One of the questions retirees face with drawing down their portfolios is, “Should I move everything to an annuity?”
In a low-interest rate world it is obvious that answer may be no. Let’s examine the actual impact of the “rising” rate period of the last two years on annuity payments with a client who posed this question in November of 2011.
Let’s use a single premium immediate annuity as an example as it’s based on sound actuarial science and have had a history of keeping their promises (for more information on why I do not recommend clients purchase variable annuities, read my past blogs here at Forbes).
In November 2011 with $500,000, a single male in the state of Michigan could purchase an annuity that would pay $29,700 annually for the rest of his life. At that time the 10 year Treasury note yielded approximately 2.05%.
Flash forward to today where the 10 year yield has risen to 2.6%. The same client, now 62, could purchase an annuity for $500,000 that returns $32,292 annually, while a 60 year old client would see a rise in their initial annuity purchase of approximately $1,000 annually, or $30,792.
Based on the increase in payouts on a relatively small increase in interest rates, it is clear it is in your interest to postpone, should rates continue to rise. The question becomes, should you have waited on an annuity if you needed the income.
Taking our 60 year old investor, and assuming he instead withdrawals $30,000 for 2 years, while leaving his other dollars invested conservatively, he would have needed to earn a 2% rate of return in order to have his total portfolio value at ~$458,000 purchase an annuity at 62 equal to the original annual amount of $29,700.
While there was no short-term way to a “safe” 2% return over the last few years, 2% or greater is not an unrealistic hurdle to overcome. An investment in the DFA Investment Grade Bond fund (DFAPX) would have returned 1.92% on an annualized basis over this time frame. Including equities that number could increase substantially. By moving 20% of the portfolio to the DFA US Vector Equity fund (DFVEX), a diversified US total market portfolio, the annual rate of return increased to 6.37%, while a 50% stake returned 13.26%.
What should we take away from the above?
It can be tempting to move everything towards safety in retirement, and if you need current income, an immediate annuity is an option to maximize your current income needs from your portfolio, but the real risk to annuitants is that of inflation, and in those environments equities will be king. In a rising rate environment, you may benefit from waiting – if you can afford to. An alternative strategy may include “laddering” annuities, or purchasing an annuity as you need additional income, while staying invested in a conservative portfolio for longer time frames.
The preceding blog was originally published by Forbes. To view the original blog please visit our blog at Forbes. http://www.forbes.com/sites/feeonlyplanner/