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Should you consider an income annuity in your retirement plan thinking?
I know, I know just the word annuity tends to make many of us upchuck but this attached article laid out a strategy for including an income annuity with some fairly simple illustrations, examples and considerations. It's not part of my plan but I will be reading through this again later. I only offer it up for those who may be considering such a path. I also hope that those who are more versed in these critters will point out any flaws or positives in the authors thinking.
Thanks for the article @Mark. Wade Pfau, mentioned in your linked article, also recommends the use of a reverse mortgage (not mentioned in your article) as an alternative strategy to access income during retirement especially when sequence of return risk is high (when selling investments in a down market would hurt success rate of outliving the portfolio).
Reverse mortgages get a bad wrap (late night sales pitch to elderly homeowners), but when carefully planned with knowledgeable guidance they can be an additional way of securing an income stream during years when equity market under perform. If you use the reverse mortgage as a short term loan bridge for withdrawals during periods of market downturns and you later pay off the "equity line" and the interest in full (up to $100K of the advance), then the interest is tax deductible in the year paid. The payments are considered a loan advances and are tax free. I believe a HELOC or a fixed Home Equity (used for income) would not be tax deductible with the new tax laws. HELOC call be called in by the lender a reverse mortgage can not be called in.
If you missed this presentation I'll link it here. The costs of a fix immediate annuity (2.5-3.5%) is lower than the cost of setting up a reverse mortgage.
Opening a reverse mortgage as early as possible (age 62) can provide a variety of income options (lumps sum, periodic tenure payments, reserve asset), your equity ("line of credit") in a reverse mortgage interestingly grows independent of the property value, and any unused equity is passed on at death.
Like you, I'm not convinced that an annuity or reverse mortgage is right for me, but doing some research is the first step in determining the path.
Here the presentation by Wad Pfau on the value of a Reverse Mortgage as part of a well designed Financial Plan:
While the general thrust of the Seeking Alpha column is okay, there seem to be a fair number of misstatements.
Here's an example of misstated, or misused, data: In citing Pfau's 2012 paper, it states:
In fact, retirement research by Dr. Wade Pfau suggests the 4% withdraw rate had fallen to 3.6% with a 10% failure rate and 30-year time horizon. This from a paper done in 2012 and assuming 8.7% arithmetic mean returns on stocks.
It doesn't explain that the 8.7% is real return, not nominal. (Pfau: "This is real data after adjusting for inflation.")
But much more important is that it presents Table 2.3B from Pfau's paper, noting (correctly) that the table shows a 3.6% withdrawal rate has a 10% chance of failure over 30 years, but incorrectly stating that this is "assuming 8.7% arithmetic mean returns on stocks."
In reality, Pfau adjusted the real rate of returns on stocks down 1.52%. Pfau wrote: "This Table 2.3B is produced using the modified return assumptions in Table 1B. " Those modifications are that "Table 1B keeps the same historical equity premium over bonds, but it adjusts all of the returns downward by 1.52%" (Table 1B shows arithmetic mean stock returns of 7.18%.)
Another misstatement: It says that credit risk is a problem in a corporate bond portfolio, but not when you buy an annuity. Except that the payment stream from a fixed annuity is backed only by the general ability of the insurer to pay. If that's not credit risk, why not simply buy the highest paying annuity from the lowest rated insurer? Insured means no credit risk, right? Just ask holders of bonds insured by AMBAC.
I've stated often that I feel a good, inexpensive, annuity backed by a solid insurance company can be used effectively to provide needed income in retirement. My comments relate to the particulars of the column, and not to using annuities generally.
The topic of annuities seem to generate contentious debate on investment forums. Bottom line appears to be they are appropriate for those fearful of running out of money in old age. Hence not really appropriate for those with above average nest eggs. In checking immediate annuities for my age (71 this month) and home state, the first 13 years the insurance company is simply paying back my principal. On a deferred annuity such as a 10 year deferral my principal is paid back in four years after the deferral or 14 years later. Of course both scenarios assume I will still be around by those times. No thanks! I have much better things to do with a portion of my principal (nest egg) in the meantime than to enrich some insurance carrier.
I have an open mind for future consideration. At 64, not planning on it now, but will consider down the road. You don't need insurance selling brokers making big commissions on these products anymore.
In effect, I don't see it any different then holding cash or bonds to use for withdrawals. Actually you are likely to get a higher return then the those investments. The crux of course is you have to make sure you don't die until you recovered your principle. But all insurance is a gamble. Will I ever recover the amount I've paid into my home-owners policy? Not likely.
Even if you have an "above average nest egg", you're going to have a given level of necessary expenses "forever". You have to plan on "forever", or at least some pretty high age that you're certain not to outlive, e.g. age 105. Either one buys a guaranteed stream for those minimum needs, or one over-saves, "just in case".
That means not spending as much on yourself as you could have otherwise. Or if you're planning on leaving money to heirs, that means investing some of the money too conservatively, as viewed from the heirs' perspective.
So there's value in guaranteeing yourself enough money to live on. It gives you the freedom to do whatever you want with the remainder of that above average nest egg.
Out of curiosity, and out of respect for privacy I'm not trying to compel an answer here, did you take SS at age 62, or did you wait awhile? I ask because if one's thinking is that one may not be around at age 82 or so (the break even point), one would be inclined to take it as soon as possible.
If one doesn't reach 82, then the earlier one takes SS, the more one gets (vs. waiting even an extra month). Conversely, if one does reach age 82, then the later one takes SS, the more one gets.
FWIW, I'm planning to defer SS for as long as possible. I may or may not come out ahead that way, but it goes a long way toward relieving me of concerns about needing to save for when I'm 90.
Regardless of what I, or you, or any one else may answer, everyone views this differently.
I took Social Security ASAP at age 62. I dont regret that one bit. Before that I rarely had any guaranteed income and SS finally gave me that luxury. I have always felt most overestimate their potential longevity and thus overcomplicate retirement planning. In my neck of the woods males 90 and over are a rarity. In fact they are a rarity in most all neck of the woods. I am single and feels that simplifies the financial aspects of retirement. Regardless, based on my low living expenses while also allowing for bouts of frivolous spending sprees (such as now owning three Nissan Xterras). I should be fine past 100. I am blessed in many ways and as such have become more religious in my advancing years. But that is a story for another time and place.
Thanks for sharing. If your SS meets your needs, it sounds like you're doing what's best for you. May you live long enough to have second thoughts about your decision
Comments
Reverse mortgages get a bad wrap (late night sales pitch to elderly homeowners), but when carefully planned with knowledgeable guidance they can be an additional way of securing an income stream during years when equity market under perform. If you use the reverse mortgage as a short term loan bridge for withdrawals during periods of market downturns and you later pay off the "equity line" and the interest in full (up to $100K of the advance), then the interest is tax deductible in the year paid. The payments are considered a loan advances and are tax free. I believe a HELOC or a fixed Home Equity (used for income) would not be tax deductible with the new tax laws. HELOC call be called in by the lender a reverse mortgage can not be called in.
If you missed this presentation I'll link it here. The costs of a fix immediate annuity (2.5-3.5%) is lower than the cost of setting up a reverse mortgage.
Opening a reverse mortgage as early as possible (age 62) can provide a variety of income options (lumps sum, periodic tenure payments, reserve asset), your equity ("line of credit") in a reverse mortgage interestingly grows independent of the property value, and any unused equity is passed on at death.
Like you, I'm not convinced that an annuity or reverse mortgage is right for me, but doing some research is the first step in determining the path.
Here the presentation by Wad Pfau on the value of a Reverse Mortgage as part of a well designed Financial Plan:
Reverse Mortgage as a Financial Planning Tool
Here's an example of misstated, or misused, data: In citing Pfau's 2012 paper, it states: It doesn't explain that the 8.7% is real return, not nominal. (Pfau: "This is real data after adjusting for inflation.")
But much more important is that it presents Table 2.3B from Pfau's paper, noting (correctly) that the table shows a 3.6% withdrawal rate has a 10% chance of failure over 30 years, but incorrectly stating that this is "assuming 8.7% arithmetic mean returns on stocks."
In reality, Pfau adjusted the real rate of returns on stocks down 1.52%. Pfau wrote: "This Table 2.3B is produced using the modified return assumptions in Table 1B. " Those modifications are that "Table 1B keeps the same historical equity premium over bonds, but it adjusts all of the returns downward by 1.52%" (Table 1B shows arithmetic mean stock returns of 7.18%.)
Another misstatement: It says that credit risk is a problem in a corporate bond portfolio, but not when you buy an annuity. Except that the payment stream from a fixed annuity is backed only by the general ability of the insurer to pay. If that's not credit risk, why not simply buy the highest paying annuity from the lowest rated insurer? Insured means no credit risk, right? Just ask holders of bonds insured by AMBAC.
I've stated often that I feel a good, inexpensive, annuity backed by a solid insurance company can be used effectively to provide needed income in retirement. My comments relate to the particulars of the column, and not to using annuities generally.
In effect, I don't see it any different then holding cash or bonds to use for withdrawals. Actually you are likely to get a higher return then the those investments. The crux of course is you have to make sure you don't die until you recovered your principle. But all insurance is a gamble. Will I ever recover the amount I've paid into my home-owners policy? Not likely.
That means not spending as much on yourself as you could have otherwise. Or if you're planning on leaving money to heirs, that means investing some of the money too conservatively, as viewed from the heirs' perspective.
So there's value in guaranteeing yourself enough money to live on. It gives you the freedom to do whatever you want with the remainder of that above average nest egg.
Out of curiosity, and out of respect for privacy I'm not trying to compel an answer here, did you take SS at age 62, or did you wait awhile? I ask because if one's thinking is that one may not be around at age 82 or so (the break even point), one would be inclined to take it as soon as possible.
If one doesn't reach 82, then the earlier one takes SS, the more one gets (vs. waiting even an extra month). Conversely, if one does reach age 82, then the later one takes SS, the more one gets.
FWIW, I'm planning to defer SS for as long as possible. I may or may not come out ahead that way, but it goes a long way toward relieving me of concerns about needing to save for when I'm 90.
Regardless of what I, or you, or any one else may answer, everyone views this differently.