When should you get an immediate annuity?

retirementIt turns out, much later than most imagine. And, in some cases, they don’t make sense at all.

My paper, co-authored with Dr.’s John Mitchell and Wade Pfau, provides insight and guidance for the retiree decision making between whether to annuitize or manage their retirement savings for income. Tables and graphs demonstrate the breakeven age between annuitizing with a single premium immediate annuity (SPIA) versus managing a portfolio and the likelihood of outliving the breakeven cash flow sums for various annuitization ages (65 to 85), longevity percentiles of Period Life Tables, and portfolio allocations.

What are breakeven asset allocations below which a SPIA provides a higher lifetime expected total cash flow? Managed portfolios retain a balance at death while SPIAs have none. How does the cash flow breakeven comparison change when that balance is, or is not, considered? Does age matter in the decision to switch from a managed portfolio to a SPIA? Is there a different conclusion if different tables are used (Social Security Table “General Population” vs Annuity 2000 Table (“Healthy Population”))? How do good vs median vs poor markets affect the breakeven comparison? How do fees affected the comparison? Can the Annual Payout Rate (APR) of a SPIA be useful in the decision making process?

So here’s some insight summarized:

For those with a bequest motive, obviously giving money to the insurance company for income is counter productive. Giving the money for a SPIA is akin to gifting your money to strangers. Even for those who may outlive 70% of their cohorts, keeping the funds for their own retirement income and bequeathing the remainder tends to come out ahead.

For those more concerned about outliving their money, the earliest age to consider the annuity is age 75, and possibly later, but age 75 may be a good age to begin to look into when breakeven favors a SPIA over managing the portfolio. And yes, the money is given to the insurance company in exchange for income you can’t outlive, the breakeven favors those who are likely to outlive 70% or more of your cohorts. Normal expected longevity (50% outlive the other 50% of their peers) favors keeping the money in a managed portfolio across most asset allocations.

It is true then, the longer you might live, the more advantageous trading your managed portfolio for an immediate annuity. However, the risk then becomes NOT living to those elderly ages (now the risk is dying too soon) and the value of that income goes to zero (and the insurance company has the money you left for those who indeed do live long – called mortality credits)!

What you are doing is trading stock and/or bond market risk (which can be broadly diversified) with insurance company risk (risk the company goes out of business – and may be diversified a little with more than one insurance company – however, there remains a concentration in both industry and sector).

Other factors should be considered. Are you comfortable prudently managing your funds? Some asset allocations do provide more income over an expected time span than others – are you comfortable with that stock allocation requirement? Are you a spendthrift? What is your health outlook? What is your outlook on broad market returns over the remainder of your life?

Our paper provides deeper insight, insight that wasn’t as clear until now, into what factors to consider when evaluating the choice between a SPIA and continuing to manage your portfolio (possibly to an older age to re-evaluate the decision again).

PS. The plan is to submit the data and findings from this working paper for peer review and publishing. More on that when that happens.

About Larry Frank, Sr.

Larry R Frank Sr., MBA, CFP®, is an experienced financial advisor and a published author on Retirement Planning Research. Have a financial question? Click Here to Ask Larry

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3 Responses to When should you get an immediate annuity?

  1. Larry Frank, Sr. August 17, 2014 at 1:16 pm #

    The paper is published and you may read it here:

    http://www.betterfinancialeducation.com/page-1

    and here’s a good summary in plain English:

    http://www.marketwatch.com/story/when-are-income-annuities-right-for-you-2013-09-07?pagenumber=1

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