Income Annuities
 
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Income Annuities

 

(@golich428)
Eminent Member Customer
Joined: 2 years ago
Posts: 32
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I think moving the discussions on annuities might better fit here as the original thread was on books.

(@hines202)

Thanks for providing your view on annuities. This is not intended to be a rebuttal to your view, I am just providing some additional information that may help others. I should have been more precise in my mention of an annuity. I am only speaking about SPIA (single premium immediate annuities), DIA’s (Deferred income annuities) and QLAC’s (qualified longevity contracts). I do not put Fixed or Variable annuities in the same category. In fact, they are apples and oranges and I wish the industry had better terminology.

First, there are many different viewpoints about the best way to approach funding retirement spending. In my opinion, the preferences of the retiree should drive the approach. For example, a risk averse retiree may prefer guaranteed income to cover all non-discretionary and maybe some discretionary spending. This may result in delaying social security and possibly even the purchase of annuities. This is what Wade Pfau calls the “Safety First” approach. A risk tolerant retiree may prefer to utilize his portfolio and rely on the market returns to cover spending. This is what Wade Pfau calls the “Probability Based” approach. There are hybrids as well. I think one of the first steps in planning is to try and determine your own preferences and goals. Pralana can then be used for evaluating the trade-offs of the different approaches. Having guaranteed income (pension, SS, annuity) may reduce the fear of running out of money and give the retiree a license to spend earlier in retirement when the retiree can enjoy it.

In my opinion, an annuity should be thought of as longevity “insurance” not an investment. You are pooling your risk. There are three sources of income from a SPIA: interest, principal, and mortality credits. It is the addition of mortality credits that can make them attractive to reduce longevity risk. If you live longer than what the actuaries estimate, you get the funds that the person who died prior to the actuarial age contributed to the pool.

SPIA’s can be purchased through an independent agent and the agent receives an upfront commission around 2-3% from the insurance company. The quotes you get are always net of this fee and there are no ongoing fees.

When you buy an annuity, you do give up liquidity but if that is a huge concern there are period certain and return of premium options available but they will result in lower payout rate so there are trade-offs. I think you should also consider the impact of inflation when determining how much of annuity to purchase and have a large enough equity allocation to help if there is unexpected high inflation. The best time to purchase an annuity will depend on many factors such as your desire to do Roth conversions early in retirement.

Wade Pfau may be biased but I would be surprised if it is because he gets paid by the insurance companies. He is affiliated with Mclean as a retirement researcher so indirectly he may get compensated from insurance commissions, but I think (if he is biased) it is probably due to the amount of research that he has conducted demonstrating the benefits annuities can have for some retirees.

According to Zacks research, insurance companies do not fail very often all things considered. From 1986 through 2011, 31 companies that sold annuities failed. Most of the companies that failed were smaller insurance companies with low to no ratings from the agencies. Because of the long-term nature of such products as annuities, the state regulators hold insurance companies to high standards and capital reserves. You can and should do due diligence on any company you are considering buying an annuity from. You should look at the ratings from the different rating agencies. AM Best has a website where you can get more detail on each company. There is also a Comdex report that ranks about 750 insurance companies that is a good start. It includes all the ratings from each agency.

Since insurance companies are backed by an insurance fund at the state level, part of the due diligence would be to understand the coverage provided by your state and possibly lower your risk by purchasing several annuities, each at a value below the limit.

Having said all this, I don’t think annuities are appropriate or even needed for many retirees. However, I think the retiree should at least consider it as an option and may be worth evaluating.


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