I watched Erin Talks Money's video about annuities today and it got me thinking.
Popular advice is to diversify between US and international stocks, between stocks and bonds, etc. However, I haven't read much about diversifying by putting a chunk of our retirement savings into an annuity. Are there any good resources I can read about the pros and cons of annuities?
I went to Schwab's annuity calculator and crunched my numbers. I'm in my thirties and a 1 million lump sum put into an annuity will pay $4,956 with "Single Life with cash refund. You will receive this income for life. Your beneficiaries will receive a lump-sum payment of the original investment less income payments made to date."
That's $59,472 a year which is a 5.9% return (likely not including inflation?). At this rate, my 1 million will be fully paid out in 16.8 years. Given I'm in my thirties and healthy, I can reasonably expect to live much longer than 16.8 years. This seems way better than a 4% safe withdrawal rate.
There are obviously disadvantages to annuities which Erin covers in her video but this seems like a very compelling option. What's the catch? If this was such a good deal, more people would be talking about this right? What am I missing?
Diversifying through annuities
byu/hatt33 infinancialindependence
Posted by hatt33
6 Comments
Many of us are already diversified with sort-of annuities, like social security or a pension. Is there a need to add more of this? Maybe for some people, but probably not for most. Especially true for those whose retirement funding is mostly social security / pension money.
> Your beneficiaries will receive a lump-sum payment of the original investment less income payments made to date. Your 1 million will be fully paid out in 16.8 years, and you will only then start to actually earn additional money at that rate.
Edit: and that’s not even comparing to if you kept your 1 million in bonds, say, earning 4%.
But if it’s not inflation adjusted, then for any inflation rate over 1.9%, it is worse than a 4% SWR, right?
Plus you automatically lose the likely upside of your investment returns above the minimum safe rate of return.
Also, is this calculation already accounting for any fees?
The point with annuities is that unless you die ahead of time you surrender your principal and there is usually no inflation adjustment.
The 4% withdrawal rate includes inflation. As your portfolio grows you take out 4% of the initial portoflio + inflation. 50 years from now, 4% of your portfolio + inflation will give you a much better purchasing power than 5.9% of your initial investment.
Annuities can make sense for older people where you have a much lower time horizon. For the FIRE crowd, not so much.
Did the video not cover inflation? Because that’s the answer. At 15 years and the average US inflation you’re behind, at 50 years that $59,472 has less than a third of the buying power of a 4% SWR.
This also disregards sequence of inflation risk, where if the sequence of inflation is bad, e.g. high up front, then you’re even more screwed than the average would suggest. Unlike SORR it’s also not very likely to be beneficially low since the Fed had huge incentives to not be dramatically under 2%.
You’re not getting a 5.9% return, you’re getting your own money back plus a small amount of interest while giving up all liquidity and upside. In your thirties you’ve got 30+ years of compounding ahead of you and locking a million into an annuity kills that. Way simpler to just run a simple global equity portfolio, stay invested, and let the market do the work. I think this beats overanalyzing products designed to make insurance companies money. But of course, if you need the „feeling of security“ it might just be the right product for you…