Question: How many have turned to annuities or "annuity - like" strategies to increase your income spending?
When I retired 13 years ago, I attempted to project my future spending needs. Over these years I have meet my spending needs with a combination of pension income (with a COLA), an Annuity Income (Savings that I converted to an Annuity), and some part time work. Since retirement, I have continue to contribute to my HSA and my IRA with contributions from part time work income. Recently I began managing one of my properties as a seasonal rental for additional income. I will work part time spending some of that work income and saving some into an IRA until age 73. My RMDs will then become a forced taxable event that may turn into an income source if needed or taxable savings if not needed.
What type of a portfolio would you design as an "Annuity - like" strategy for yourself? Maybe a combinations of Balanced mutual funds/EFTs that distribute periodically? Am I describing the 4% rule?
Shifting from a mindset of saving for retirement to a mindset of confidently spending in retirement is a huge challenge we all face.
Sourced through Ron Berger's Weekly email Newsletter:
https://robberger.com/newsletter/Working Paper:
Retirre's Spend Lifetime Income, Not Savings
Abstract: The shift to defined contribution savings plans means that more retirees must fund spending
from savings. Prior studies find that there appears to be a behavioral resistance to spending down
savings after retirement in a manner that is consistent with life cycle models. We explore how lifetime
income, wage income, capital income, qualified savings, and nonqualified savings are used to fund
retirement spending. We find that retirees spend far more from lifetime income than other categories of
wealth. Approximately 80% of lifetime income is consumed, on average, versus only approximately half or
other available savings and income sources. Overall, the analysis suggests that converting savings into
lifetime income could increase retirement consumption significantly, especially for married households.
Comments
But annuities and annuitization are unpopular terms now.
The industry has moved on to lifetime income or guaranteed income.
The irony is that basic SPIA bought online may be good for lot of retirees. It's the expensive annuities with lots of bells and whistles and bought from insurance agents or brokers that are BAD.
The full OP paper does mention annuities a handful of times.
There is lot of new work by Blanchett (author of the linked paper in OP), Pfau, etc that suggests a mix of lifetime income (see what I just did?), income streams (Social Security, pension - if any) and portfolio withdrawals.
If workable, legally sell the house to a relative or trusted friend & live on mortgage payments. Terms could be mutually beneficial.
That sounds just plain brilliant!
Except for the mortgage payment part, this sounds like the deal Harlan Crow made to buy Clarance Thomas' mother's house (formerly owned by Clarance, his mother, and his deceased brother's family). Gives a whole new meaning to "trusted friend".
Thomas' mother got to stay in the house rent free by retaining a life estate. That's where she still owned (had exclusive right to use/occupy) the house until she died. Using a life estate as partial payment for the purchase introduces a couple of tricky items:
- The holder of the life estate (being owner of the moment of the house) is still responsible for property taxes. Crow's company paid the taxes.
- Since the buyer paid not only the dollar amount agreed upon but gave the seller(s) a life estate, ISTM the sale price is the dollar amount plus the value of that life estate (based on life expectancy). The Thomas sale was supposedly structured where the life estate was part of the deal. Alternatively, if the life estate is not part of the purchase price, then it is a gift from buyer to seller, triggering gift tax filings.
Instead of using a life estate, the seller could simply pay rent. That often happens short term in real estate sales. The old owner needs a few extra days to move out, so they pay rent to the buyer starting on the closing date.
Regarding capital gains on any seller financed sale, the IRS provides a nice loophole. (I learned about this just a couple of years ago when a relative looked into selling some property and financing the sale.)
You and I might think of a seller financed sale as a completed sale (complete with recognized cap gains) plus a mortgage held by the seller. But the IRS looks at this as no different from an installment sale. As such, the seller recognizes cap gains in parts over the lifetime of the mortgage.
https://www.sellerfinancedream.com/resource-center/seller-financing-tax-benefits-and-seller-financing-tax-implications
This can help tremendously if the seller would have a large taxable gain (in excess of the $250K/$500K home sale exclusion).
Are there AA-AAA rated companies that would do seller financed purchases, with or without life estate?
What is the highest duration of installment sale one could get comfortable with becoming a creditor?
Since they are different types of transactions, the mechanisms for continuing to live in your home are different. With a mortgage (forward or reverse) you continue to own the property so long as the mortgage isn't foreclosed. With a sale (seller financed or other), the buyer owns the home. You need to make some sort of arrangement (as a renter or as the holder of a life estate or owner for some period of years, or ...) to continue to use the property. Consumer Financial Protection Bureau, What is a Reverse Mortgage?
FHA-approved reverse mortgage lenders
https://www.hud.gov/program_offices/housing/sfh/hecm/hecmlenders
In any case,
Are there AA-AAA rated companies that would do seller financed purchases, with or without life estate (i.e., lease back)? If not, I would think there is a lucrative market for this product.
I would like to defer gain and reduce cap gain tax but have to balance the risks of being a creditor for 10 years or more. The 5% (20 to 15%) lower cap gain tax + 3.8% extra tax on NII + state tax income tax on higher brackets + extra Medicare premiums can all add up.
Let us see if the goodies Trump will dole out to unfreeze the residential RE market include targeted tax brakes.
Thanks for the thoughtful, and timely article. As I believe we're due for a substantial correction and what many pundits are forecasting what may be a replay of the 2000's "lost decade", allocating a portfolio for generating reliable passive income may be an attractive solution...a DIY annuity, so to speak.
I'm having trouble making sense of some of this.
"Do seller financed purchases". What does "do" mean? Are you thinking of brokering (arranging) purchases? That is, finding an interested buyer and/or handling the paperwork? For those types of services I don't see what difference a company's credit rating would make.
Or does "do" mean taking the buyer side in the transactions? There, the credit rating of the company (as borrower) would matter. But what's the business model? Would the company build up an inventory of homes that it is buying "on time" and resell them to other buyers?
"lucrative market"
Would the profit come from paying well under market value, as "we buy homes for cash NOW" companies do? But then the seller wouldn't have any motivation to provide financing.
Or would such a company pay a better price for the seller financed homes? It might hope to make a profit from the use of the cash (full price) it receives from the sale of inventory homes.
It would pay the original seller one rate of interest (the seller financing rate) and earn another rate of interest on the proceeds from reselling the home. But where's the spread? The company would be borrowing long term from the original seller. Or would you expect seller-financed sales to be relatively short term (say, five years) with a correspondingly lower rate of interest?
Can you offer an example of a transaction "done" by such a company? I don't get what you have in mind.
"life estate (i.e., lease back)"
These are two different things. A life estate is actual ownership of property. A lease back is a rental where someone else owns the property. If you want more clarification, look up the difference between freehold estate (ownership) and leasehold estate (rental). See, e.g. here (it's not letter perfect, but gets across the general idea).
As far as Selleck is concerned, it's not a bad ad. https://southshoresenior.com/2024/05/what-tom-selleck-did-not-say-about-reverse-mortgages/ https://www.boldin.com/retirement/tom-selleck-reverse-mortgages-telling-truth/ Kiplinger, 10 Things You Should Know About Reverse Mortgages
*certainty about the size of their wealth if they are worried about real estate price corrections
*desire to continue to live in the house after they lock in the sales price
*reducing taxes on the sale.
Freehold estate would not work.
Let us see if some company like Blackstone (as a buyer) can not find juice in such a product.
(Not everyone is lucky enough to have a son like Clarance or a friend like Harlan.)
When I retired 13 years ago, I attempted to project my future spending needs. Over these years I have meet my spending needs with a combination of pension income (with a COLA), an Annuity Income (Savings that I converted to an Annuity), and some part time work. Since retirement, I have continue to contribute to my HSA and my IRA with contributions from part time work income. Recently I began managing one of my properties as a seasonal rental for additional income. I will work part time spending some of that work income and saving some into an IRA until age 73. My RMDs will then become a forced taxable event that may turn into an income source if needed or taxable savings if not needed.
What type of a portfolio would you design as an "Annuity - like" strategy for yourself? Maybe a combinations of Balanced mutual funds/EFTs that distribute periodically? Am I deribing the 4% rule?
Shifting from a mindset of saving for retirement to a mindset of confidently spending in retirement is a huge challenge we all face."
For me, I accumulated a significant amount "defined contribution" assets through my employer, along with some estate inheritance assets inherited by my wife. Those all reside in our property, in our Schwab Brokerage, and in local banks and credit unions. As part of our retirement, my wife and I depend on income from Social Security, a small government pension, which pays enough income for about half of our normal living expenses. We produce additional income through a changing array of asset holdings at our brokerage and our bank and credit unions. The closest thing to an "Annuity-like" strategy, that we use are fixed income instruments such as Money Market accounts, CDs, high yield Savings Accounts, and treasuries, to supplement SS and the small pension of my wife. The fixed income instruments are comfortably producing a 4 to 6% stream of income, so I am able to maintain principal and just live off the income that my "principal assets" throw off annually. I have in previous years used bond oefs, that were very low volatility, low "risk" funds, such as RPHIX and DHEAX, but when the Market went through a severe correction in 2020, I sold all the bond oef funds, put all the sales proceeds into MMs, and then moved money out of MMs into other low risk fixed income instruments, many of which are covered by FDIC and NCUA government insurance protection. That is where I am now, but I always have to maintain enough investing flexibility to make investment decisions necessary to throw off enough income, with the least amount of risk, to meet my 4 to 6% annual earnings.
The challenge with the original question is developing that strategy and putting it in place TODAY. As with anything, it takes some time and the right market conditions. If a person cannot wait, then an annuity may make sense.
Wouldn’t it be smarter to do a traditional refinance of your existing home for whatever you can pull out? Then invest the money and draw it down as you need it? The bank or other institution would of course hold a lien against the property. I’ll add that at 7% (+-) interest rates this would be a last resort. However, it sounds better than a reverse mortgage. Guess I don’t understand RMs very well.
Oops - I should have read @msf’s above link first:
”A reverse mortgage loan, like a traditional mortgage, allows homeowners to borrow money using their home as security for the loan. Also like a traditional mortgage, when you take out a reverse mortgage loan, the title to your home remains in your name. However, unlike a traditional mortgage, with a reverse mortgage loan, borrowers don’t make monthly mortgage payments. The loan is repaid when the borrower no longer lives in the home.”
Psychologically, I’d find that difficult to adjust to. It defies everything I’ve been taught about sound financial management - an open-ended lien. Alas, the concept does have some logic behind it.
@bee - I think @PRESSmUP’s above response / suggestion is spot-on. If you can cope with an occasional down year or two it should be possible to construct a portfolio that at least keeps pace with inflation and allows relatively small annual drawdowns. Let’s assume that pulling out 5% (maybe a bit more) a year isn’t going to kill the goose even if the portfolio sustains 2 or 3 back-to-back negative years, His suggested investments are excellent. Obviously, the more additional risk you can afford comfortably to take the better you’ll do over longer (3-5 year) periods.
"When I retired 13 years ago, I attempted to project my future spending needs. Over these years I have meet my spending needs with a combination of pension income (with a COLA), an Annuity Income (Savings that I converted to an Annuity), and some part time work. Since retirement, I have continue to contribute to my HSA and my IRA with contributions from part time work income. Recently I began managing one of my properties as a seasonal rental for additional income. I will work part time spending some of that work income and saving some into an IRA until age 73. My RMDs will then become a forced taxable event that may turn into an income source if needed or taxable savings if not needed."
I never know if posters are in similar situation as the OP, or if they are in a very different situation, when they offer their input to the OP.
Color me skeptical. Money managers like Vanguard and Fidelity tried to do this and failed. Barron's, Vanguard Throws in the Towel on Its Managed Payout Fund, Feb 28, 2020
The insurance component is what is missing in DIY (or professionally managed) alternatives. In order to guarantee (self insure) that you won't run out of money in your lifetime, you have to overfund. That may be okay if you're planning on leaving a legacy and are willing to dip heavily into that legacy if things don't work out. But it reduces the income stream that you could otherwise have.
A similar point about underspending is made in the originally cited paper: What annuities do is pool risk. Some people die early, others later. Instead of each individual self insuring (collectively overinsuring), individuals pool their risk through an insurance company. This provides larger income streams safely.
The risk is in outliving your money. A traditional immediate annuity is not the only way to protect against this tail risk. A longevity annuity (a form of immediate annuity where payouts are deferred) will also do the job.
T. Rowe Price recognized this and recently came out with a product for employer-sponsored plans (401(k)s, etc.). Its Managed Lifetime Income product provides a managed payout investment for 15 years followed by a QLAC (qualified lifetime annuity contract).
I don't see any reason why one cannot do this oneself, self-managing a portfolio (as @PRESSmUP described) and adding a longevity annuity (either QLAC or nonqualified).
Alternatively, one can annuitize a variable annuity. The Mechanics and Regulation of Variable Payout Annuities (50 pages. TL;DR)
HSA Eligible List
Which opinion? I’ll try to compare my situation to yours but not sure if that affects most of my opinions about investing or finance..
- “When I retired 13 years ago,”
I retired 25 years ago
- ”I attempted to project my future spending needs”
Ditto. I worked this out over the 2 or 3 years before retiring.
- “Over these years I have meet my spending needs with a combination of pension income (with a COLA), an Annuity Income (Savings that I converted to an Annuity), and some part time work.”
Pretty close. I have Social Security and a pension. While working I opted-in to a pension feature that adds 3% yearly of initial amount. Not really COLA - but helpful. The pension provides some supplemental health care coverage in combination with Medicare. I’m not as up-to-speed as I should be on the out-of-pocket expenses - but there are some. Never owned an annuity. No part time work. Active maintaining home infrastructure others might farm out.
- ”Since retirement, I have continue to contribute to my HSA and my IRA with contributions from part time work income. Recently I began managing one of my properties as a seasonal rental for additional income. I will work part time spending some of that work income and saving some into an IRA until age 73. My RMDs will then become a forced taxable event that may turn into an income source if needed or taxable savings if not needed."
Had a 403-B at work invested 100% in a global equities for 28 years. On retirement I converted it to a Traditional IRA and diversified the assets more broadly. In early ‘09 I converted about 40% to a Roth to take advantage of the crash. Made 2 smaller conversions over the next decade. 90% now in a Roth. RMDs alone from the Traditional are adequate to meet all my needs (along with SS & pension). The Roth provides a safety-net that might be needed for major infrastructure repair or other unexpected needs. I’m single and once-divorced. Own some nearby real estate that could be sold for additional cash. The home has a small fixed rate 3.13% mortgage (less than 20% of value) taken out for some renovation more than 5 years ago. Could pay it off, but think I can do better investing across a diversified portfolio consisting largely of OEFs, CEFs & ETFs.
"Color me skeptical. Money managers like Vanguard and Fidelity tried to do this and failed."
No doubt. But your Barron's article suggests why my portfolio is perhaps different than that of those 2 firms..." One hurdle: Managed payout funds have long had trouble hitting their income targets without dipping into capital—simply giving investors part of their money back."
You see, I'm not smart enough to engineer a dedicated income stream, so I don't try. So for my income sleeve I buy things which already generate a distribution. When bought at opportune pricing and from solid companies or firms which have a history of maintaining/growing their distributions, the income takes care of itself.
And it's no wonder the managed payout funds closed up...in 2020, during the pandemic. But 2020 was a perfect time to buy stocks/funds for an income portfolio. JP Morgan, Prudential, AbbVie all selling at fire sale pricing with big dividends. I even bought Broadcom for <$30 yielding ~5%.
After 2 straight years of 20%+ growth in the S&P, this coiled spring is going to unwind sometime in the next year or two, and things will go on sale once again.
Yeah - @bee and I both taught. Probably some similarities to situations. We’ve both been here through thick and thin many years. bee is smarter than me. Adds greatly to the forum with really deep incisive / informative posts. Sorry for my miscue!
My own take is that we develop confidence in how we invest over a lifetime of investing, reading, listening, sharing. There are many ways to skin a cat. Examine your past experiences and plot the best course you can based on that experience. If you don’t have a background that gives you confidence in some approach, don’t change horses (or wagons) midstream. But folks with past experiences may be comfortable with and able to handle risk taking that others shouldn’t undertake.
Maybe relevant - The cost of living varies by geographical location and standard of living desired. I couldn’t afford beachfront in Miami or a condo in a NYC high-rise. Housing in southern Michigan (Metro Area) is more expensive than the upstate regions. These differences make individual comparisons difficult.
Annuities haven’t appealed to me personally. And I don’t distinguish between dividend income and asset growth. If my holdings’ NAV is rising X% a year over time, I don’t care how that gain was achieved. In a taxable account it would matter. But in a tax-deferred / tax-exempt account a gain is a gain ISTM.
A. Of those fully retired, how many manage their portfolio for total return and how many target X amount of income per month / year.
B. Of those that target X amount of income, (1) did they ever manage the portfolio in retirement entirely for total return and (2) if so, how many years into retirement (or age) did they add the element of income requirement?
P.S.: for me (A) so far total return. I have not figured out if and when I might introduce income requirement but given some people have it, I can not assume that I will only manage for total return. So far, I draw from the portfolio of what is needed.
"Spending cutbacks to self-insure against the tail risk associated with medical costs or advanced age is clearly suboptimal when products exist to pool these risks."
I wrote: "The risk is in outliving your money. A traditional immediate annuity is not the only way to protect against this tail risk. A longevity annuity (a form of immediate annuity where payouts are deferred) will also do the job."
You can use a fixed immediate (traditional) payout annuity but you don't have to. If you want to continue to keep market exposure for several more years, a longevity annuity can enable you to do that.
Here too, there's more than one way to skin a cat. A variable payout annuity, even with immediate payouts, also provides a measure of market exposure. And as noted in another quote I gave, it protects against the risk of locking in a low rate of return if you annuitize when rates are low.
My implicit suggestion was to think about what your objectives and risk concerns are and to look around. Products usually do exist to meet those objectives efficiently.