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Investing/Strategies / Bonds & Fixed Income Investments
|Subject: Bond and F-I FAQs: Part 4 D||Date: 2/14/2007 2:33 PM|
|Author: Lokicious||Number: 19774 of 35122|
Someone Is Always Trying to Sell Me a Lifetime Annuity. Should I Buy?
• Lifetime annuities have been aggressively hyped, by the insurance industry and some financial planners and advisors, because of the high stake typically taken out for “costs,” compared to many do-it-yourself investment options.
• Naturally, this has led those who view such costs as excessive to dismiss annuities as “bad-buys.”
• However, under certain circumstances, putting some or all of remaining assets into a lifetime annuity may be a desirable or necessary option.
Are all annuities lifetime annuities?
• Lifetime annuities should not be confused with buying an after-tax variable annuity as a tax shelter and simply putting money into the same assets (i.e., stock and bond funds) you would have in a taxable account, usually for a higher expense ratio, with an age restriction for when you may start withdrawing assets.
---Since stock dividends and capital gains are taxed at your marginal rate when you withdraw the money, whether such after-tax variable annuities are worth it is unclear, but that isn't a “fixed-income” issue.
• There are “fixed-income” options for after-tax annuities, usually with a rate guaranteed for a period of time, such as 5 years, that can then be rolled over to a new rate.
---If you are interested, shop around for the best deal (and don't be fooled by introductory offers, if you can't easily switch to somewhere else, later).
---Here is the link to Vanguard's “Single 5”: https://flagship.vanguard.com/VGApp/hnw/content/AccountServ/Retirement/ATSFixedDefAnnOverviewContent.jsp
---And to TIAA-CREF's fixed after-tax annuity: http://www.tiaa-cref.org/performance/after_tax/profiles/4003.html
• See Vanguard on different types of annuities: https://flagship.vanguard.com/VGApp/hnw/VanguardViewsArticle?ArticleJSP=/freshness/News_and_Views/news_ALL_annuities_06262006_ALL.jsp
What are lifetime annuities?
• Lifetime annuities are an insurance product aimed at protecting you from the misery of outliving your savings and investments.
----Annuities insure you will have a steady income stream, even if you live past the point when you would otherwise have used up all your assets (or all of a particular asset).
• A lifetime annuity allows you to draw upon the principal with which you buy the annuity, plus income or returns, until the end of your life, with the insurance company taking the risk that you will outlive when the money is calculated to run out.
---If you die before the money runs out, the insurance company keeps what is left.
---If you live past when the money runs out, the insurance company keeps up the payments.
---Of course, the insurance company has the actuarial projections set in their favor, so they have plenty of leeway (usually 2-3 years) between when you are expected to die, statistically speaking, and when they start losing money on you.
• There are joint annuity options, so a surviving spouse won't run out of money, and some options allow you to leave assets to your heirs, both for lower monthly/annual payouts than for an individual annuity with no legacy.
How much does a lifetime annuity pay?
• Your annuity payment will depend on how much you invest, what kind of annuity you choose, whether you want an individual or joint annuity, and how old you are when you purchase it, as well as on prevailing interest rates at time of purchase (for fixed and inflation adjusted annuities).
• You may choose a variable lifetime annuity, usually using stock and bond funds, with your monthly/annual payments dependent on the return, plus the portion of your principal being drawn down.
• You may also choose a fixed lifetime annuity or an inflation-adjusted lifetime annuity.
---Vanguard, which uses American International Group to provide annuities, has an easily accessible, anonymous, calculator, without having to risk inquiring of an insurance agent:
• A true “fixed annuity” will provide the same income through the life of the annuity.
---The initial payments (for a given investment) will be higher than for other options, but will not keep pace with inflation.
---On 12/3/2006 (all of the following quotes are from that date, and change regularly), an individual male who bought a fixed annuity through Vanguard with $500,000 at age 70, with no survivor benefit, would have received an annual payment of $44,030 (over 8.8%); a female would have received $40,099 (women live longer).
---A joint annuity, with 75% survivor benefit for a wife with the same birth date, would provide $36,995.
• Another option is an inflation-adjusted annuity.
---An inflation-adjusted annuity starts with a lower payment than a fixed annuity, but the payment increases every year to keep pace with inflation (usually using CPI-U).
---For a single male, age 70, the Vanguard inflation-adjusted annuity would start with an annual payment of $33,693.
---For the joint annuity, with 75% survivor benefit, the payment would be $27.195.
• The rates on fixed and inflation-adjusted lifetime annuities do change with interest rates, so if you are considering one, it may be worth starting it earlier than you would otherwise if interest rates seem high.
For whom is a lifetime annuity appropriate?
• If someone reaches a time when the amount of money he or she needs to cover expenses exceeds income, a lifetime annuity should certainly be considered.
• Even when a retiree starts retirement with more than sufficient income/gains from savings and investments, together with Social Security and, perhaps, a pension, increasing expenses from inflation will likely eventually overtake the earnings.
---At this point, the original principal starts being used up, and given enough time, it will all be gone.
---As Dickens' Mr. Micawber famously said, “Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery” (David Copperfield, Chap. xii).
• However, just because the original principal is breached, this does not mean buying an annuity is necessary.
---The questions are: at what age is this breach of principal reached and at what rate?
---If someone is old enough that there is almost no chance of running out of money, even with longevity far beyond the actuarial tables, there is little reason to choose an insurance company for a heir.
---For example, someone retiring at 65 with initial expenses (after Social Security) of $40,000 and a nest egg of $1,000,000 earning $50,000 at 5%, with 3% inflation, would not end up flat broke until about age 99, and might not need to worry just because principal dipped below the $1,000,000 mark at about age 73.
---On the other hand, for someone retiring at 63 with $45,000 in expenses and a year-to-zero projection of age 92, buying an inflation-adjusted annuity when principal is breached at age 66 may make sense. (However, the initial payment for an inflation-adjust annuity, with 75% survivor benefit at age 66, using the Vanguard calculation as above, would only be $46,5000, less than the $50,000 expenses.)
• One possibility is to buy a lifetime annuity with only a part of one's assets.
---An inflation-adjusted annuity, together with Social Security, could be used to insure necessary expenses would always be met.
---Then other assets could be used for discretionary expenses, with the expectation that if one outlived the actuarial tables by a long time, discretionary expenses would be less needed.
• In conclusion, lifetime annuities are an option to be aware of, but they need to be looked at critically, estimations made, and the likelihood of really running out of money, even with a lifetime lasting long beyond life expectancy, calculated.
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