Buying the Right Annuity

I’ve said a lot recently about how education is important so that you can make the final decision for retirement.  Using an annuity mostly improves a portfolio but how it does that is up to you.  In most cases two or more options will work but the ultimate strategy depends on the preference of the customer.  You get to decide but you need all the information first.

Once in a while I see a case where it’s not so open-ended.  A case like this came across my desk recently so I decided it’s a good time for a case study.  In this situation there is really only one way to do it.

This lady is a 75 year old widow on a fixed income that just covers basic necessities.  Part of her income is sourced from a period certain annuity that pays her $950 per month for another four years.  When that stops she needs to replace the income.  On top of that she would like to be able to spend another $300-$400 per month to make life a little more enjoyable.

Her assets to accomplish both goals consist of $150,000 that’s sitting in the bank.  Safety is of primary concern but enhanced yield is also necessary to make these goals attainable.  The goal is to keep $20K available at all times for emergencies, which gives her $130K to work with.  She had talked to a few other people and got a standard pitch that was obviously better for the salesman than it would have been for her.

The proposal included putting the entire $130,000 into a bonus annuity with guaranteed income.  It was recommended that she take free withdrawals for extra cash flow in the near term and let the guaranteed income side of the contract grow until it could replace the $950 per month in four years.  This would possibly work using the highest projected returns possible but there’s far too much variability to guarantee a result that would work.  My guess is that it would fall short and the salesman would be long gone by the time she really needed him, forcing her to make some dramatic changes in lifestyle at a very vulnerable time in her life.

For comparison purposes it’s important to note that the highest guaranteed lifetime income payout for $130K with income starting in four years would be around $1200 per month.  This falls short of the total income goal and does nothing to provide for additional spending today.

The reasonable solution would be something so simple that most people overlook it.  Or, a nice commission gets in the way and the customer ends up getting the short end of the stick.  Let’s assume that the agent involved just doesn’t know any better rather than accusing him of placing his own interests in front of the customer.

The solution is just as simple as improving the yield on the portion of available funds.  Set aside the $20K as planned and keep another $30K in a separate account that is easily accessible.  Buy a five year fixed annuity that pays 4.25% interest with the remaining $100K and it’s done.

From the $30K in the bank, she can withdraw a few hundred dollars per month and the interest from the fixed annuity will more than replenish what she takes out, so long as she doesn’t go overboard.  After four years she can withdraw the $950 per month from either the annuity or the cash account and after five years the fixed annuity is completely liquid.  She gets extra spending money every month, covers the shortfall from lost annuity payments in four years and arrives at age 80 with nearly the same amount of money as she has now, all without taking risk.

If she spends $300 per month for five years and replaces $11,400 in lost annuity payments during the fifth year, it will total $29,400 in spending.  The $30K in the bank is essentially gone but without touching the annuity it would be guaranteed to accumulate to over $123K during the five year period.  She retains control over all the money and five years of spending only cost her seven thousand dollars.

The solution is so simple and there’s no concern about figuring out a complicated contract.  She will live past 80 and at a very conservative estimate will be able to continue spending the same amount of money into her early 90s before she runs out of money.  If rates rise in the future it will be even better.

There is plenty of more detail that goes into the little intricacies of this but nothing material that would cause it not to work.  I’ll touch on many of these things in the podcast and if you have any specific questions then don’t hesitate to ask.  Whether you are on a fixed budget with modes assets or have plenty of assets and just want to do things efficiently, then this is the place you’ll figure it out.

Thanks again for sticking with me and let me know if I can run some numbers for you.

Enjoy your weekend!


Written By

Bryan Anderson

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