Why an Annuity Could Be in Your Future…

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If you’re like many independent-minded boomers who cut their teeth on the market conditions of the 1990’s, you may harbor serious suspicions about annuity products. Who needs an annuity? With the stock market averaging near double-digit returns in the past, you could easily live off 4%, 5%, even 6% of your portfolio every year, without fear of drawing it down, and even expect that your holdings would grow in the process!

The independent financial press — writers such as Scott Burns, Richard C. Young, and Todd Tresidder — have done much to debunk the complex annuity products offered by the insurance industry. Many variable annuities, and more recently equity-indexed annuities, have been exposed as frightfully complicated contracts, larded with administrative expenses, underlying fund charges, costly riders, and poisonous surrender fees.

Even if one of these opaque products happened to be a fair bargain, it would be extremely difficult to know which one, because they are almost impossible to compare to one another!

Small wonder that many careful, frugal investors have long ruled out any sort of annuity as a retirement solution. Count me in that camp. For years, I loathed annuities because of what I read about the expenses and complexity. Why would I need an annuity, when I was enjoying great success at growing my own diversified portfolio well in excess of our retirement income needs?

But then three events transpired:

  1. The market crashed in 2009. Though our portfolio did better than most, and we had no need to produce income at that time, the huge stock market swoon allowed me to see a less-than-rosy picture through the eyes of others who had the ill-fortune to retire at the wrong time. And I knew that those who had purchased annuities, even the overpriced and complicated ones, were mighty happy with the steady paychecks they received during the crisis. I realized that annuities, of some sort, might have a place, at least for those without the investing skills and fortitude to endure a great recession. And that’s a lot of people.
  2. I retired. The decades looming ahead of me without a regular paycheck suddenly became very real, in a way they never could until I began the actual experience. It didn’t matter that I had many years of investing under my belt, and was highly confident in my ability to manage our portfolio at least as well as the pros at the large insurance firms. It didn’t matter that I knew our budget cold, and was confident that we could make significant reductions if needed. Because there was one thing I realized I couldn’t control: how long I would live. But, ironically, those large insurance firms could control for that factor. Simply put, by pooling my lifetime with thousands of others in annuities, they could economically insure us all against running out of money.
  3. I reviewed my estate plan. I realized that, even though I had done a decent job of saving and providing for my family, in terms of the amount of assets we had accumulated, I had overlooked one important factor: I had assumed that I would be around to manage those assets for the duration. But what if I weren’t in the picture? Was I confident that my loved ones could make those assets last as needed, regardless of whether they had any interest or skill in investing or money management? I could see they would need at least the option to put a portion of our assets on "autopilot," so they could count on a minimum of lifetime income without worries….

In light of these events, I began to see annuities differently, and more positively. Then along came new research demonstrating that adding an annuity to a diversified portfolio might increase the safe withdrawal rate by a percent or more. (In general, an immediate annuity lets you create a higher lifetime income stream than you can generate with the same amount in a conventional portfolio of stocks and bonds. This is because, with an annuity, you’re consuming both principal and earnings, and also pooling your lifetime risk with other buyers.)

Given my penchant for diversification, I began to realize that it could make sense to diversify my long-term portfolio management strategy by using an annuity for at least some of our assets. I wouldn’t do this right away, but as we grew older and had fewer options in life, I could see a more and more compelling case for locking in an income floor.

I’m talking here about using plain vanilla single premium immediate annuities (SPIA’s), not their complex and expensive cousins — the variable and equity-indexed annuities. With a SPIA you hand the insurance company a lump sum and they immediately begin paying you a monthly amount, no variability, no indexing, no extra fees. And I’m gradually coming around to viewing these "good" annuities, the SPIA’s, as functioning like another asset class in diversifying a post-retirement portfolio. They have the added bonus of removing longevity risk (the chance you’ll outlive your assets) from the equation.

Of course all kinds of annuities still have significant limitations, including:

  • They are only as secure as the underlying company and its state guarantee association
  • They reduce your flexibility for meeting large or unplanned expenses
  • They typically eliminate or reduce your ability to leave principle in a bequest to your heirs
  • They generally do not keep up with inflation, or require expensive and imprecise riders to do so
  • Their costs and value fluctuate with interest rates, which are not predictable over long retirement spans

So it’s important to realize that annuities of any flavor are not a silver-bullet solution for retirement income. They are simply one tool to be used in conjunction with your other retirement income assets. In my view, annuities can be applied incrementally and strategically as part of your overall retirement income plan. And I’ll be focusing on the associated details and mechanisms for that in posts to come….

Meanwhile, have you priced or purchased an annuity? What has been your experience? If you chose one, would you do it again, or what would you change?


  1. Darrow,

    Are you currently using a SPIA? What portion of one's portfolio might one consider to commit to
    such a product. What might be the earliest age one would consider putting one of these in place,
    and finally what can you expect in upfront and annual fees on these products? I would think
    sources like TIAA-CREF and Vanguard's portal to the ins. companies might be among the

  2. Darrow Kirkpatrick says

    Hi Steve. I don't currently own a SPIA. However, a SPIA is now in my long-term retirement plan, when conditions are right. Exactly when we pull the trigger is going to depend on interest rates, market returns, Social Security, and our lifestyle in early retirement. The portion of your portfolio to commit to a SPIA is going to be a tradeoff between how much income you need to produce vs. how much flexibility/legacy you want to retain. It's a tricky mathematical/behavioral problem, but I hope to develop some rules of thumb here.

    I don't think there is a definite starting age, but I can say that the quotes I've gotten so far (in my early 50's) haven't been compelling to me yet. A SPIA is a relatively simple product. I think you can just look at the bottom line (the monthly payout), and shop for the best deal among insurance companies (taking into account their financial strength ratings). makes this easy, but, as you mention, low-cost providers such as TIAA-CREF, USAA (if eligible), and Vanguard should be checked as well. Thanks again for the feedback!

  3. How does this compare to "buying" an annuity/longevity insurance by delaying social security as long as possible?

  4. Darrow Kirkpatrick says

    Hi Steve, thanks for the question. Social Security is essentially an annuity. And it's a very valuable one, because it is inflation adjusted. However, for most of us, it's not enough to cover all our living expenses. By delaying Social Security you can grow your eventual payout very effectively, generally by about 8% per year. (That assumes you have money to live on until Social Security starts, and that's one time span where an annuity may be helpful.) But for many, even if they delay Social Security to the maximum age of 70, it won't be enough to live on. So that is an additional time span where an annuity could be helpful, to add to your income on top of Social Security, so that you establish a guaranteed baseline of income for your minimal required living expenses.

  5. Thanks for the article, I have been feeling exactly the same as you. I have gone a step further, research wise, than your article regarding Vanguard Index annuities with a rider. Have you looked at that, or anything like that? I am thinking a combination of that and the SPIA along with your other investments might be a good option, thoughts?

  6. Darrow Kirkpatrick says

    Hi Paul, thanks for the comment. I've taken a quick look at Vanguard's variable annuity product with the guaranteed lifetime withdrawal benefit (GLWB). It appears to offer the transparency, simplicity, and low expenses that Vanguard is known for. Essentially you give up 0.95% annually in order to guarantee a 4.0% withdrawal (joint option) in early retirement (age 59-64). That might be an ok deal, but it really depends on how you feel about the future.

    With what I know now I would probably still choose a SPIA coupled with a standalone investment portfolio, rather than an all-in-one variable annuity product. However that is based more on my penchant for simplicity, than any detailed financial analysis. More study is warranted. Stay tuned. Meanwhile, I welcome input from everyone who has experience with annuities…

  7. One commonly discussed strategy related to SPIAs is to use them to fill in any gap you have in "essential" (versus discretionary) expenses, with the remainder of your assets allocated to a balanced portfolio. If I chose to purchase an SPIA, I would use this approach.

    Stated another way: Required SPIA Value* = Essential Expenses – (SS + Pension + Other Guaranteed Income**)

    * The monthly income amount from the SPIA
    ** An example would be rental income

  8. Darrow Kirkpatrick says

    Thanks Mark, currently I see it the same way, buying a SPIA to "backfill" from Social Security (and any other guaranteed income) up to the level of our minimal living expenses. The rest of our assets would stay in a diversified portfolio. Appreciate your clear formula. Thanks again for the comment!

  9. I feel that some work needs to be done too on what are "essential expenses." Unfortunately, no matter how hard we try to nail that down, we just are not certain enough (to our satisfaction) that we are accurate enough to use this essential only budget for making the big decision about leveling our income via an annuity. The book "Spend to the End" (crappy, inaccurate title but good book indeed) is shedding much needed light on the entire subject.

  10. Darrow Kirkpatrick says

    Thanks for the book recommendation Phil. Anything from Burns/Kotlikoff is worth a look. The book "Die Broke" covers some of the same terrain. It's a bit dated now, but still worthwhile.

    You have a good point about "essential expenses." I went through our budget and flagged food, insurance, medical, property tax, and utilities as a first cut. But obviously that leaves little room for fun or emergencies, and some of those essential items could change significantly over the course of a retirement.

  11. Hello again Darrow,

    I guess another reason I am leaning toward the Vanguard GLWB vs. the SPIA is the ability to "change your mind' meaning with the GLWB you can pull all the money out and close the account and get back whatever the value is of your index funds at that time vs. handing the entire amount over to an insurance company and not being able to rethink the decision (for the most part). I am thinking maybe a little of both?

    I am curious about your thoughts regarding taking the lower rate knowing you can get out if you want…….


  12. Darrow Kirkpatrick says

    Hi Paul, the more I look at Vanguard's Variable Annuity plus GLWB rider, the more I like it too. It offers lifetime income guarantees, some market upside, plus a lot of withdrawal flexibility, for what appears to be a reasonable cost. The only downside for me would be the relative complexity, in terms of evaluating that cost. Though it's wonderful having Vanguard on the other side of the deal, with their track record of consumer-friendly financial products.

    It may come down to how much income you need. All other things being equal, the SPIA would always maximize your income vs. a variable annuity product where you retained some principal. In one scenario I just evaluated for a 65-year old single male, the SPIA would pay 1.6% more. So if that extra income was critical, you'd have no choice but to go with the SPIA. Otherwise, like you, I'm finding the Vanguard Variable plus GLWB more and more compelling for the flexibility of being able to access principal, and the possibility of some inflation protection through investment growth.

  13. Darrow,
    This is my first visit to your website (got here via a link on Oblivious Investor). Very insightful and concise info–and I read your entire biography. As a candidate for CFP certification and a new and upcoming financial planner, I see that there is still a lot for me to learn.

    I was sold an ING single premium deferred variable annuity years ago by my Morgan Stanley broker with the pitch of a "guaranteed 7% return". I should have asked more questions about the "distribution" part of the product, but I was naive and trusting at that time. As you note–these are very complex products. Which brings me to my question. Are there web resources, books, or tools that you know of that can help me analyze the particular annuity I have against a SPIA? I have no surrender charges any more, so I can cash it out and buy a SPIA, but I need to be able to compare apples to apples. And if it can buy me an income floor, I want to consider it.


  14. Darrow Kirkpatrick says

    Thanks for the feedback Johnny. I don't know of any effective tools for comparing annuities. There might be some, but a quick Google search wasn't encouraging. If it were me, I would probably go do some online "comparison shopping" using the current cash out value as premium, and see how the benefits of SPIAs I could buy compare to my current annuity. Good luck, and let us know if you discover any solutions. And best wishes on that CFP certification. It's a stout exam, I know, but we need good people in financial planning.