Erika Hubbard:
The next question that we have from the live room, actually we had two questions about what you all, but I think specifically Larry, thinks about annuities in the current environment. And I can’t find the first one, let me see … but I definitely wanted to address at least one, if not both of those.
Larry Swedroe:
Yeah. So, I wrote a book as co-author with my colleague, Kevin Grogan, Your Complete Guide to a Successful and Secure Retirement. In that book, there is a section on annuities. So, I encourage you to read that if you’re interested. It goes into great detail. And Adam, if you’re interested, can also get you a copy of the book as well.
The short answer is this. First of all, there’s only one general type of annuity that you should consider, and it better not have the word variable in it. You only want what’s called a payout annuity and single premium spheres…they’re called. And there are two types of those. You don’t want anything like equity index annuity, basically they should not be considered in general. There are two types of annuities that you should consider. One is an immediate payout. So, you’re age 70 or so, and you buy it, and it starts paying immediately, and that’s worth considering. The other type is the one I would only recommend generally.
And that’s what’s called the deferred annuity. And that has, in effect, a deductible. Just like on your home, you buy insurance, you don’t buy it for the $50, $100, or even maybe $500 repair. That’s too expensive. You can budget for that, and self-insure, you want a big deductible to keep your premium down and you budget for the amount you can afford, and you insure the rest. My home, for example, I have a $10,000 all deductible on the house. So, that keeps my annual premium down.
Well, the deferred annuity works the same way. Say you’re age 65, and your life expectancy is 80. You should budget for that. Your concern is that you live to 90 or 95 so you buy an annuity that only starts to pay out at age 80. That allows you to keep a much larger amount of your estate and invest it accordingly. It gives you a lot more flexibility of your assets. And of course, if you did die early, you saved those assets for the estate. But you did accomplish what you’re wanting, which is the insurance against living longer. Why do you want to insure against living a relatively shorter lifespan? That makes no sense to me. So, we recommend that you at least consider these deferred annuities or even a regular annuity. And the reason you want to do that is it gives you what are called mortality credits. So, the people who die early subsidize the people who live longer.
So, for example, my mother-in-law, we bought her annuity that started paying out at age 85, I think her yield was 10% when CDs were yielding too. And that 8% was the mortality credit. Well, she lived to 96 and turned out to be a great investment for us.
So, that’s the kind of annuity I would recommend. The one thing I caution about that is all these annuities, none of them really provide you with significant inflation protection. And they’re all designed to last a long time. We don’t worry too much about inflation in the next year or two, but compounded over 10, 20 or 30 years, and that is a problem with these annuities. So, it’s something to keep in mind.
What Adam can do for you is if you’re thinking about buying an annuity, is we run a money call-all and say, “If we buy this type of annuity, take the dollars. What are your odds of running out of money with the annuity and what are they without it? And then let’s look at a deferred annuity and see how that plays out.”
That’s the only really right way. It takes the emotion out of the decision. You can look at how does that impact my odds of success, and then we can help you choose that. But I really urge people to stick with these deferred annuities and budget for the early part (that gives you a lot more flexibility to address issues and concentrates the mortality credits where they’re the largest, which is at the tail end of your life).
James Lange:
Well, I liked everything that Larry just said, but I’ll add two things: 1) Larry said, “Well, the people who die early are subsidizing the people who survive longer.” One of the things is you have a piece of information that the annuity company does not, which is you know what your genetic history is, and you likely know how long your parents lived; you know what your health is; you know if you have cancer or if you don’t; if you’re 50 pounds overweight, or if you’re weight appropriate; if you smoke cigarettes or if you don’t. So, you have a much better idea of your own life expectancy. And if it is a good one, because for example, you’re weight appropriate, you don’t smoke, you exercise, etc. and you have a great genetic history, then it’s probably a better gamble than if you have cancer and you smoke and your parents died at 50, etc. So, I’ll add that you have that additional piece of knowledge that would tend to make this investment either better or worse.
And 2) Well, I’m always writing a book of one type or another, but I actually looking at this, is a variation of what Larry is talking about called a QLAC, which is basically the same thing, but you’re using IRA money to buy the annuity, which means ultimately if you do survive the term and the money comes in, it’s going to be taxable.
But one of the things I like about that is that you’re taking money out of the IRA, which is reducing the required minimum distribution, because there’s no minimum distribution on a QLAC until it actually goes into payment mode. So, you’re also getting a great tax benefit and let’s say if otherwise your required minimum distribution would’ve pushed you into a tax bracket that Roth IRA conversions, for example, didn’t seem likely, it might reduce your tax bracket in which case Roth IRA conversion is a good thing.
If you live a long time, great, you’re covered it. If you don’t well, you at least have the Roth. So, I actually think it’s a much better idea. And that said, I have never seen anybody buy one in practice. I’ve been doing this for over 30 years, and I like it, I’ve written about it, I put it in Retire Secure! in all three editions. I talk about it a lot. Maybe you guys know somebody who has done it. Maybe you’ve even done it yourself. Larry. I don’t know anybody who has done it.
Larry Swedroe:
Jim, one of the great puzzles in finance is why aren’t annuities used more and it’s that people have this fear of regret. “I’m going to die early and then, therefore, I wasted that money, and it could have been left to my heirs.” We buy insurance to protect against things, and we should have expectation, if you will, of negative returns. And if you died early on, my argument is you didn’t need the money anyway. You bought the protection, turned out you didn’t need it. But that’s why annuities generally are underutilized.
James Lange:
And that’s why the economists really like it. So, Larry Kotlikoff’s big line is that dead people don’t have financial problems.
Larry Swedroe:
That’s right. Yeah. But my concern now is that because of the elevated risk of inflation with excessively loose monetary and fiscal policy, that risk is gone. It doesn’t mean I think you shouldn’t consider them. I just think that’s important. Let me add one other thing. I think the regulations that are either imposed or proposed on this IRA annuities is, I think there’s a limitation on how much.
James Lange:
Yes, I think it’s $135,000.
Larry Swedroe:
All right. So, that is something you have to consider. And what I’m about to say doesn’t in any way negate your first point about you have inside knowledge that if you’re healthier, you’re going to live longer. I only point out that the insurance companies know their people who buy annuities are all people who have good genes, expect to live longer, because the people who are smokers and overweight are self-select out because they expect to die early. So, that’s already built into the system. So, you really can’t game that. That’s already built in.
But it does mean if you have good genes, you maybe are a better candidate to buy the policy than otherwise. But don’t think, “Boy, I’m going to live longer than average.” And they already know the people who are buying the annuities expect to live longer than average.
James Lange:
Yeah.