Is an annuity the best form of investment for my situation?
I'm 68 years old with no family whatsoever. I have $30,000 in a 401(k) and $220,000 in cash (savings). I need to generate some income from those monies because my Social Security is low. Financial planners suggest an annuity, but I've always heard to stay away from annuities due to fees. What would be the best ROI for me?
Many financial planners will suggest an annuity because they receive a high commission from selling it. While you do want to consider potential downside risk, you should also be aware of other annuity cons such as typically capped returns and loss of principal during the payout phase. You might want to consider a conservative to moderate ETF portfolio instead, which can be managed to provide income and targeted to keep up with inflation at Betterment.
Just like you don’t go to a local Home Depot/Lowe’s to get a hammer for every project, you buy whatever you need for that specific task. Annuity got some bad rap in the past, but is it the devil you must stay away from? NO. Depending on your situation, it may help you supplement your social security income.
First, you need to know your budget, or how much your annual spending (living expense) is. If your annual SS income is low, you must find a way to bridge the gap. It’s unrealistic to expect that your investment from the 401k and/or cash account earn a superb return year after year and generate lots of dividend income, thus your alternative is to use an annuity for reduced market risks and a source for some steady income. However, with so many annuities (fixed or variable, plain vanilla or what riders are most important to you) to choose from, you must match the right one with your needs.
Secondly, you also need to evaluate your health. If you have a poor health, annuity may not make sense to you. Conversely, if you’re healthy and have a great family health history (say, parents live to 80s), the chances are you may live to 80s or even 90s too. Annuity takes the longevity pressure off you; as long as you live, you will get a steady stream of income for your lifetime. A word of caution: some annuity may not have an inflation adjustment, which means the same $1k/mo. annuity income will buy only $800 or less worth of products/services in the future, the so-called inflation factor. Another decision to make!
Considering those two factors, I would shop around to find a trustworthy financial planner, preferably a CFP®, from the family/friends’ recommendations to see what’s your best option. Best!
There are many other ways to generate a safe income besides an annuity. Be very careful of salespeople who make large commissions and who only sell annuities. I have found that most people do not understand the true expenses of annuities, all the restrictions, and all the surrender penalties that go with them because of the high sales commissions paid to those who sell them. Look for a fee based advisor that you pay directly, since he works for you not an annuity company.
This answer is intended for informational purposes only and is not intended to provide specific tax, legal, or investment advice. I invite you to schedule a meeting with a me for more information regarding your specific situation.
Although I have my insurance license, I do not sell annuities for the very reason you stated. And you are giving up an asset for "guaranteed income for life." So while it sounds risk free, you have inflation risk, also known as purchasing power risk. So that cash flow stream will feel like less and less over time. And this is an irrevocable decision and once made, you cannot take it back
With the Central Banks driving interest rates down to artificially low levels, there is no such thing as a guaranteed, safe investments like a CD that pays enough to make it worthwhile. But I don't care what you call it - income, capital gains, royalties, growth etc.. - you just want appreciation net of fees and taxes to buy the things you need to live.
Now dividend paying stock and bonds also carry their own set of risks. This is why if you go that route, you need to have a sell discipline to limit your downside especially in this market. In full disclosure, I am an active, fee based only money manager and favor this approach because the investor retains control of their assets and doesn't rely on an insurance company. If managed correctly, your ROI will be better with a portfolio consisting equities and bonds if you have an exit strategy to limit drawdowns. Then you can create your own monthly cash flow as needed, and it can be adjusted.
I think what you need is more research and investigation because this is a very important decision for you and nobody cares more about your money than you do. One thing you could do is get a 3 or 4 quotes from various insurance companies on the amount you would receive monthly. Let them know it is a competitive bid. I would also interview a few different portfolio managers as long as they have a defined sell discipline.
From there, you can make a more educated decision. You may even decide to do a combination of the two as they are not mutually exclusive. My biggest concern is that if we experience an inflationary time like the 70s, the guaranteed income stream wouldn't be able to adjust and protect your purchasing power. I want flexibility to adjust to the changing economic environment, and am not a big fan of one "pie chart" for all seasons based upon your age, net worth, station in life etc..
This is because it is as much about the market & economic cycle we are in and the risks in the markets as it is your risk tolerance. These are the choices or spectrum of choices that you have. I do not believe you can just buy-and-hold in this particular environment and valuation levels. If we were coming off of a major correction or bear market like 2008 my answer would be different as the risks would be lower.
I didn't mean to be long winded and wanted to give you a complete answer to stimulate your thinking. You have some research to do.
Hope this helps and best of luck, Dan Stewart CFA®
First off make sure you are speaking with a Fee-Only Fiduciary Financial Planner. Whether an annuity is right for you or not we want to make sure that you aren't just being sold something so someone can make a big commission.
Pro's to an annuity- You can set up a lifetime guaranteed income. So when you are 95 you will still have money coming in.
Con's - if you annuitize the annuity (turn it into a lifetime income stream) there will be nothing left for your heir. From you comment I don't think is a big issue.
The other potential CON to annuity is some have high fees. This is important to be aware of, but shouldn't be what you base your decisions on.
You said what is the best ROI for me- Run if anyone say the are going to have the BEST INVESTMENT returns- whether in an annuity or other investments. With an annuity you may be giving up some of the potential "big returns" in favor of the security of a lifetime income stream, and not having to worry about running out of money before you run out of life.
Depending on who you talk to- the assumed "safe withdrawal rate" is somewhere between 4-5%. WIth an annuity you could potentially get a return in that range or higher- with a guarantee never to run out of money. Of course these guarantees are based on the claims paying ability of the companies providing the annuity.
To wrap this up, don't be afraid of looking at annuities, just make sure you find the right option for and your needs. Work with a Fiduciary Fee Only Financial Planner to help find the best option for your to get your most efficient ROI.
Live for Today, Plan For Tomorrow.
DAVID RAE, CFP®, AIF® is a Los Angeles-based retirement planning specialist with DRM Wealth Management. He has been helping friends of the LGBT community reach their financial goals for over a decade. He is a regular contributor to the Advocate Magazine, Investopedia and Huffington Post as well as the author of the Financial Planner Los Angeles Blog. Follow him on Facebook, or via his website www.davidraefp.com