The Case for Annuities in a Retirement Portfolio

If you are going to consider using annuities in a retirement plan it’s necessary to start by improving on traditional advice.  If an annuity isn’t the better option then there’s no reason to buy one.  The only reason I sell annuities for a living is because I know there are many instances where an annuity is the best choice.

For comparison purposes let’s start with a fairly standard portfolio example.  Generally speaking this is going to consist of a pre-chosen blend of equity stocks and bonds.  Traditionally people have been advised that a 4% withdrawal rate is sustainable so assuming no major volatility issues, a $1M portfolio should be able to produce $40,000 income annually with inflation adjustments.

Bonds provide steady income, stocks and mutual funds provide some dividends and the growth from the equity side is supposed to offset inflation.

We can use current interest and dividend rates to see how a mix of 40% bonds and 60% stocks will produce the income needed.

Five year bonds are paying 3.5% interest and the average dividend on stocks in the S&P 500 is around 2.5%.

40% of the portfolio in bonds will produce $14,000 interest annually.

60% of the portfolio in US-based equities will produce $15,000 in dividends annually.

This is a portfolio that is not particularly risk-averse and well positioned for growth on the equity side.  But the mix will leave someone $11,000 short of the initial income goal.  Making up the difference will require selling into principal and growth on the equity side will be needed to offset inflation and maintain a growing balance over time.

Selling into principal compounds risk and damages portfolio growth over time.

If you sell bonds, you have interest rate risk that could devalue the withdrawal, plus it will decrease future income payments with less principal.

Selling equities is fine except when the market is down in value.  Selling stocks when down in value only compounds losses and also decreases dividend yields with a lower balance.

“Interest rate risk and low rates on the bond side and market risk on the equity side make it complicated to manage income and achieve optimal growth.”

Over time the market will rise but if the timing is wrong on any withdrawals it will only be more difficult to keep pace with the income difference and any necessary inflation adjustments on spending.  This is the issue that causes long-term problems and has puzzled academics and industry analysts for years.

The insurance industry has an answer for providing the income needed but producing $40,000 income annually will cost $700K or more.  Income would be covered for a lifetime but only $300K of the portfolio would be left for inflation protection and discretionary spending.  For some, the peace of mind is worth it but I think that’s far too expensive and the kind of emotional leap that is hard for many to take.

I have always found that to be a hard way to sell annuities because I don’t especially like to prey on the various fears retirees have.  It takes a major shift in the portfolio to accomplish this as well.  The annuity expense is not the only problem.  You would also have to relinquish a significant portion of growth potential.

There happens to be a better way that addresses the issues with the standard stocks and bonds portfolio approach and also eliminates the substantial cost of the annuity.

Start by replacing bonds with an indexed annuity.  The first benefit is that you are not making a significant change to the overall portfolio.  Similar growth potential exists on the equity side and I’ll show you why the indexed annuity improves the safe allocation.

Rather than use the bonds in a portfolio to produce income, use the indexed annuity as a place to draw income when the market is down in value.  10% of the account can be drawn annually without penalty of interest rate risk.  And to beat a bond it only needs to grow at 3.5% or better, which is fairly easy to do.

If you consider the $15,000 available annually from the equity side of the portfolio that means a maximum withdrawal of $25,000 from the annuity.  Withdrawals can be increased on the annuity side so that dividends can be reinvested in good markets or bad in order to maximize growth or enhance recovery, depending on performance and personal goals.

Having developed a basic model to test the various options I can tell you with confidence that what I call the Flex Strategy produces substantially more growth on a portfolio than traditional management or the standard approach with a lifetime income annuity.

Targeting short-term indexed annuities without income riders will eliminate fees and enhance growth on the contract.  When the term is up the portfolio can be rebalanced to maintain the desired character for growth and income.

This is an excellent way to produce systematic or discretionary income but that’s not all.  When required distributions come at age 70 it is also the optimal way to manage a portfolio when you have to take withdrawals.

The details of this example are intentionally general in nature.  Average yields for both bonds and dividends can be increased by taking on more risk with lower rated bonds or by accepting less growth on higher dividend stocks.  The interest and dividend figures are also void of management fees so I call it a wash.

If you were able to manage it all yourself it takes a substantial amount of work and experience to accomplish total interest and dividend yields that exceed 4%.  If you are looking for a more care-free retirement then the annuity option would give you all the benefits needed.

Please feel free to comment or give me a call if you would like to see models using your numbers.

All my best,



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Last Updated on May 10, 2024 by Bryan Anderson