I want to buy an annuity. As I’ve written before, they make sense to me, in theory. In practice, I’m having a hard time pulling the trigger….
We received a modest inheritance. It doesn’t change our financial picture substantially, but it does mean we have some free cash to put to work — money we weren’t necessarily banking on. So this is a good opportunity to experiment with a new asset class. Diversify a bit. And one of the most compelling asset classes for retirees is an annuity — guaranteed monthly income for life….
We’re not interested in an immediate annuity right now, because we don’t need the income yet. We have several years of cash on hand, and years beyond that in conservative investments. We have a bit of business income. We are still at an age where our lifestyle remains flexible, where returning to work would be an option, where we can manage our own investments. In short, there is no need to put our retirement income on “autopilot” just yet.
But, a while back, I read about a new type of annuity, a deferred income annuity or DIA, also sometimes called “longevity insurance” or a “longevity annuity.” At the time, it was said, you could hand over a relatively small amount of cash (a 5-digit sum) to an insurance company while in your 50’s or 60’s and that could guarantee much of the income you’d need farther on in life, say from your 80’s onward.
So, I could potentially spend a small portion of my investment portfolio, and guarantee that we would never run out of money should we be fortunate to survive into our 80’s, 90’s, or beyond. That sounded pretty good!
And now we have some free cash that we hadn’t been counting on, potentially available to spend on such an annuity. So it was time to get serious about shopping for one….
I started by calling USAA. They originated as an insurance company after all, so I figured they’d have some compelling annuity offerings.
I’ve long been a USAA fan. My Navy father joined me up before I left home, and I’ve been a member ever since. I’ve had my auto insurance with them for as long as I can remember. And then, about 10 years ago, we closed all our local bank accounts and moved our banking to USAA. All of our day-to-day transactions — checking, credit cards, savings — move through their capable systems now. A few years ago, I even opened a brokerage account at USAA, to hold a portion of our taxable investments (still invested in Vanguard funds).
USAA has won numerous awards for customer service and I generally find their representatives to be top-notch: courteous, efficient, and knowledgeable. Since the money I’d earmarked for a possible annuity purchase was already on deposit at USAA, it would certainly be convenient to purchase the annuity through them and keep all the paperwork under one roof going forward….
Unfortunately, my annuity-shopping experience was disappointing. It took quite a bit of awkward discussion to establish that USAA doesn’t actually offer longevity or deferred income annuities. Oh well, I figured I’d get a quote for an immediate annuity, just for comparison purposes. That quote wasn’t particularly competitive, and when I asked to add an inflation rider, I was told they were having technical issues with their software and they’d have to get back to me. A follow up message arrived the next day informing me that “…we don’t offer the inflation option for a person under the age of 59 1/2, or for anyone at any age in New Mexico.”
Next up was Vanguard. Vanguard is not an insurance company, and doesn’t actually offer its own immediate annuity products. But I knew that they had partnered with other companies to offer a suite of related products including variable annuities, guaranteed income (GLWB’s), and fixed annuities. For the latter, they offered a comparison and purchasing service, where Vanguard leverages its name in order to get institutional pricing for its existing customers.
The representative at Vanguard was a seasoned pro who answered all my questions and then quickly generated quotes for the options of interest.
The answer to one of my questions was a bit of a bombshell: When you buy a deferred income annuity with inflation protection, when exactly does that inflation adjustment start? Turns out that such annuities don’t adjust for inflation until their income stream begins in the future. There is no inflation adjustment in the deferral interim. The representative was not aware of any products that offer full inflation protection. In other words, in our case where we might be waiting 25 years for the income to begin, just what that first year’s paycheck would be worth in today’s dollars is a total gamble. The amount would adjust for inflation once the income began, but the starting point, and therefore the ultimate value of the annuity, would be an unknown.
The suggested solution: You must bring more money to table if you want inflation protection in the interim. For example, in our case, if inflation held at its approximate historical value of 3% for 25 years, we’d need to invest almost exactly twice the amount of money, to preserve purchasing in today’s dollars. But it would still be a gamble. That amount might be too much, or too little, to match today’s purchasing power.
I got a quote to receive $1,000/month income starting when I was 80, and ending only when both of us died. This included a “return of premium” feature: meaning if we both died prior to the income start date, our estate would get the original premium back. Once payments started there would be no refund or cash value after we died. The best quote, for an annuity that would adjust based on the CPI-U inflation index, was for about $53K, and without the inflation protection, about $43K. This was from an A-rated insurance company.
Vanguard’s representatives do not work on commission. There is a transaction fee equal to 2% of the deposit amount built in to annuity quotes.
Shortly after hanging up the phone, I had the detailed confirming quotes in my inbox. A positive experience.
Finally I called ImmediateAnnuities.com for a quote. They are one of the more prominent web portals for learning about immediate annuities. Their site is widely referenced, and I have always found it quick and easy to use. Recently, I subscribed to their email newsletter series on immediate annuities, and I was impressed. It contained easy-to-understand, accurate information based on the real-world experience of founder Hersh Stern. There was no sales pressure. The company seemed to evoke integrity at every turn.
The representative at ImmediateAnnuities.com was as professional as the one at Vanguard. He quickly quoted me on a comparable annuity: starting in 25 years, joint life, indexed to the CPI-U, paying $1,000/month, with the return of premium option. It, too, offered no inflation adjustment in the interim. The quote came in at over $59K and was from the same underlying insurer as the Vanguard quote. From this I concluded that Vanguard’s institutional pricing may, in fact, give it an edge. (But I’d recommend confirming pricing carefully for your own situation by getting quotes from both sources, and possibly others.)
ImmediateAnnuities.com charges no additional fees. (Presumably they receive a percent of the annuity premium as their commission.) The application process sounds very easy. They do a 5-minute questionnaire with you on the phone, prefill an application, and overnight it to you with an envelope to the insurance company. You then mail in the application with your check.
I had a detailed follow-up email in my inbox within moments. It contained lots of helpful information including a definition of terms, insurance company ratings, even a life expectancy table. Altogether, ImmediateAnnuities.com comes off as a highly professional and transparent company. Even if their pricing seemed at a disadvantage to Vanguard in this case, I would probably get a quote from them before making any final annuity decisions.
Given my different options, buying an annuity versus investing in something else — stocks, bonds, real estate — how do I analyze the best use of my money? Valuing annuities is notoriously difficult, and even professionals can disagree on the details. Deferred income annuities seem doubly hard to assess because they are composed of a two-stage investment: the first of which — the interim before payments start — is not inflation adjusted, and the second of which may or may not be.
I analyzed the annuity quotes from several different angles, including comparing them to a balanced portfolio of stocks/bonds over the same period, and to a portfolio of dividend stocks. Unfortunately, none of these analyses filled me with confidence. The time span involved — 45 years in my case, up to age 100 — is immense, given financial variables that most experts can’t get right a year in advance. Ultimately, the fact that inflation-adjusted deferred income annuities are not quoted with inflation adjustment until payments start, years in the future, makes their true value for comparison purposes virtually unknowable.
So, the most fruitful analysis seemed to be comparing the non-inflation-adjusted deferred income annuity to the balanced stock/bond portfolio. And, according to my calculations, to match the income stream that a deferred income annuity promised me from age 80 to 100, a balanced portfolio would need to return a little over 5% annually over the same 45 year period (25 years until the annuity starts, plus 20 years of payments thereafter). If the investment portfolio returned less than that, the annuity would be a better deal. If our investments returned more than that, or if neither of us lived to age 100, then the portfolio would have been the better deal.
Will we do better than 5% with a balanced investment portfolio over the next half century? It’s anybody’s guess but, frankly, the odds are good. We’ve done close to 7% over the last tumultuous decade. For other data points, consider Vanguard’s flagship balanced funds: The conservative Wellesley Income Fund has returned 10.14% since inception in 1970 (44 years), and the Wellington Fund has returned 8.33% since inception in 1929 (85 years). Even if you knock a couple of percentage points off future returns, based on today’s low interest rates and high market valuations, a balanced portfolio is likely to outperform an annuity. And yet, the balanced portfolio is not “guaranteed,” while the annuity appears to be….
The Problem with Annuities
Buying a deferred income annuity is a paradox. On the one hand, it’s an extremely conservative thing to do with your money: You are accepting a return that will almost certainly be below the market, in exchange for the assurance of receiving some income for life. On the other hand, it’s an extremely risky thing to do with your money. You are “buying” a product that you won’t unwrap and use for decades hence. What kind of world will you be living in then?
People are attracted to annuities because they provide “guaranteed” income. But, looking at my deferred income annuity quotes, how “guaranteed” is anything 25 years from now? That’s almost half my lifetime. Twenty-five years ago, personal computers had just appeared on the landscape. Cell phones and the Internet didn’t exist. Do I really think, if I buy something now that I won’t use for 25 years, that I have any real “guarantee” of what I’ll be getting? Among the many wildcards — market performance, geopolitical risk, insurance company solvency — the biggest one might be inflation. What will our public and private debt have done to the value of the dollar by then? If I buy a product now in nominal dollars, without inflation guarantees, its value in 25 years is almost a complete crapshoot. Without inflation adjustment over multi-decade time spans, you really have no idea what you’re getting!
Wouldn’t it be wiser to hold assets like real estate, commodities, and businesses — in other words, stocks — that, pretty much by definition, will keep pace with inflation? The insurance companies that issue annuities are investing in the same markets available to the rest of us, then taking their cut. If a do-it-yourselfer invests in those same markets over sufficient time spans, and can ride out volatility, then they are statistically certain to come out ahead. Or, in the worst case, in a world where a balanced investment portfolio, subject to a reasonable withdrawal rate, somehow evaporates, do I really think that insurance companies will somehow be able to honor their contracts?
The one clear benefit delivered by an annuity is its “mortality credits” — the extra return you get from putting your money into a pool with others, where those who live longer rely on the assets of those who die sooner. But, given the rather parsimonious deferred income annuity quotes I’m getting, it’s been tough to see the benefit of those credits on the bottom line….
We all crave security and certainty. The marketing departments at the insurance companies know this very well. But annuities may only deliver the kind of certainty you get from dining at a fast food chain: guaranteed mediocrity. After going through this annuity shopping exercise a couple of times now, I’m starting to think that the main benefit of an annuity may be simply that it forces people to budget, keeping them from spending their money all at once. In other words, they’re simply paying the insurance company to act as ‘Dad,’ handing out their own allowance money on a regular schedule!
Our Decision: Still Window Shopping
So, will we buy a deferred income annuity this year? No. Will we ever buy one? Doubtful.
Are we still in the market for an immediate annuity, at some point, so that we can lock in lifetime income and offload the need to manage investments in our later years? Probably.
But, for now, with interest rates low, with a flexible lifestyle, with plenty of cash on hand, and with a good investment track record on our own, there is simply no need to make the annuity decision. Rather, we will keep our assets diversified in the market. And we’ll revisit our options further down the road….