Many investors approaching retirement think they have no real need for annuities. However the lifetime-income guarantees offered by these insurance-company products can add security to portfolios which are mostly composed of stock and bond mutual funds.
A market downturn that hits before or at the start of retirement can leave even conservative investors with far less money to draw from than planned and little time to recoup the losses, increasing the risk they could go out. By placing a portion of their retirement funds in annuities, some investment researchers say, investors can arrange for a more dependable income stream for life.
“The longer we live, the higher stress that puts on our ability to purchase our retirement-income goal-an inflation-adjusted income stream that lasts so long as we do,” says Tom Idzorek, chief investment officer at Morningstar Inc.’s Ibbotson Associates unit. “We need to go beyond the universe of mutual funds and exchange-traded funds and consider longevity-risk products.”
According to Financial Research Corp., a Boston research firm, a 65-year-old retiree who withdraws an inflation-adjusted $45,000 annually from the $1 million portfolio of stock and bond investments includes a 25% possibility of running out of money before age 92. However, if the retiree gets the same annual income by investing $400,000 in an immediate annuity and withdrawing the remainder from $600,000 invested in stocks and bonds, the chance of not having enough money drops to 6%, the research firm says.
To be certain, Ibbotson along with a quantity of others and academics that have cited the benefits of annuities do consulting work or otherwise earn money from insurers that sell annuities. However they create a persuasive case, particularly in light of these two bear markets of the past decade.
An Annuity Fan
One believer is Bud Hebeler, 77, a retired Boeing executive who runs www.analyzenow.com, a retirement-planning website. He says annuities have made his retirement more secure, helping him steer clear of the problems that plague many retirees who rely primarily on their savings.
“People didn’t think they’d live that long, plus they spent an excessive amount of too soon,” Mr. Hebeler says. Low interest rates in the last couple of years have hurt, too. “Now, they are attempting to ration a limited quantity of savings.”
According to actuarial mortality tables, a healthy 65-year-old man has a 33% chance and a healthy woman a 44% chance of living beyond 90. For any 65-year-old couple, there’s greater than a 50% chance that a minumum of one of them will live beyond 90.
Mr. Hebeler has committed to “immediate” annuities in stages over three years-a strategy known as “laddering”-to make the most of potentially rising interest rates. By having an immediate annuity, investors hand a lump sum payment to an insurer and get a promise of regular payments that will last for as long as they live; when rates of interest are low, because they are today, investors lock in payments that are small compared to they might get in other environments.
People in illness or those with a family history of early death usually are advised to steer clear of annuities. But Mr. Hebeler says he hopes to live into his 90s like his parents did, which may result in the annuities a great deal for him and permit him to leave more income to his children. He also says the security supplied by the annuities has allowed him to get the remainder of his portfolio more aggressively, having a larger percentage in stocks than he might have had otherwise.
Two kinds of Annuities
Retirees may do best by augmenting their mutual-fund portfolios with both immediate annuities an additional variety-variable annuities that have lifetime-income benefits-according to both Ibbotson and Moshe Milevsky, a finance professor at York University in Toronto who has written extensively about the benefits of annuities.
Having a variable annuity, investors typically invest in mutual-fund-like subaccounts-but have the option of buying income benefits that can lessen the risk that the market downturn during retirement will devastate investment values.
For an added fee, typically 0.5% to 1% annually, a rider promises anything owner a collection area of the initial investment, typically around 5%, annually for life.
When the investments do well, anything value and annual payout may step-up to reflect the higher balance. Money not withdrawn within the holder’s lifetime can be left to heirs.
On the gloomy, variable annuities have long had a reputation to be too costly and pushed by salespeople for big commissions.
In a paper written for insurer MetLife Inc. Mr. Milevsky explains that immediate annuities and variable annuities with guaranteed living benefits provide different benefits of a portfolio. He gives immediate annuities top marks for protecting investors against the risk of outliving their cash, particularly if the investors live longer than expected. Variable annuities with lifetime-income benefits, meanwhile, protect investments from “sequence of returns risk,” or even the hazard of a giant downturn right before or after retirement.
Ibbotson has developed proprietary guidelines to make personalized recommendations on annuity purchases based on an investor’s solutions to typical retirement-planning questions. It’s licensed the program with a insurers and investment managers, including TIAA-CREF, New York Life and Great-West Retirement Services, a unit of Great-West Life & Annuity Insurance Co.
Generally, the guidelines suggest that older investors allocate much more of their money to immediate fixed annuities to consider benefit of the larger payout that is keyed to age at that time payments begin. An average 65-year-old should put around 20% of his money in a set annuity contributing to 30% inside a variable annuity, based on the guidelines. A 75-year-old should put around 35% in a fixed annuity and a little less than 30% in a variable annuity having a minimum withdrawal benefit for a lifetime, Ibbotson says.
Conservative investors should consider investing a little more in each than investors who’re confident with market risk.
Wealthy investors who face no recourse of outliving their money probably don’t need annuities whatsoever, many advisers say. But retirees whose pensions and Social Security income fall well short of their demands might want to put a greater area of savings into a longevity product. For investors who wish to maintain greater charge of their assets, a variable annuity with a minimum withdrawal benefit for a lifetime ought to be favored over immediate annuities, some advisers say.
Ibbotson’s Mr. Idzorek recommends that investors take advantage of the downside protection in a variable annuity by investing their subaccount funds as aggressively his or her contract allows. The fee for the guaranteed-minimum-withdrawal feature is typically the same regardless of how the funds are invested.
Most investors buy variable annuities around retirement. However it can be a wise decision to begin buying these products five to 10 years before retirement and spread the deposits over several years, rather than try to time the market with one big buy, based on Great-West Retirement Services.
Bottom line is Fixed Index Annuities are are the safer better rout.