How using a deferred income annuity can increase retirement income compared to an immediate annuity or a bond ladder.
Topics covered include:
- How immediate annuities and deferred income annuities work
- What are mortality credits, and why they are a key diversifier
- Examples of how mortality credits lead to a 1% to 1.5% higher annualized return over several decades
- How to decide whether an annuity is right for you
Show Notes
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Transcript
Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I’m your host, David Stein.
Today is episode 512. It’s titled, “Unlocking Hidden Returns. How Mortality Credits Boost Retirement Income.”
Immediate Annuities
For the past six months I’ve been part of a working group that is seeking to pull together some best practices for financial planners and advisors. This group is made up of some very smart advisors, very well known. Now, I’m not a financial planner. My expertise is in investing, so I’m not sure how I got invited, but I have found it incredibly interesting.
I certainly have given a lot of thought to financial planning and advisory practice, especially when it comes to annuities. We’ve done over a dozen free and premium Plus episodes on different types of annuities. Up until the Great Financial Crisis, I knew very little about annuities.
We were managing assets for financial advisors, and I met with some of their clients and saw how shell-shocked they were, having lost a lot of money in the downturn, where the stock market fell close to 60%. And that sent me looking for other solutions that could help retirees that didn’t want to be exposed to market risk, or at least to the extent that they had been, and that is where I learned about annuities. I went to some conferences, did a lot of study on it.
And so on a recent call, one of these advisors made a comment about immediate annuities and annuities in general that really surprised me. An immediate annuity is a type of insurance product in which the insurance company accepts a one-time premium from the annuitant—it could be $100,000—and then the insurance company agrees to pay that annuitant, and in some cases the annuitant’s spouse for the remainder of their lives.
These income annuities are a form of longevity insurance, because you get guaranteed income for life. Now, often when an annuitant purchases an immediate annuity, there is a guaranteed period of time in which their beneficiaries will continue to get the payment, the monthly payment, even if the annuitants pass away. It could be 10 years.
And partly, it’s because in the initial years of the annuity, much of those payments are being funded by the principal, the premium that was paid. And having that period guarantee can be quite comforting, because otherwise, if the annuitant dies the first year or two after making the payment, then they’re out of luck. That money is gone and not available for their heirs.
Now, back to this working group. This financial advisor said he would never buy an immediate annuity. Now, that didn’t surprise me. A lot of financial advisors wouldn’t buy an immediate annuity, partly because maybe they don’t understand them, but they also know that they’re paid an asset management fee. Their income depends on the size of the portfolio that they’re managing. And if a big chunk of that portfolio goes to an insurance company, then the advisor is making less money now. And in working with this advisory client I had back in 2008, that was one of the issues when we started talking about annuities—how will the advisor get paid, since they didn’t sell insurance products.
I recently saw a social media ad for Fisher Investments, and the headline was “Beware of annuities.” And their lead was to try to discourage the use of annuities, but insurance products are tools. They can be incredibly helpful if we understand them. But every insurance product isn’t suitable for a given individual. There are many very high net worth individuals where an immediate annuity as guaranteed income for life, doesn’t make any sense; not useful because they already have enough income, even if they invest very conservatively.
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