I Don’t Have A Pension…. Do I Need An Annuity?
August 15th, 2018 / by Bryan Anderson
Mary recently asked a question about retirement income that is very common, so I posted it along with my answer below.
“My husband and I have nearly $1.5 million in savings and are nearing retirement, although he has some health issues that may force him to retire sooner than we’d hoped.
We like the plan our adviser has put together for us, but we’re unsure of the markets and are considering using some of our savings to buy an annuity for guaranteed income.
Our financial adviser says we’re fine without an annuity, but we’re still unsure since neither of us will receive a pension. What do you think?”
There are two fundamental things you mentioned that make me think you should consider annuities. Plus your advisor’s response indicates that you absolutely need to approach this from a different perspective.
First, you said you were unsure of the markets…
“If you’re unsure about the market, the major benefit of an annuity is that it insulates you from market volatility.”
Second, the right annuity may give you exactly the certainty you are lacking without a pension. If you’re smart about it you can use an annuity to solidify your portfolio, provide the income you want and position your total portfolio for continued growth through retirement.
But, getting all this from an annuity will require you to use it in a way that goes against conventional thought.
Let’s start from the beginning:
When first considering whether to buy an annuity it all comes down to the level of assets you have in relation to the amount of income you need each year in retirement.
Your advisor is likely taking this into account when saying you don’t need an annuity. Your annual spending must be relatively low so you can easily handle volatility in the years ahead without negatively affecting long-term performance. Objectively speaking that may be the case but the problem is the emotional toll you will pay when market corrections reduce the value of your portfolio.
I work with a lot of people who don’t need annuities, but out of prudence and for peace of mind they decide they want one.
You’re not alone if you think the only purpose for annuities is guaranteed income. Marketing from inside the industry and the willingness from most advisors to follow the status quo has given this misconception widespread acceptance.
Try instead to think of annuities as just another safe asset. If you are in retirement then you should have around half of your assets allocated to safety. Traditionally this means bonds but if you need income from your portfolio it takes a lot of bonds to produce anything reasonable with low interest rates.
That alone is one of the reasons annuities are so popular. It’s essentially a drawdown of assets with a guarantee that income will continue as long as you live. This gives you a relatively high payout in relation to other income producing assets but it requires you to surrender a big chunk of assets to get it.
Is the trade-off worth it?
It all depends on what you want. Plenty of people buy into the “guaranteed lifetime income” pitch and there’s nothing specifically wrong with it but I believe there are better ways to manage assets over time.
It makes no difference to me whether you are talking about immediate, indexed or variable annuities with income riders. Regardless all you can count on is the steady paycheck. In most cases it takes close to 20 years to break even so the average retiree is not in the money until well into their 80s.
The big chunk of assets that funds the annuity will take a serious bite out of your portfolio so if you’ve saved enough then you may consider it not worth the cost. I don’t think it is. From this perspective I will agree with your advisor and say you probably don’t need an annuity.
But do you want one?
For a more reasonable approach that doesn’t require a huge commitment, consider using a deferred annuity more geared for growth. Right off the bat you are eliminating fees and avoiding a long-term commitment so it’s already looking better.
If you just look at it like shifting a portion of safe assets to a different allocation then it’s nothing more than responsible portfolio management. For the sake of diversification, why would you want all your safe assets in bonds anyway?
Annuities will typically yield better than bonds but regardless carry one distinct advantage over bonds. Liquidity. That’s not what most people would think of as an advantage of annuities but it can make a big difference in a portfolio.
Most annuities come with 10% free withdrawals annually. You can use this to offset market volatility over time which will set you up for optimal long-term performance.
Bonds won’t allow you to dip into principal without accepting some interest rate risk so it’s not prudent to do anything but collect the interest. This typically means you may have to systematically sell equity assets in order to meet income needs. When markets are down in value that’s not something you want to do.
An annuity with 10% free withdrawals will allow you to take greater amounts in years when the market is underperforming, giving equities time to recover to full value. Over several years this makes an enormous difference in portfolio value. And you don’t have to commit half your assets to a guaranteed income product to make it work.
Consider this basic exercise…
In retirement, people shift to greater levels of safety because the stock market is not dependable.
Annuities are used to guarantee an income base for all years of retirement so the stock market doesn’t negatively affect spending.
But, the average bear market has taken an average of 3.3 years for markets to return to previous levels.
So why do you need income for all years of retirement when you may only need to weather a market storm for a few years every now and then?
I would advise you to consider diversifying some of your safe assets and using an annuity to do it. You will give yourself more flexibility to draw income when you need and take pressure off the more risky assets in your portfolio. This doesn’t directly contradict what your advisor is telling you, it just gives you some additional benefit and a little more security.
I’ve recorded a video below that goes into a little more detail but how it would work for you depends on several factors. Then you should download the 2018 Indexed Annuity Guide. This will show you how the product works and a couple ideas for the best way to use an annuity.
When you’re ready to talk about your specific numbers you can use the link below to make an appointment.
All my best,