Good Annuities in Retirement

How do you use an annuity in retirement? Which annuities are “good” for retirement? Annuities, when used appropriately, lower both potential risk and possible reward.

For significant current income needs, a SPIA is a good tool. Longevity risk, or worrying you might run out of money means considerations of DIAs or espectially QLACs. Other annuities must be used more cautiously.

How do you use an annuity in retirement? Wisely! First, figure out if you want income or longevity insurance. Then, if you want an annuity, buy one; don’t be sold an annuity.

 

Annuity and Opportunity Cost

No one can guarentee the stock market will give you stable, life long income. An annuity will. But there are opportunity costs of using the money for an annuity rather than choosing a different way to invest.

Since all investments are tradeoffs, you must understand the pros and cons.

 

PROs and CONs of an Annuity in Retirement

I do not sell annuities. I don’t often even suggest them. But I firmly believe you need to buy one, not have one sold to you. Thus, you need to understand the pros and cons to know when you might consider buying one.

 

Pros of an annuity

Let’s look at the top reasons to have an annuity:

Fees are worth the cost

Not all annuities are chock full of fees. Advisor-sold Variable Annuities seldom tend to be worth the cost. But Investment-Only Variable Annuities can be used to 1035 exchange prior bad decision annuities or life insurance into lower-cost alternatives to make up your basis before finally selling them.

In addition, no-load variable annuities with income riders might be considered if you want to use them as a sequence of return risk hedge. The strategy here: aggressively invest in a low-cost VA for retirement. If the market does great, you do fine. If the market doesn’t do well, you still have the guaranteed return you get from the income rider. Win-Win. Some suggest putting up to 30% of your nest egg in the VA Sequence Risk strategy. I don’t think I’d ever bite on this, but it is, in fact a use case for a VA. Blame Moshe Milvesky for the idea, not me!

Some annuities are “Free”

You will often hear that Fixed Indexed Annuities have no fees. While that is strictly true (100% of your money is put into the account—sometimes with a bonus!), the advisor is being paid from the spread on your illiquid money. That is, the insurance company earns more than they pay out, and there is a surrender penalty to get out of the annuity before the lock-up period. They use that spread to pay the salesman if you leave early. Let’s be honest, though. Nothing in life is free.

Principal Protection

Index Annuities are deferred annuities and protect against loss of principle. If you want return of your money more than return on your money, a MYGA or Fixed Indexed Annuity might be worth considering.

Tax-deferral

Enough said. If you are a high-income earner and max out your other tax-deferred space, this is at least worth considering. Tax-deferral is an indication for Life Insurance as well. Careful as there is a 10% penalty if you take out income before 59 and a half.

Income You Cannot Outlive

People who have annuity income are happier than people who don’t. Spend your account down to zero, and magically more money appears next month. That is a nice feeling! Of course, maximize social security before you consider this use of an annuity. Social Security is the best annuity around.

You Cannot Tolerate Market Volatility

If you understand that volatility is not risk and you don’t lose out unless you sell, then this is not a problem. But people sell low all the time. They would be better off if they didn’t invest in the first place! For these troubled people, an annuity might help. If you cannot help yourself and you will sell low, don’t invest in the stock market; look to a VA or FIA.

Mortality Credits

I’m going to say that again: Mortality Credits. Understand these if you are going to buy an annuity.

If you are worried about outliving your savings, an annuity is right for you. Your bond portfolio will not provide you with as good of an income floor as an annuity because of mortality credits. Mortality credits mean that the annuity company can pay your more from day one because they know some people will die and stop being a liability on their balance sheet. This “risk pooling” allows them to pay you more. Many complex features of annuities (such as period certain and return of premium) destroy mortality credits and much of the reason behind getting an annuity in the first place.

Income

You cannot beat the fixed-income returns of an insurance company. They are big and get better prices on bonds and hold them for the duration. If you want income, think no further than a SPIA

You SPEND All Your Money Every Month

If you cannot save, you might want to think about an annuity. After all, once you turn on the income stream, you can spend everything you get, and next month there will be more. But then again, if you blow all your money, how did you save up enough for an annuity in the first place?

Creditor Protection

This might be oversold, but not infrequently, annuities have better creditor protection than your brokerage account. This is state-specific, so see here.

You have under-saved for retirement

Honestly, if you take your cash out and buy a SPIA, you will be better off if you plan to live a normal or prolonged life span. Mortality credits will pay you better than your bonds do.

You think you need an income-producing portfolio, so you are taking too much risk

Risk can sneak up on you in all sorts of ways if you reach for yield. If you are reaching for yield, annuitize some of your reach, and you will reduce risk significantly. Total return investing beats the pants off of income production for this generation. If you need income-producing assets to retire on, think again, and think about a SPIA instead.

You have longevity

Longevity insurance is what some annuities are all about.

You are already old but desperately need to do Roth conversions

Yes, you can still do partial Roth conversions when older than 72. A QLAC or two might help out in this situation. If you take longevity out of the equation by using a QLAC or two, you might be able to save your heirs a ton of money, especially if they are in a high-income tax bracket or you must put your legacy assets in a trust. This is a new idea I just had. I’m not sure how well it would work out, but it is a consideration if you want longevity insurance and the ability to aggressively Roth convert after RMD age.

You desperately want Long-Term Care Insurance but cannot get it with traditional or hybrid policies

Annuities with Long-Term Care riders tend to be based on your mortality risk rather than your morbidity risk, whereas the opposite is true with hybrid Life Insurance/LTCI policies. We are getting far into the weeds here, but if you have a pot of money lying around and you desperately want LTCI and cannot get it through other means, talk to a salesperson about an annuity with an LTC rider.

You must have guaranteed income for life

The safety-first vs. investment-only spectrum is just that—a spectrum. I suppose some people cannot take any risk at all and cannot have any stock market risk.

Cons of an Annuity

1. Because you got sold one.
2. You don’t know the purpose of the money.
3. You don’t understand every feature and bell and whistle attached to the product
4. The money is already tax-deferred. Don’t get snookered into investing your pre-tax money into an annuity. This is called a qualified annuity. One of the nice features of annuities is tax deferral. If you are investing in an already tax-deferred account, please be careful!
5. You know how to invest your money and are comfortable with volatility. If so, a total return approach will beat out an annuity. Only if you use an annuity as a bond-alternative might you win. If you are thinking about an old-fashioned bond ladder just stop it—and get an SPIA instead
6. Your Gut Tells You No. Just Walk Away if your gut tells you no. There is almost no reason why you cannot buy an annuity tomorrow instead of today. If considering a deferred product, the longer you wait the less you might make. Eventually, you will lose out to inflation, but not in just one day. Remember, you buy annuities, you are not sold them.

Summary: How to Use an Annuity in Retirement

A lot of the complexity baked into annuities are “answers” to people’s problem. Here are some of the problems:

They are Illiquid—so FIAs and VAs have withdrawal features that allow you to take out 10% or so a year

Loss of Legacy—they make return of premium riders and death benefit riders for these. I’m not sure these will ever make sense because if you plan to die early, an annuity is seldom right for you. If you plan on living a long time, then you will be happy if you die early, and the kids can have whatever is leftover.

Loss of Money—there are period certain annuities that pay you or your heir for a certain period of time. These mostly don’t make sense unless you are using them to cover expenses until some other income source kicks in. Again, this takes away mortality credits which is what makes simple annuities so special.

I like to keep it simple. If you want income, if you understand mortality credits, and if you want a safety-first retirement, then consider an annuity.