An advisor correctly pointed out if one buys an immediate annuity at age 65, and inflation averages 3 percent, the after-inflation income would be cut by 45 percent by age 85. But then he dismissed inflation-adjusting annuities because the initial payouts are lower than if they don’t adjust for inflation. So what’s his solution? Wall Street’s old stated-withdrawal percentage method.
There are two problems with this. First, the reality of all Wall Street stated-withdrawal percentage plans is there is a probability the plan will fail, the assets will be spent to zero, and the income will stop before death. If the disease in retirement is running out of money, the annuity cures the disease while the Wall Street approach treats it as a chronic illness without a cure.
Second, the typical Wall Street plan says if you have $100,000 in a securities portfolio at age 65, you can take out $4,000 a year initially, and if inflation averages 3 percent, the plan would hopefully produce the $7,224 needed at age 85 to keep you even with inflation.
However, today you could buy an immediate annuity for under $75,000 that would produce $4,000 today and produce $7,224 at age 85, assuming the same inflation rate. No “odds,” “hopes” or “guesses”– simply a guaranteed inflation-adjusting income for life. If you don’t think inflation will be a factor, I priced a straight life contingent annuity for a 65-year-old, and the premium came in around $55,000 to receive $4,000 a year. These immediate annuity solutions solve the stated problem–running out of money before death.
At this point, myopic planners will say the annuity solution decreases the size of the estate–but that’s not the problem they said they were trying to solve. The annuity solution solves the longevity problem and leaves money to create an estate. The remaining $25,000 or $45,000 could be used for a single premium life policy or invested to produce additional income and build a potential estate.
Providing the income needed for retirement essentials is the role for annuities–both immediate ones and deferred annuities with lifetime withdrawal benefits–because this enables remaining assets to be more aggressively invested because withdrawals from these other assets can be reduced in bad market times. Write retirees a prescription for the annuity cure.