Converting your investments to a pension with annuities
Annuities, like pensions and Social Security, offer the promise of lifetime income, something no other investment class can do.
With stocks, bonds, real estate, and other alternatives, income that one cannot outlive is a risk-based probability (and a hard one to figure accurately), not a certainty.
With annuities, so long as the insurance company stays in business and honors its promises, lifetime income is guaranteed. This is why lotteries and pensions often turn to annuities for funding, and it is an extremely powerful proposition.
We explored earlier in this blog series the various ways that annuity payouts can be figured based on single and multiple life expectancies, and contractual provisions like variable, equity index, and guaranteed withdrawal benefit rider accounts can complicate the income math and opportunity/risk permutations quite a bit.
Why lifetime income with annuities can be so important
This lifetime income feature is so important that in many cases it potentially counterbalances and even overcomes the many shortcomings that particular annuities may be saddled with, including high costs, high taxation, illiquidity, and others. You still need to weigh all the factors, though, and do deep research to understand and control costs.
For those whose asset levels are such that the ability to ensure lifetime income is uncertain—true for many but not all consumers—annuities should be seriously considered to fill the income gap, especially for those whose only true pension is Social Security, or for whom pension income is comfortably high only so long as both spouses are living.
For many, converting some assets to lifetime income (which I call pensionizing) is an important strategy, which should merit serious consideration and analysis. Unfortunately, this analysis—how much asset value to convert, what income deficit must be funded for, and when, and which annuity products offer the lowest costs, best value and most applicable features for a given consumer’s needs—can be extremely complicated, and is probably best not left to a given commission salesperson’s advice.
Annuities and running-out-of-money risks – income and inflation
The preceding section addresses one of the most profound risks facing today’s retirees: that of longevity risk; the risk of outliving your money.
For most people facing retirement today, traditional pensions, with the exception of Social Security, are very much a thing of the past.
Supplementing Social Security with annuities
For most folks, Social Security provides a very baseline sustenance income, but is not nearly sufficient to fund a comfortable retirement. The balance must come from personal savings, but if we do not invest well, live too long, or both, odds are good that the well will run dry, even without the added risk of higher health or long-term care costs.
Annuities are really the only practical way to control this, offering lifetime, guaranteed payments. Like most things, such guarantees come at a price. We may not live as long as we hope, and risk getting less back from the insurance company than we pay for the guarantee.
This, of course, is the only way the insurance companies can afford to pay for those that live much longer than expected.
Annuity income – the big risk of inflation
The other risk, though, is less obvious. Inflation—the high risk of rising prices, especially for things retirees really need, like health care, medication, and other lifestyle assistance—is not well addressed by most available annuity products.
Unlike Social Security or some traditional pensions, cost of living increases are not typically found in available guaranteed annuity products, or extremely expensive (read even lower payouts) when found.
For some folks, a retirement income strategy combining Social Security, a limited amount of pensionized assets in quality annuities, and a pool of well-managed risk capital is probably the best compromise and best shot at achieving retirement goals.