Who need annuities? I used to think that I’d rather invest our retirement portfolio and just live off the income, but with the recent volatility, I’m taking a second look at annuities.
Annuities can be an important part of retirement if you don’t have a pension. Here is how an annuity works. You give the insurance company a lump sum payment in exchange for a guaranteed monthly payment for the rest of your life. This might be a good way to go if you don’t have a pension and you want the peace of mind that comes with a guaranteed minimal income. I’m just looking at an immediate annuity for now.
Lately, I have been thinking about an annuity as a part of our retirement income portfolio. Previously, I didn’t like annuities because I always thought I could do better with stock and bonds. However, an annuity has one big advantage over stocks and bonds which is guaranteed income (as long as the insurance company stays in business.) The stock market has been volatile and I wouldn’t want to depend on it too much in retirement. Bonds have very low interest right now and they are riskier than annuities.
How much annuity to buy?
This is a difficult question to answer if you are not near retirement. You need to figure out your retirement income and yearly expense. Our full retirement date is still out 25 years so it is pretty much impossible to figure out our retirement income at this point. We’ll just take a guess and see what happens.
- Social security income – Social security income is the biggest question for us. The Old-Age and Survivors Insurance and Disability Insurance (OASDI) Trust Funds is projected to run out in 2038. Social security would be able to pay only 73% of scheduled benefit in 2039. My social security benefit projection is around $2,000 and Mrs. RB40’s benefit is about the same. We’ll assume 60% of $4,000 to be conservative. Social security income = $2,400.
- Pension – We’ll assume no pension.
- Passive income – All our passive income is from rental properties, dividend stocks, bonds, and peer to peer lending right now. For this article, let’s assume we liquidated everything right before retirement for a lump sum.
- Active income – We’ll assume no active income
Our average monthly expense from 2012 was $3,420. This is a comfortable level of spending and we can probably function on less if we need to. However, let’s stick with this to see how our calculation ends up.
How much would it cost?
From above, we have a short fall of $1,020/month and the annuity can fill that gap. I plugged this into an annuity calculator and the cost for joint life income came out to $219,196. Joint life means we’ll receive payment until both of us pass away. That’s a lot of money to hand over to an insurance company at one time.
*You should buy annuities from several insurance companies so you don’t put all your eggs in one basket.
Too early to call
This whole exercise seems a bit pointless when we still have 25 years left until full retirement. There are just so many things that can happen in 25 years.
- Social security might get a reform and we might get 100% of our benefit (yeah, right…)
- Mrs. RB40 might qualify for a pension at some point.
- We might move to a lower cost location.
- Our expenses would probably increase due to healthcare.
- Our mortgage would be paid off at some point and our monthly expense will be reduced.
It’s still a good exercise though. It gave me an idea of how much an annuity would cost in comparison to our assets. I could trade in our dividend portfolio for an annuity and wouldn’t have to worry about minimum income for the rest of my life. At least we’ll have enough for food and rent with social security + annuity. Of course, depending on social security might be a bit foolish too. We’ll just have to see what happens to social security in 25 years.
After trading in our dividend portfolio, we would still have our retirement portfolio and rental properties. We could trade in all that in for a 60/40 stock/bond portfolio and withdraw 4% every year. At that point, volatility wouldn’t bother me much because we’d have enough money to cover the basics. Any income from the rest of our portfolio can be our fun money.
What do you think about annuities? I would love to get some input from people who are a bit older. I’m pretty sure my risk tolerance would be much lower when I’m 65.
For 2018, Joe plans to diversify his passive income by investing in US heartland real estate through RealtyShares. He has 3 rental units in Portland and he believes the local market is getting overpriced.
Joe highly recommends Personal Capital for DIY investors. He logs on to Personal Capital almost daily to check his cash flow and net worth. They have many useful tools that will help every investor analyze their portfolio and plan for retirement.