The last post discussed two ways to gain income from retirement savings: annuities and percentage withdrawal rules. This post describes marrying the two approaches. We learn that retirees can, in a manner of speaking, eat their cake yet still have it.
Using part of retirement savings to buy an annuity offers robust income for life. Managing the rest with a 3% or 4% withdrawal rule ordinarily leads to a slowly growing portfolio.
Alice, our model retiree, might be interested in marrying the two approaches. She is now 77; she has used a 4% rule since she retired at 65; and her portfolio is about 44% larger now than when she retired.
If Alice wanted to boost her income now, she could buy an annuity with part of her portfolio, say $100,000. Immediate Annuities predicts Alice could receive $747 per month, or $8,964 per year, of additional income. Added to her standard $12,000 withdrawal, that would give her $20,964 annual income, and she would still have $331,380 in her portfolio, which is 10% more than she had at retirement.
Alice might want extra monthly income to help relatives but have that help restrained to a fixed monthly or annual level that would not jeopardize her retirement. Or she may see her interest and commitment to financial vigilance fading and want a secure boost in income now. Or she may worry about her ongoing competence if she is beginning to experience episodes of partial dementia.
In my family’s case, we have not purchased an annuity yet. I retired when I was 57, and my wife when she was 63. Now I’m 68 and Barbara is 67, and we are still mentally competent and in reasonably good health. Our investments help us with extra’s: an occasional automobile, home remodeling projects, some travel, and help for family members. Our basic living costs are mostly covered with a pension and Social Security.
We plan to buy an annuity at some point in our 70s, depending on how we age. An annuity will help Barbara maintain a constant level of income if I die first. Part of my pension and one Social Security payment will stop at my death. We will need to decide just what kind of annuity may be best, but now we are thinking a joint-life, standard annuity will satisfy our needs.
We will stay away from complex annuity products with variable payments, options for change, and other features. Insurance companies like to sell complex annuities because they are more profitable. Comparing complex annuities among companies can be more difficult because each company offers slightly different features. Alternatively, with a single- or joint-life standard annuity comparisons are straightforward and the products’ characteristics are easy to understand.
An annuity will relieve Barbara of responsibility for portfolio management. Although Barbara manages our household expenses, she has never studied finance or investments and doesn’t warm to studying them now.
Finally, our interest in financial management seems to be waning. I’m less keen on keeping track of accounts, less determined to be vigilant, than I was 10 years ago. Right now, as we look toward our 70s and hopefully 80s, we expect these tendencies to grow more pronounced. An old, inattentive portfolio manager is a good candidate for bad decisions or fraud.
Annuities help transcend these common problems of aging retirees.
One drawback is that there is nothing left for heirs. Another is the very low interest rates in current annuity markets. On the Immediate Annuities website, a little math can show that the quotes for annuitants who are about 65 years old are based on interest rates between 2.5% and 2.75%. That’s one of the reasons my wife and I are waiting. We’re hoping that in five or so years, interest rates may be higher.
Yet our particular interest rate might not be higher. Insurance companies may link life span to investment profiles and offer older people rates based on less risky investment pools, which would have lower expected returns. That practice would lower our implicit interest rate. Of course, a shorter life span would increase the principal component of each payment. Absent information from the insurance companies about how they price their products, it would be difficult to separate these effects.
Nonetheless, combining annuities with self-management using modest withdrawal rules strikes me as an excellent way to manage the financial aspects of retirement. Under most circumstances, retirees can achieve robust incomes from the savings they’ve accumulated, a guaranteed income for life and a modest accumulation for extended care or bequests to heirs.