Annuities and the Puzzle of Income- New York Times

 

Here is still more information that documents the difference between a person with a pension and one without. This time, Richard H. Thaler from the University of Chicago writes of the difference in the New York Times this past weekend. In the article found here, Thaler considers two individuals, Dave and Ron, with identical ages and retirement portfolio balances to illustrate the point perfectly. Dave has a pension and Ron does not.
 
The lesson is clear; Dave has a substantial amount of guaranteed income for life whereas Ron has some difficult choices to make. Here it is straight from the article…
Dave can count on a traditional pension, paying $4,000 a month for the rest of his life. Ron, on the other hand, will receive his benefits in a lump sum that he must manage himself. Ron has a lot of choices, but all have consequences. For example, he could put the money into a conservative bond portfolio and by spending the interest and drawing down the principal he could also spend $4,000 a month. If Ron does that, though, he can expect to run out of money sometime around the age of 85, which the actuarial tables tell him he has a 30 percent chance of reaching. Or he could draw down only $3,000 a month. He wouldn’t have as much to live on each month, but his money should last until he reached 100.
Which option would you choose? It seems taking the pension route carries several additional benefits, all of which we’ve covered recently. And while many people malign the fact that defined benefit pensions are going extinct, the same kind of secure benefits can be found with an annuity. While that may be true, this article considers that relatively few people choose to purchase an annuity to fill the pension void.
 
In the author’s words…
Although people like Dave who have them tend to love them, old-fashioned “defined benefit” pensions are a vanishing breed. On the other hand, people like Ron — with defined-contribution plans like 401(k)s — can transform their uncertainty into a guaranteed monthly income stream that mirrors the payouts of a traditional pension plan. They can do so by buying an annuity — but when offered the chance, nearly everyone declines.
As we know, there is no shortage of economic evidence to verify the superiority of pension income.
Economists call this the “annuity puzzle.” Using standard assumptions, economists have shown that buyers of annuities are assured more annual income for the rest of their lives, compared with people who self-manage their portfolios…
If it’s this obvious, why don’t more people purchase annuities? Maybe you should tell me. I know first-hand that many consumers decline the annuity option, but rarely am I told exactly why. For starters, let’s take a look at the reasons mentioned in the article.
 
Stiffing Heirs– Many people feel that purchasing an annuity will decrease the likelihood of leaving a future inheritance. With the basic structure of most products, this is actually the case, although annuities can be designed to meet individual wishes.
 
Complicated Set of Choices– With the extreme amount of available annuities on the market, choosing one that fits perfectly is a daunting task. That’s exactly why this site was created. Here you can learn to grade specific contracts to find the most efficient way to produce long-term income without sacrificing other individual desires.
 
Payoff Is a Gamble– If profiting with an annuity contract requires that you live longer than average; many people would be justified to balk at the risk. The key to a suitable purchase is to not over-commit. By using an annuity to meet only your basic expenses you will keep additional assets available for the other financial goals you have.
 
If the economists are correct in saying that people with pensions and annuities are able to guarantee a higher level of cash expenditure over retirement, I think it’s worth raising all objections so you can give the option to purchase an annuity a chance. With a reasonable advisor, you should be able to take an academic approach to the question to verify a valid strategy.
 
I happen to think I’m a reasonable guy… and my clients would probably agree, it’s definitely worth closer inspection. What are your concerns with using an annuity for retirement income? An open discussion is the best way to answer every question. You’ll do yourself a disservice with any other approach.
 
I invite all your comments and look forward to helping you answer some very important questions.
 
Thanks for your time and have a great week!
 
Bryan J. Anderson
800.438.5121
3 replies
  1. ted j cooper
    ted j cooper says:

    I am one of those few people who actually went searching for an annuity last year.  Actually, I went searching for retirement management of my pensions/accounts and found a team who pitched annunities.  I am a Ph. D. physicist from M.I.T. and consider myself a reasonably smart person.  But when I looked at what has happened to my 401K and retirement accounts that I trusted the big broker houses to manage for me, I find that my IQ rating is going into the negative numbers.  From 1992 to 2008, I basically made maybe 2% overall…..not including inflation.  That stings in the worst possible way.
    So why did I not like the concept of annuities?   History,  my mother had one and it did not give her any guarenteed income, no lifetime payout, nor anything to pass on to the kids.  It was a 10year growth time annuity that paid out a fixed amount for a fixed time.  She outlived that time and so she had to go deeply into her savings to make ends meet at the end of her life.   I think that is the same story that most retirees have of annuities from the 1950-1990 timeframe.  They were rigid contracts that had a fixed return with no "share" in market growth.
    But the retirement managers I spoke with really had to break down all the old notions and basically say that there are "old annuities" and "new annuities".  They have almost nothing in common except for the fact that they use your money.  Everthing else is different.
    I read the Straight Talk site, and about 25 other sites.  I spent well over 100 hours pouring over contracts, blogs, news-groups, etc.  I seriously considered the 2nd area market of annuities.  But what I wanted was all the riders.  My family history has us living well beyond the median age.   I still do Shotokan Karate three times a week and I am 65 this August.  Short of meeting a semi on the wrong side of the street, I stand an excellent chance of making 100.
    My big gripe:  the contracts are too hard to understand.  I made a 30 page Excel spreadsheet to cover Aviva's BPA-12 to see how it performed.  I called the home office 5 times to talk to their marketing people.  When asked very critical specific questions about very specific examples…..they could not give me the answers.  They didn't understand their own products!  How absurd!   I will grant that the BPA-12 is one of the most complicated annuities out there, but someone should be able to answer technical questions about how it works with a given set of conditions.  Anyway, I bought it because it gives me a guarenteed 8% growth until I need to take out more than their 10% per year free withdrawal.  And I got all the riders.  Why?  because I want to give my kids something when my wife and I pass away.  And I want to participate in any market growth in the next 10-12 years.  
     
    I was absolutely sure that all my big broker agents had not done that for me in the prior 15 years.  My best long term growths have always been when I controlled the investments, but I am simply too busy now to put in 5 hours a day following the market and making decisions.   I gladly will pay someone else to do that.  But there is a catch…..I cannot loose money.   I want to grow when there is good growth, i will go flat when the markets are bad, and I will pay 2% for all the riders to insure I get what I want…..but only if I am in the growth mode.  I will pay nothing (no fees whatsoever) if there is no growth.   That has to be better than what I had before.
    So don't call them "annuities" like the insurance regulators call them.  That is old terms with old associations connected with old times.  Call them "gain only accounts".  That has more reality associated with it.
       Ted

    Reply
    • Bryan
      Bryan says:

      Ted,

      It sounds like you have considered several angles and done your due diligence. Yes, annuities have evolved over time to offer more benefits including the BPA contract you purchased.

      The BPA is a benefit-rich contract with a good income guarantee and solid death benefit. If purchased a year ago when benefits were better than they are now you probably did alright.

      It is complicated and you are not the first to comment on the shortcomings of a home office call center. At least they admitted not knowing the answer. That’s better than some I’ve talked to who give misinformation. The biggest issue is that there are so many working parts that require a lot of if/then analysis.

      As long as you focus on the benefits such as income and death benefit, you’ll get what you paid for. I will, however, stand by the secondary market as it will beat the pants off any other contract or strategy when structured properly.

      Primary products, such as the BPA, still have their place but there’s no excuse for an advisor who can’t explain the details of a contract. As long as you get what you want, I have no problem with the transaction.

      Feel free to let me know if you’d like someone to finally explain that contract you have. I’d be happy to oblige the service.

      bryan

      Reply
  2. Don Brammeier
    Don Brammeier says:

    Ted,
    Are you really receiving 8% compounding annually – or- are you receiving 8% of your ORIGINAL investment each year?
    I've been looking at Aviva's Multichoice Lifetime Solutions Annuity and was told that I would receive 8% interest each year BUT no one stated that it was only 8% of the original investment and NOT compounded.  Sort of misleading don't you think.  Almost makes me thing of fraud OR at least lying by omission.
    I wonder what else I have missed that they are not telling me!

    Reply

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