Notes on Immediate Annuities (Updated 7/5/08)On my journey to learning about using immediate annuities in retirement, I have come across interesting conversations and research materials. I will use this web page to share them with you.
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This conversation is from the Bogleheads Forum:
TimDex writes: My approach to annuities has always been that they have a place, and can be useful to investors. On efmoody.com (commentary) I ran across a different perspective, one I hadn't seen before:
I see the point, but I think immediate annuities are still useful for an investor wanting a guaranteed income. But I hadn't seen this argument before and thought I would post it. Tim
BrianTH writes: Right, but that is just underscoring the primary purpose of an immediate annuity, which is to provide longevity insurance. So, for example, if you took your $100,000, put it into something returning 4.17%, and also took out some capital each year for a total of 7.4%, then at the end of your expected lifespan you should reach zero. But what if you then live longer? Oops, you are out of cash. But the immediate annuity will keep paying as long as you hold on (and obviously, that extra money comes from those who do not make it to their expected lifespan). So, the immediate annuity protects you against unexpected longevity. And this is crucial because one of the major reasons why safe withdrawal rates are so low is that people have to self-provide for longevity. Immediate annuities free you of this need and so allow you to increase your safe withdrawal rates. Of course, nothing comes free, and there is a loser in all this: your heirs. If you have to self-provide for longevity, and if you die around on schedule or earlier, [your heirs] get the money you were holding onto. And odds are you will do that--that is where the actuarial tables come from. But with the immediate annuity, [your heirs] get nothing no matter when you die (assuming no special provision to that effect, which will cost you). So, the immediate annuity serves to increase your withdrawal rate by freeing you of the need to provide against longevity, but at a cost to your heirs. And when you view it that way, those numbers look pretty good, meaning it does not look like the insurance company is taking too much extra for itself. Just don't ask your heirs to be happy about it.
Bob writes: TimDex and BrianTH, Thanks for the info. It helps me up the learning curve when it comes to learning about immediate fixed annuities. I found an annuity calculator here: http://www.moneychimp.com/articles/finworks/fmpayout.htm
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This excerpt is from Reducing Retirement Income Risks: The Role of Annuitization (pdf):
The distinguishing feature of all life annuities and what makes them a powerful tool for managing longevity risk is that at least some payments in the annuity contract are life-contingent (discontinued at death). This contingency allows the annuity provider to offer living annuitants an implicit per-period total rate of return above that attainable from similar investments outside of the immediate annuity arrangement. Because the assets backing the annuity are pooled and payments are at least in part life-contingent, a portion of the assets contributed by early decedents can be used to finance higher payments to those that live longer. Contrary to a widely held misperception, it is the pooling of assets and risk that enables providers of fixed immediate annuities to support implicit rates of return significantly higher than a risk-free rate. This has nothing to do with the investment acumen of the annuity provider; it’s simply basic principles of insurance. Dealing with longevity risk is in fact not a matter of choosing the right investments—it’s an issue of pooling and thereby reducing longevity risk. |
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DaleMaley writes THIS POST on the Bogleheads Forum:
Good Conversations on Morningstar's Vanguard Diehards site on Immediate Annuities:
Conversation #54229
Updegrave on Variable & Fixed Annuities
Annuities 101 - How to sell to Senior Citizens
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Moshe Milevsky is an associate professor of finance at York University in Toronto, Canada. Milevsky has written several articles on annuities -- some of which I have included HERE. So I was surprised to learn that Milevsky has engaged in activities which may not make him an unbiased source of information. THIS POST is from the Investing DURING Retirement Forum:
Ron writes: Milevsky is paid by the insurance industry. He is executive director of the Individual Finance and Insurance Decisions Centre. IFID is a non-profit corporation funded in large part by insurance companies. Milevsky is also president of the Quantitative Wealth Management Analytics Group. QWeMA is a private, for-profit company that develops marketing software for insurance companies. Despite his academic credentials, I wouldn't trust Prof. Milevsky to present an unbiased view of annuities. Readers should be skeptical of his writings.
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For annuities in their basic form, the amount left for heirs after the annuitant dies is straight-forward. Heirs will receive the amount left in a deferred annuity. By contrast, heirs receive nothing from a basic immediate annuity. However, immediate annuities do have other options. Taylor Larimore writes THIS POST on the Bogleheads Forum:
Quote: Most, immediate annuities have options. These include:
Of course, each of these options reduces the guaranteed monthly lifetime income. But the bottom line is that most annuities CAN provide payments to heirs if the annuitant dies early.
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There are five independent agencies that rate the financial strength of insurance companies: A.M. Best, Fitch, Moody’s, Standard & Poor’s and Weiss. For details, click HERE. I was not familiar with Weiss. But THIS POST from the Bogleheads Forum provides some interesting history.
Mike writes: In my more innocent and trusting days, when Jimmy Carter was president and interest rates and inflation were sky high, I bought four single premium deferred annuity policies from four different companies. One company was Executive Life of California, and another Fidelity Bankers Life Insurance Company. Both had top ratings from Best, and one had an excellent S&P rating as I recall. The broker said that all the companies were financially strong. I periodically checked the Best and S&P ratings and never saw any problems. Nevertheless both companies failed, costing me a significant amount of money and grief. I later found out about Weiss Ratings. Weiss had given both companies problematic ratings well before they failed. If I had known about Weiss back then, I'd be a bit richer now. Weiss is not paid by the companies they rate, and they rate everyone. Unlike some other ratings companies Weiss ratings are distributed reasonably, as opposed to the top heavy distributions (i.e. almost everyone gets an A+) often seen. Consequently they're the only ratings I feel I can rely on.
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I am aware of three insurance companies that offer fixed immediate annuities with inflation-adjusted payouts. AIG offers them through Vanguard, the Principal Group through Elm Income Group and Lincoln Financial Group. You can check them out at the links listed below. Vanguard’s website allows you to get a quote online. Principal only offers a sample quote. And Lincoln does not display any quote information at all. |
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Jonathan Pond wrote a book on retirement called You Can Do It!: The Boomer's Guide to a Great Retirement. In one part of the book, there is a section that has good information describing annuities for retirement. Generating Income When You Retire (pdf)
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Here are three interesting charts. The first chart shows that fixed immediate annuity payouts generally track the yield on 10-year Treasury notes. The second chart shows how payouts can differ with different options. And the third chart shows that purchasing a fixed immediate annuity with a portion of the retirement portfolio can improve the odds of survival.
Source: 2007-Jan-Annuity-Shopper (pdf)
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Henry Hebeler wrote a book on retirement called Getting Started in a Financially Secure Retirement. He sprinkles in several sections that discuss annuities. Here is one passage that talks about the tax treatment for fixed immediate annuities:
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Immediate Annuities in Retirement Pros and Cons of Immediate Annuities Immediate Annuities Links Page Immediate Annuities - From the Reference Library at the Bogleheads Forum
More good conversations from the Bogleheads Forum:
Conversation #2257 More good conversations from Morningstar's Vanguard Diehards Forum:
Conversation #38119 |
