Immediate Annuities vs. Safe Withdrawal Rates

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Annuities have a rather mixed reputation, which I think is mostly deserved. Some are amazingly complex and expensive (the word “Indexed” can be bad in this world). Then there are simple, straightforward ones that are worth consideration, including single premium immediate annuities (SPIA). The most basic version lets you convert a lump-sum payment into a regular stream of income payments that is guaranteed and doesn’t ever vary, period.

Michael Edesess has an article Are Annuities the Best Strategy to Fund One’s Retirement?. The article is on a site meant for financial advisors, so it’s got a lot of jargon inside. However, I do like that it provided some hard numbers to consider.

Here are current market rates:

In other words, a 65-year-old male hands over $100,000 and will get $6,720 per year ($560 per month), every year, for the rest of his life. Putting up $1,000,000 will get you $67,200 per year ($5,600 per month). Whether he lives to 68 or 108, he will end up with zero dollars. A female would get a bit less due to a longer average lifespan, and a joint annuity even less than that as the likelihood of at least one person living a long time is higher.

The article then compared the annuity payout against the “safe withdrawal rate” as calculated by popular industry methods. The Bengen method has a fixed payout percentage every month, adjusted annually for inflation. The HWS strategy uses a variable payout with a floor rate and allows a higher payout if the portfolio has high returns. I’ll just share one of them.

As you can see, the immediate annuity offers a higher annual payout in almost all cases. This is good.

However, you are giving up certain things in exchange for this higher income. Once you die, there is nothing left for heirs or charity. Thus, part of your return is simply them giving your own money back to you (return of principal). You have lost permanent control of that money, with no liquidity if for any reason you had a big expense. Finally, unless you buy a special inflation-adjusted annuity with a much lower initial payout, your monthly payment will buy less and less as inflation eats away at it over time.

I would also read about your applicable state guaranty limits and always stay under them. It is rare for an insurance company to fail, but it has happened. Read about the Executive Life Insurance Company. The state guaranty association system is not as good as FDIC insurance, but being within the limits is much better than being above the limits!

Bottom line. I would research single-premium immediate annuities as a source of retirement income once your reach age 59.5. I would avoid any annuity that is linked or “indexed” to the stock market. Personally, I am thinking of annuitizing a fraction of my portfolio (less than 10%) once I reach a certain age, but only if it remains under state guaranty limits.

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  1. An interesting read however, if you are only going to put 10% of your portfolio in a SPIA it is not going to provide a material increase in your annual retirement income. In order for this strategy to make a significant change in one’s retirement income you have to put a majority, 50% or more of your portfolio in SPIA’s. If one of your objectives is to leave a legacy to children it is probably not a good choice.

    • Well, I suppose I think it would all depend on the size of your portfolio, and what you think is “material”. 🙂 You could raise it to 25%. My main goal was to stay under the state guaranty limits. For example 10% of $2,000,000 is $200,000. If you were a joint couple, that would add $11,400 to your annual income, on top of Social Security. For the average retiree getting $18,000 a year (roughly $1,500 a month x 12), for a couple your total is now $18,000 + $18,000 + $11,400 = $47,400 per year, forever. I think of that as a solid base paycheck, and the SS will go up with inflation.

      I’m also thinking that I can build up an annuity base while I am younger with MYGAs. These are “kind of” like CDs in that they offer fixed interest for a fixed number of years. For example you could have gotten 4% for 5 years this year. You just keep rolling these MYGAs over until you’re ready to convert to an immediate annuity. In my opinion, this move is only for people who have already maxed out their other tax-advantaged options (401k, IRA, Backdoor IRA, etc). However, if your investment plan has you left buying bonds in a taxable account, why not consider getting them into a tax-deferred MYGA annuity?

      Also see this old post:

  2. “In other words, a 65-year-old male hands over $100,000 and will get $6,720 per year ($5,600 per month), every year, for the rest of his life.”

    I think you added a zero to that monthly total.

  3. Thanks! I had never even heard of the state guaranty association system–it might be interesting to expand on this topic for us someday–perhaps with a case study or two. Also, I assume the “insured” value of my immediate payout annuity is the original purchase price. The max in the two states that I checked is $250,000 per customer . . .

  4. Based on my quick calculation, it makes sense to stay away.

    Average male life expectancy in the US is 79.

    By subtracting 6720 every year and adding 2.5% interest on the remainder, I’m coming to break even past 18 years mark so 83 years old. So the obvious idea of this annuity is that the person is statistically likely to die before breaking even. And then on top of that there’s inflation risk and insurance company failure risk.

    • ” insurance company failure risk.”

      State guarantee associations protect you against that risk up to limits. Its kinda like FDIC.

      • Personally I prefer Federal guarantee to State guarantee but that was not the point of my response.

    • You are effectively paying an insurance premium for hedging your longevity risk, or often the longevity risk of one person in a couple.

      You are paying for insurance to avoid being 90 and out of money. The likelihood of at least one person in a couple reaching age 90 is quite high. For a couple both at 65, roughly a 50/50 chance that at least one person will reach age 90.

    • Actually, once a male has reached 65 his average life expectancy is 84.

    • Average life expectancy is meaningless. Whats relevant is the average life expectancy of someone purchasing this.. oe the life expectancy of someone already 65

  5. Richard Zaehringer says

    A comprehensive article addressing the more consumer beneficial type of annuities should be your follow up. Unfortunately, this article
    provides a description of one particular annuity type, which has severe limitations. A fixed index annuity with a guaranted lifetime withdrawal benefit(GLWB) will contractually generate a mathematically higher cash flow than the ‘SPIA’ type in the article. While Perhaps counterintuitive, that is a contractual fact. Only when the purchaser is age 75 will the SPIA have a payout higher than the fixed index
    with GLWB. Additionally, the fixed index has a contractually guaranteed increase of between 8 and 10 percent on the value used to calculate the generated cash flow, which is not annuitized. An important distinction as the owner does not forfeit access to the principal balance as in a SPIA. Also, the fixed index annuity is not locked into the prevailing interest rates attached issue. In fact the blended indexes available to determine gains on the principal, which belong to the consumer, are now uncapped and have 100 participation rate and often higher than 100 percent on several policies. The remaining balance always goes to a beneficiary named by the consumer. True information on annuities is available, all backed by contract language. Far too many advisors dismiss annuities without further study. The consumer I help investigate the fixed index with GLWB and are pleasantly surprised at how they actually function.

    • Yikes. I’m sorry, but that is way too complex. How many pages is that contract? Can you post a PDF of it, so we can all see it? I would not recommend any of my family members to buy such a product that is indexed to a stock market index (but no dividends!). No, no, no.

      The only people who I know that are huge advocates of fixed index annuities, are salespeople of fixed index annuities. This site is about what someone passionate about personal finance would do for his own family and loved ones. I would NOT recommend any of my friends or family to buy a fixed index annuity.

      I’m perfectly fine with the fact that the simple SPIA will only pay out more once I reach age 75. That’s one of the main reasons to buy it.

    • ^Richard, do you by any chance sell annuities?

  6. Richard Zaehringer says

    Is it too complex to have more income, maintaining control of the asset, and owning the growth? Most will understand that question as rhetorical. There are index allocatios which include dividends, factually. The passionate consumer who has a small or non existent pension, who desires to create a pension-like monthly cash flow higher than available elsewhere plus guarantee that cash flow, protect the principal and retain the gains (including dividends on some available index allocations). Sounds prudent even some may say common sense. Unfortunately closed minded people who choose not to learn about the next generation of annuities and the functionality aren’t going to benefit. Like those who are apprehensive of learning about any new material which challenges their known understanding. Open minded people will benefit, those who continue to learn and have the drive to refuse to accept the opinion of a pundit of managed strategic portfolios. In an effort to clarify. The fixed index annuity with GLWB will payout more cash flow than a SPIA prior to age 75 and if funded early, multiplying the 8-10 percent contractually guaranteed annual increases of the value used to calculate income, the FIxed index with GLWB will exceed the SPIA payout subsequent to age 75. You have the power to persuade people. The fiduciary advisor will never prejudge investments, including annuities. Educate the people and let them decide. Lastly, an advisor who charges one percent or more each year over a 25 year to 30 year retirement of their clients make far more than a “salesperson” does on an annuity. Perhaps that mathematically explains the reason they dismiss annuities out of hand. Or show the worst type of annuities (SPIA and variable) to skew perspective on the benefits of the new type and sway people toward managed portfolios. That doesn’t sound fiduciary, does it?
    Thank you in advance for an open mind.

    • Sounds like some sort of magical unicorn! Please share the contract to the specific annuity product to which you are talking about, which can serve as the starting point to an open-minded and transparent discussion.

  7. Larry Kohler says

    I have sold both and much pefer Guarantees against Non Guarantee’s. You should Not compare Annuities against Investments/Risk based products. It’s really not fair to either. Bottom line is if you should probably have some of your Money in both since if don’t seem to mind some type of Risk.

  8. When using a SPIA, one shouldn’t get caught up in payout, and payout from an annuity is different than a rate of return, not a good comparison. Most married couples do not use the non-beneficiary payout, but instead take a lower payout to have the annuity pay another beneficiary (spouse).
    While the annuitant gives up a lump sum to an insurance company there are a few major reasons to consider it and its potential benefits.
    -#1 Transferring longevity risk to insurance company. You can’t outlive it. I had a grandfather live to 103, without his monthly pension payments he would have run out of assets long before his death.
    -An annuity generally can’t be lost, stolen, or swindled away. Markets go down (all investments have risk), and elderly are often targeted for scams. In some states it is creditor protected, an extra benefit.
    -Money management risk. Many people cannot handle a lump sum investment and take out well more than any safe withdraw rate. Having some money in a guaranteed SPIA, for say basic expenses protects retirees from themselves. Bills come monthly and people struggle to manage lumps sums of money.
    – A great deal of money put into the SPIA market is qualified, e.g. from IRA, 401K etc.. and a SPIA satisfies the RMD requirement on that portion. Safe withdraw rates can get tricky if RMD on qualified money forces withdraw rates, which occurs even in a down market.
    When one understands qualified assets like 401K and/or IRA assets , they realize they aren’t an efficient wealth transfer. Typically, for most retirees their largest assets are qualified, and/or their home (primary residence).
    -Peace of mind. Knowing you have some guarantees in your portfolio allows you to enjoy your retirement and have less stress about living to long and what the market is doing. And, can even allow for a slightly more aggressive portfolio allocation for other assets to beat inflation. Try to beat inflation with other assets not an annuity.
    Last, pick a good quality company to buy the annuity from that way the state guarantee (which is limited) doesn’t end up mattering.
    Hope this helps!

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