with inflation. Of course, this means I’m not spending down the principal which will be great for the kids but may make things a little tight for me. An inflation-protected annuity would be attractive for at least part of my assets.
My plan is to take my pension as a lump sum and buy inflation-adjusted immediate annuites. I’ll mitigate risk by purchasing from about 7 highly rated, conservative insurance companies. I’m taking my 401K and investing in index funds, probably 60-70% bonds and the rest in equities. Most essential expenses will be covered by SS and the immediate annuities. Money for vacations, new cars, etc. from the investment accounts.
A question rather than a comment: Why should we trust in the solvency of any insurance company regardless of it’s rating? Have the recent failures of major corporations and the self serving deceit of rating agencies made me overly paranoid? Is the insurance world better regulated than the rest of the financial world? I don’t know, but it appears many commentors share my nervousness on this point.
We’ve looked at annuities and see them mainly as income streams for the insurance companies who sell them. We couldn’t find a way to justify the high expenses, surrender charges and loss of control over your funds.
Often times the only folks pushing annuities are pushy commissioned salespeople. Several of my colleagues have parents who were pushed into inappropriate annuities that were linked to equity index funds that were clearly adobe the level of risk that they were willing to accept.
There needs to be more transparency in the industry re: annuities for them to take off.
Annuities are general a bad decision while the small investor can do it their selves with discipline and little knowledge of financial markets. Simple invest in the total stock market and bond market indexes and live off of the proceeds. Of course you need discipline to not over-spend.
My former employer is one of the few that still have a traditional retirement plan in addition to a very generously matched 401K. The traditional plan offers the option of an annuity or a cash lump sum at retirement. The annuity is FAR cheaper than anything you could buy later on the outside!!
It is very telling almost all retirees from my company take the cash option and roll it and their 401k into a roll-over IRA. I know only one person that recently took the monthly pension check.
Everyone bets they can do better in the market than the pension. Even in the face of 15 years of market chaos. Go figure.
My comment got lost so i’ll comment again. I would be willing to put all my IRA into a lifetime annuity, or one of the variations that i have heard about if the absolutely guaranteed rate was at least 5% and it was with a super solid
insurance company. i don’t think that is asking too much for such a length of time (20 to 25yrs with no cost of living increase consideration)
Most states have an insurance guaranty fund that back-stops annuities up to a stated amount should the insurer fail, often $100,000 – 300,000 per owner per failed company . My husband and I used about a third of our IRA assets to buy an immediate annuity through Vanguard, in an amount covered by our state’s fund. Should we decide to convert more of our IRAs into immediate annuities, we would be careful not to exceed the guaranty coverage limit with any one company.
Of course, one should still ascertain that a prospective insurer is highly rated. It could be very distressing having to wait around, perhaps missing payments, until a guaranty fund paid up in the event of a failure. But all in all, I believe these products are safer than they sound, and worth it for those of us without pensions.
I have wondered as to the advisability of annuities and of course there are many different opinons on this. Do you happen to know if deferred annuities can be turned into income annuities at the point of retirement?
“So, on the one hand we have the retirement experts, who are looking to promote annuities, and on the other hand there is the broader public, largely uninterested in them”
so who are these experts and can they explain how an annuity is better than self managing your retirement investments? Why pay for the overhead expenses of Annuity management? Even if a person has limited investment knowledge they can keep their investments in the Total Stock Market and Bond ladders which are as safe if not safer than a Annuity provider.
I agree with the first two above that the longevity of the insurance company and its continued commitment to the contract, is a show-stopper. In particular there’s great risk when a surviving spouse has to lay claim to the policy written on the deceased spouse’s IRA. I’ve been dealing with my deceased father’s life-insurance policies, written by company A then sold to and “converted” by company B, and the excrutiating paperwork and difficulty in jumping through all the hoops they place between a death and a payout. Worse has been a medical insurance plan written by company A, sold to company B that then sold it to company C; I now deal with company C only by Certified Mail, Return Receipt. About the only reassurance we the public have is that the various states do regulate the insurance industry — indeed, my mother’s lawyer had to contact the US Senator’s office in order to get some action from insurance company D (the payout came immediately). The only good luck I’ve had was with my parents’ long-term health policy. Although written many years ago and sold by company A to B, there are real people there who actually answer the phones or call back quickly. The insurance industry has no one to blame but themselves for their bad reputations.
Income Annuities are only good for the Insurance companies and are generally not good for the retiree. Why pay fees for something you can do on your own— not to mention it would you family’s money when you die. I am hard pressed to find any advantage in Annuities.
I am very interested in buying a single premium lifetime fixed annuity in several years. I think there may be an opportunity for companies like Vanguard to serve as a broker and/or clearing house for this type of annuity. My understanding is that an insurace agent makes about $5000 for each $100,000 fixed annuity that the agent sells. The value added that an agent provides is education. The price seems a bit steep, especially for a consumer who is already educated. I know that Vanguard and AIG have had a relationship in the past and I appreciate that. I have something in mind like a company (Vanguard) that would provide quotes from multiple insurance companies instead of just one insurance company. This might bring the cost down by competitve bidding but also by eliminating the sales commision. Vanguard would also be able to negotiate a better return, just like a large pension plan can negotiate a better return with insurance companies because of the large volume of business. I have heard of a company that does precisely this, but it operates through large employers. Why not Vanguard?
Guess I have listened to Clark Howard very carefully and am happy I did. It appears the the majority of folks all ready retired and those close to retirement are not in love with annuities. I just do not have the faith to hand over a considerable amount of money for a 20-30 year timeframe and know it is in good hands and will do the job that it was intended. With the current financial situations we have all been following in the news over the past couple of years it just takes a whole lot of trust to go the annuity route and one I am not prepared to take.
As fellow vanguard investors, we are doing a bit of preaching to the choir; part of the reason that we invest with vanguard is because we’ve gained the confidence to do our own research and make our own decisions and manage our own money. Many of us reading this blog are probably comfortable with the notion of creating our own retirement income stream using the 4% safe withdrawal rate and using web based calculators to provide on going projections so we can adjust them when needed. But, just based on ca sual conversations with people i know, i start talking about this stuff and thier eyes just glaze over. They have not a clue, not because they are stupid, but because they lack the confidence to trust themselves to make the right choices. Personal finance is fascinating and interesting to personal finance geeks, and boring and overwhelming to just about everyone else. Its not complicated, but people think it is, perhaps because so many in the financial industry make a living by successfully making people think that it is. I shudder to think they they will be successful in making politicians think we need to be saved from ourselves by buying insurance products like annuities.
John Ameriks of Vanguard led a very fine webinar last December that covered a lot of the questions people have in this discussion. I watched, and found it extremely informative. You can find a link to it under the What We Offer tab on the Vanguard site. Click on Annuities; the link is at the bottom of the annuities page in the Tip. I also requested and got a brochure about annuities from Vanguard that was helpful.
A deferred fixed annuity has some tax advantages and some safety if purchased from a highly regarded company and in an amount under state insurance limits. There are many options available when the annuity matures – if converted to an immediate fixed annuity the portion of money considered income is small and spread over many years. That plus deferring social security can create a nice floor for retirement.
A bit more for other investments, good stock and bond funds is also nice – but with this floor established I think the investor can be slightly more aggressive with other funds.
Annuities, 401K, 403B none of these are guaranteed 100%, look at what happened to AIG the largest insurance company, if not for the bailout the parent company would have disappeared. For those who do not have traditional pension plans, government needs to some how guarantee income in old age, otherwise government will wind up spending on welfare for old.
I put in suggestions for with my senators long ago about 401K bail out, guarantee like that is available for traditional pensions via pension guarantee corporation, and a national pension plan (an extension to social security) for every one not just for public school teachers, police & firemen etc.
Removing traditional pensions was a big mistake. Every one should have a pension plan, it should not be based on employer who you work for. All government employees (local, state, fed) have guaranteed traditional pension plans as well as 401k/403b, while rest of us have may be just 401k that you cannot rely on, especially with market crashes. This problem needs to be addressed as soon as possible.
The three legged stool for retirement financial security ( social security, pension, retirement savings) has been undermined to a point where public policy needs to drive a correction. One solution may be to tie tax incentives to a refined 401k/IRA process that requires the use of “target date” fund investing with a managed payout mechanism. This solution might be backed by an insurance back stop. As a society we need a solution to ensure the financial security of our aging population. I believe some form of a reliable annuity stream is needed.
Deferred annuities are bad: high expenses, surrender charges, etc.
Immediate annuities can be great. The income they pay you is part return of your capital, part return on investment, and part money from other annuitants who have already died. That third part isn’t anything you can do by yourself: without being in an annuity pool, nobody’s going to start giving you some other dead retiree’s money. For older annuitants, most of their payments come from this third source; return on investment is rather irrelevant.
Want to be sure you can leave a bequest? Annuitize enough to cover any possible expenses, then you know for sure you can bequeath the rest, because you’ll never need to spend any of it, even if you live to be very, very old.
We do need an FDIC-type government agency to guarantee policyholders will be held harmless if their annuity insurance company fails.
When people talk about “safe withdrawal rate,” I wonder what part of “past performance is not a guarantee of future results” they don’t believe. Sure, 4% or 3.5% was a safe withdrawal rate in the 20th century. Nobody knows what a safe withdrawal rate is for the 21st century. With an annuity, you’re not counting on a particular rate of return on a portfolio, instead you’re mostly just counting on your fellow retirees dying. That’s a much safer bet.
And if you died early? Well, that was the deal; you lived a happier life knowing you’d never outlive your income. (Or, get an annuity…
My husband and I are also retired; have a defined benefit pension and a good chunk of money in 401K and IRA rollovers. We are waiting to take his social security until age 70 (even though he retired at 59) and he is allowed (the Social Security Administration informed us of this ability) to take half of my SS until he is 70 and takes his own SS. I have also considered a fixed anuity (as my mother is 105) but also have been concerned about the Insurance companies longevity. I found the comments by others very informative and interesting.
The reason for buying an income annuity is that you can get a better return if you are old enough than the safe 4% withdrawn from investments. In exchange for this you give up your principal. I feel there is a real risk that the insurance company, no matter what is current rating (and we know what those are worth), will not be well managed 10 or 20 years from now. Unfortunately, here in California, the state insurance is limited to 80% of the first $100,000 of the annuity with any given company. That’s far to little.
I think an advantage of immediate annuities that hasn’t been mentioned is that they provide some protection against the risks of incompetency/dementia. Some 90-year olds will be able to invest their money, but many will not. Will those who cannot manage their investments have someone they can trust to take over that responsibility? At least with an annuity, they will receive a check every month. Would that be the case if the investments were handled by a child or a broker? Perhaps, but that seems riskier than an insurance company. Remember this is retirement money – we’re going to be old.
I am going toward buying an income annuity, what I’m worrying are who would say and guaranty that any big and hight rating insurance company that will never go under, or even say my money would guaranty up to certain amount, in the between when trying to get my money back, that gap with no monthly income how these retiree going to live, is the government enforce the length of time that money must be return?, I don’t have faith that guarantee by the private company. We do need an FDIC-type government agency to guarantee policyholders will be held harmless if their annuity insurance company fails.
I agree with one post above the government should have a national pension plan (an extension to social security) for every one not just for public school teachers, police & firemen etc. We citizen paying tax too
Look at all the companied that make all that messed than the government bail them out, because of them most of nearly retiree lost a lots of their 401K no once bail us out, with what ever little money we have left go into buying annuity for the monthly income and hope it won’t get hit again by those insurances company if they are belly-up.
Do I have this right? You buy a fixed annuity that locks in about the lowest interest rates we’ve had in about forty years. Then you get a fixed income while the government inflates its way out of trillions of dollars in debt.
I am unsure at present about an immediate annuity, however you have options. You can get inflation protection,make your wife a beneficiary if you die before her and she would receive income until death. You will need to shop for the lowest expenses,the highest return and make sure the insurance companyis AAA rated by Best or Standard and Poors.I would make sure my State insures most of my Capital. One disadvantage is you will be taxed at ordinary tax rates instead of capital gains if you were invested in stocks. If you manage your own investments like I do it may not be as advantages but if you do not an annuity can be less complicated. There is something to be said about a guaranteed check until death especially if you live to be 90 and beyond.Its not as safe as social security but it comes close.Its like life there are trade offs.
Annuities, like mutual funds/asset allocation models/LTC insurance/CDs, etc, are a tool, nothing more and nothing less. The annuity “tool” will look better from some vantage points than others. Those managing their investment accounts in retirement and withdrawing 4% as their conservative annual cash flow in some cases saw their accounts lose between 30 and 40% of value in 2008 alone. The person with cash flow from a SPIA was unaffected (unless they have an automatic annual increase built into their contract…..then they received more income than in 2007). Who slept better at night through 2008 / early 2009? Clearly, the advantage of annuities is they have guarantees. And yes, a person needs to scrutinize the insurance company they contract with. How individual companies fared through the last few years is very revealing. Some did quite well because they keep expenses down and are conservatively managed and avoid risk (stocks). Diversifying your annuity portfolio over several companies is an excellent idea that doesn’t typically cost you a dime. Perhaps a strategy that is most comfortable involves diversification of the tools in your toolbox…..an annuity or a managed investment doesn’t have to be all or none. An income stream that is stable and provides a sound base and is supplemented by an investment portfolio which is invested appropriately and provides the potential for growth would seem to be an ideal combo for most retirees.
Will Vanguard EVER offer a Low cost Variable Annuity with a “guaranteed
withdrawal” rate of at least 5%????
You talked about it 1 year ago and said you would revisit the option.
It is certainly something that would greatly appeal to the Vanguard investors.
Fidelity has such a variable annuity. Can’t Vanguard look seriously into that ?
I too would like to see a low cost variable annunity with a guaranteed withdrawal rate of at least 5%. I know you have the expertise to compile such an annunity!
I view an annuity as a way to take more responsibility for my future cash flow needs. So, I am willing to give up ownership of a cash asset in exchange for an income stream. This does not mean that risk is removed. There is risk to one degree or another in any financial transaction (inept rating agencies, default, inflation, deflation, economic crisis, etc.). I chose charitable gift annuity as part of a diversified investment/income strategy. Fixed charitable gift annuities were contracted without fees through Clairemont/Mckenna and Pomona Colleges at very fair payout rates. These are designed to begin payout at the same time that I take Social Security at age 701/2. The main risk with the annuity is default by these universities and inflation. That risk is offset to some extent by other types of investment. I am planning in this way in consideration of the possible default of a defined benefit pension, another risk in a changing, global economy.
I didn’t think annuities were a good idea prior to 2008 because of sales tactics and difficulty in evaluating the insurance companies that back them up. I did enough research to know that if I were to buy an annuity it would be thru USAA (I have been a member since 1967) or thru Vanguard (I have been investing with Vanguard for over 20 years) With the problems in the markets we have experienced I do wonder about the competence and ethics of those who make promises of guaranteed pay outs for investments. Same goes for long term care insurance. The insurance promise (to provide income or benefits) may be made in good faith, but I am not so sure that these guys really know what they are doing.
Good presentation – somethings left out – such as an immediate annuity with a guarateed payment to person taking out the annuity or beneficiares of a certain term as 10yrs, 15 yrs or 20yrs.
Hybrids are interesting – is Vanguard going to offer them?
I am recently retired and took a lump sum buy out and therefore have no pension. I am very comfortable managing my own investments and have done so for many years. However, I do get a little stressed some times with market volatility and do not like being totally at the “mercy of the market” when it comes to my financial future. I do NOT believe in some of the complicated types of annuities that are on the market, but I do believe that a simple immediate annuity, where you pay an insurance company a set amount of money for a set amount of income, possibly for life with a highly rated insurance company is a good way to go. You can actually get more than the 4% recommended withdrawal amount on your invested amount in an immediate annuity and it can allow you to withdraw maybe only 2-3% from the rest of your investments to make up the rest of your needed income. I will say that credit risk of the issuing company is a noted concern and I would not use anymore than 20% of investments to purchase the annuity!
Hello, did you know that the surrender changes in a equity index annuity is far less than a 20%, 30%, 40% or 50% loss of income in the stock market. Having your saving in the stock market is the biggest risk there is, if a person is depending on this money for future needs.
Did you know the surrender charges never come into play, because the policy holder will have a life time of income paid out and there is a guaranteed death benefits. Even when you spend down the principal, you still have that check coming in for the rest of your life. Annuities pays 25% to 40% more income than the average person could create in other investments. Simply because there is no guarantee from lost due to market risk in those other non- guaranteed investments..i would really like to see you put this up front for readers to read. I know brokers know all this and that is why they give annuities a bad rap…
It is wise to have annuity thats will guarantee a income for life, on top of a pension plan and social security, the annuity income fills in the income gaps and lack of income. This is so important for the person who has limited income, and less commission fees compared to other ongoing stock brokers fees and company fees on top, and the taxes in annuities are stretched out and the state and federal taxes are less. So the Gov. gets less taxes paid to them over time, and that means more of your money in your pockets and less to the goverment…..life is good..
this come from a annuity…
Would not a treasury ladder built 4 years ago been better than any annuity out there?
I see lots of opinion here on how bad annuities are. I wonder why? Do you really think you can do better in the market? I’ve found over the last 30 years that it’s a crap shoot at best. A fixed stream of income for the rest of my life doesn’t seem a bad thing. A garanteed check from the SS, Annuity, and my pensions seems like a good idea to me.
I wish Vanguard would offer a Hybrid annuity that allows a good return on a deferred annuity that could be changed to a lifetime income when spouse died. Surrender charges should be only 5 years and principal safe, allow a withdraw of up to 10% per year. Have no market ceiling but give a percentage guaranteed every year of about 3 to 5%