Senior Magazine

Re-thinking Annuities as part of your retirement asset allocation by Michael P Carroll appearing in SENIOR Magazine 

Colorado Springs SENIOR Magazine 

Re-thinking Annuities As part of your retirement asset allocation 

Michael P Carroll, CLU, ChFC, CFP® – American National Bank 

I have decided that crow may not taste so bad after all. Since I feel compelled to eat some of it, in a figurative sense, let me clarify. I thought I would be one of the last people to ever suggest that annuities might—just might—have a place in financial planning. If I sound like I am choking a little bit it is because crow is tough to swallow. 

The increase in the number of retirees, longer lifetime expectancies, the decrease in appetite for risk, and prospects for lower returns of both equity and fixed income, have all caused people to re-think retirement investment assumptions. Old “rules of thumb” work well until the underlying assumptions change. 

For most of the last 30 plus years, 1970 to 2002, we had a period of relatively attractive fixed income (bond) rates. During this time the 10-year treasury note stayed mostly above 6%. In that period we had five years, 1979-1984, when it was actually above 10%. The average has been over 7% since 1970. As a result of these higher fixed income yields one assumption that nearly became a financial planning standard was that after 60 you should have the same percentage allocation in fixed income as your age; i.e. at 65 you should have 65% in bonds, 70 you should have 70%, etc. This assumption worked relatively well until 2003 when we began to see fixed income rates fall. Today the 10-year treasury yield is 3.4%. 

One of the other financial planning assumptions we relied upon is that the stock market always goes up. Since 1940 we never had a 10 year period in which the S&P 500 was not positive. Over the last 83 years it has averaged a 9.7% positive return. We are now about to end a decade that has brought about the defenestration of that trend. 

These two putative assumptions have literally collided and in the process destroyed the old rules of thumb about safe withdrawal rates in retirement. When the stock market was going up every decade, and fixed income yields were in the 6-7% range, life was good. Now many people in or nearing retirement are finding gaps in their available retirement resources. 

Take the situation of a 65-year-old couple with $750,000 in retirement and personal savings. They will be receiving $30,000 per year in social security (SS) income, $20,000 from the husband and $10,000 from his spouse. They need a minimum of $65,000 in guaranteed annual income during retirement. This means their gap is $35,000 per year. If they use a risk free interest rate of 3.4%, they would spend all of their savings in 39 years. That might be fine, but there is not much left for the kids. 

However, what if they put $500,000 of the $750,000 in an immediate Joint Life Annuity which paid them $31,000 per year for life? Remember they still have $30,000 in SS income so they only need an additional $4,000 annually to reach their goal of $65,000. If they invest the remaining $250,000 in a long term balance index fund yielding approximately 7%, they could pay themselves $4,000 per year and have nearly $1.5MM after 30 years. Which is the better plan? 

I don’t know the answer to that question because I don’t know this fictitious couple. I am not familiar with their values regarding money or their specific goals and objectives for the future. I also do no know their health, health risk factors, or family history. But I do know that there may be alternatives available to this couple that are not addressed by our old assumptions about investment and withdrawal rates.