On Fixed Payment Annuities by David Merkel, CFA of Aleph Blog
Before I start, thanks to all those who e-mailed me over my “sorted weekly tweets.” I am likely to continue doing them. That will start next week, because I have had a flood of new clients, and other obligations.
On Fixed Payment Annuities
How often do you run into articles in quality publications talking about annuities that will pay a fixed sum over your life, or over your life if you live past a certain age? Not often, right? Right. Well, today I got two articles on the same day:
- Using Immediate Annuities to Guarantee Retirement Income
- Betting on Getting to 80: Draw $40,000 a Year Forever, If You Don’t Die First (note: the title in the link is more graphic than the article’s title… enjoy the meatloaf, if you will…)
Longevity insurance is an important topic, and everyone should consider getting an income that they can’t outlive. That said, there are two problems with this:
- Inflation, and
- Credit risk (will the insurer survive to make the payments?)
It is possible to buy inflation-protected annuities, but at a cost of a lower initial payment. With credit risk, consider what the state guaranty funds will cover in insolvency, and realize that any payments over that amount could be lost due to insurer insolvency. If you have a large payment, only buy from strong insurers.
Then there are the deferred fixed payment annuities. You are 50 years old, and you want a payment stream that kicks in when you are 80, should you live so long. You can buy a lot of income that far out, which will help you if you survive, subject to the same two main risks: inflation and credit risk. I am not aware of any deferred inflation-adjusted payment annuities.
Now, you can think of your annuity as a replacement for long-dated fixed interest bonds. A portfolio of fixed payment annuities, cash, maybe some commodities/gold, and stocks could be very stable, balancing the risks of inflation and deflation, and of high and low real rates.
There is the added benefit of the regular income which is useful to average people, who are okay with budgeting, but really don’t understand investments. Just beware inflation and credit risk.
One more note: most insurance agents will never suggest immediate annuities to you because when you buy one, that’s the last commission the agent ever gets. They would rather you buy a deferred annuity, where they can gain another commission when the surrender charge period is up, and roll you to a new product.
Longevity insurance is good, but be sure you avoid credit risk, and have other assets to compensate for potential inflation risk.