Recently, I wrote about how retirees could assemble their own pension to replicate the ones our parents and grandparents used to get. Two of its pillars would be Social Security benefits and your required minimum distributions (RMDs) from IRAs, 401ks, and other retirement accounts.
But that still may not be enough to provide you with a comfortable standard of living in retirement or to prevent you from outliving your money.
That’s where annuities come in. A times, annuities have a bad reputation. In this column I’ll focus on a specific kind of annuity—the single-premium immediate annuity (SPIA)—which could be an excellent complement to Social Security and your RMDs. (I’ll highlight other attractive annuity products in future columns.)
When you buy a SPIA, you fork over (or annuitize) a lump sum to an insurance company and you’ll start collecting a monthly benefit at a date of your choosing over the next year. Although most SPIAs are lifetime annuities, you can also buy them for, say, 10 years. You can also include a yearly cost of living adjustment (COLA) and leave the balance to your heirs after you pass on. Some of these extra features will reduce your monthly payout, so you have to be willing to make the trade-off.
Let’s say you’re a man turning 65 and you’re getting Social Security but you want an annuity “pension” as well, beginning in January 2020. You have $100,000 to invest. Using the calculators on www.immediateannuities.com, I got quotes from several insurers (all rated at least A) for a simple lifetime policy with a 2% annual COLA that offered payout rates ranging from 6.26% to 6.65%—or monthly payments of $522-$554.
For a woman, the payout rate would be a lot lower—mostly below 5%—and you’d receive $100 less a month, presumably because women live on average almost seven more years than men do in the U.S., so the insurer will have to pay out the balance over a longer time. (You can buy a joint policy that includes your spouse as well.)
And unlike many annuities that charge steep commissions and annual fees, SPIAs are no-fee products, says Kyle Brossard, an agent at ImmediateAnnuities.com, based in Englishtown, N.J. He says his firm is paid a small commission from the insurers whose annuities they sell.
“It’s profitable, but I don’t think it’s a huge moneymaker for them,” Brossard told me. Insurance companies make money by investing the premiums they receive, mostly in the bond market. So, you’ll get a steady payout, while big insurers take on more risk to earn higher yields in, say, corporate bonds or emerging market debt. Better them than you, as my mother used to say.
The good news is there are no steep surrender charges on these policies. The bad news? There’s no surrendering them while you’re alive or during the term of the policy. That’s why taking a lower monthly payout to leave any balance to your heirs is probably a good idea.
One other possible drawback: If you’re funding an annuity with money from a tax-deferred retirement account (not a Roth), you’ll be taxed at your ordinary income rate on the payouts you receive. Please consult your tax adviser.
Unlike other annuities, which are so complex even math teachers can’t understand them, SPIAs are pretty straightforward. “It’s a simple product. It’s something the public wants,” says Brossard.
Sales of all fixed annuities (of which SPIAs are a small part) rose 27% to $133.5 billion in 2018, according to S&P Global Market Intelligence.
Wade D. Pfau, a professor at the American College of Financial Services in King of Prussia, Pa., has published a paper on the role SPIAs can play in securing people’s retirement.
For a 65-year-old couple whose Social Security benefit equals 2% of their retirement assets and who have a standard 4% annual withdrawal rate from their retirement accounts, a combination of stocks and a SPIA would be an “optimal” allocation, Pfau concludes.
“…Clients need not bother with bonds, inflation-adjusted SPIAs or [variable annuities],” he writes. “Though SPIAs do not offer liquidity, they provide mortality credits and generate bondlike income without any maturity date…”
I certainly wouldn’t recommend retirees put 100% of their investible assets into equities, but buying a SPIA would allow you to hold slightly more stock and reduce your bond allocation. Bonds are particularly difficult investments these days when the 10-year U.S. Treasury note yields 2% and may be headed lower.
Even Ken Fisher, founder of Fisher Investments, whose whole marketing pitch is that he’d “rather die and go to hell before selling an annuity,” wrote in USAToday that SPIAs “can be OK, done right.” That may be damning with faint praise or high praise indeed from an avowed annuity hater. Either way, this kind of annuity is worth exploring.