A question about retitement insurance

Factual Questions
1

Insurance Queston

With TIAA, and I assume other companies offering retirement accounts, you have money in a pool made up of your contributions and interest they have warned.
You have the option, which many people take, of devoting a large portion of your pool funds to an annuity, a monthly payment that lasts until you die, at which point the company keeps whatever is left of the money you devoted to an annuity. (There can be other arrangements, like half your annuity going to your spouse when you die, but we’ll ignore them here.)
Now, no doubt the fact that it pays until you die is an attractive aspect of an annuity.
But, it you have a relatively large amount in your pool, you can easily have the pool pay you each month an amount equal to that which would be paid by the annuity.
And by doing this your estate, rather than the company, gets whatever is left over from the amount you had devoted to your self-paid monthly payments.
QUESTION: If the above is correct, why would anyone get an annuity from the company, which would keep whatever is left of the money you devoted to the annuity, rather than what’s left going your estate.?

Note: The above assumes that you die before the money you have devoted to your monthly annuity payments is used up. But perhaps this is balanced by money the company must pay if you outlive the money you have devoted to your monthly annuity payments, so that the company, which must pay you until you die, must pay out of it’s own money. But this is just agues.

2

You have it in your last paragraph. Like many retirement options, you have to make some decisions based on your expectation of how long you will live. The insurance company uses actuarial data based on your lifestyle etc, but you should be able to do better. If your parents lived to a great age, that is a good start. The insurance Co is basically gambling that you will peg it before the annuity begins to lose money.

In fact, all insurance is like this. I am in the UK so medical insurance is not really necessary, but I used to pay into a low-cost scheme that paid for minor surgery that would probably have a long waiting list on the NHS. After a few years, they wanted to up the premium so I calculated that I would be better off putting the money into savings and making my own decisions about how to spend it.

So, if you expect to live to a great age, stick with the annuity; otherwise, take the cash.

3

The simple fact is that you can’t. With market interest rates at a given level, an annuity will pay you more than bond interest, to reflect precisely the fact that the annuity does not ultimately return your principal.

4

An annuity might be a good investment for a person who might not have enough money saved to last for the rest of their life. The old four percent rule isn’t precisely accurate, but a certain level of savings and withdrawal rate will ensure that you’ll never run out of money no matter how long you live. Most people don’t have enough for this to be true, so they face longevity risk.

Yes, as a group annuity purchasers lose money. They have to; the sellers of annuities pay salaries, comissions, and make profits, but some individual purchasers get back much more than they pay in. That’s pretty much how all insurance works, some large percentage of people pay thousands in, for example, fire insurance so that a small percentage of people get back much more than they paid in or will ever pay in over a lifetime. An annuity is longevity insurance; you’re paying a premium to protect against living longer than your money.

5

I am no expert, but the OPs description is pretty old school. Does anyone actually sell/buy such an annuity any more?

Annuities are insurance, not investments.
I purchased a couple of annuities several years ago and we discussed the current state of the market. Annuities where one lost the balance at death were precisely the reason that annuities had gotten such a bad reputation. I would never have considered such a plan and none were offered. Indeed I got the impression that such annuities were not offered any more. The financial calculation makes them such a bad deal no one would buy them.

The annuities I did get made up for the loss of that money at the end by having high fees, so there is no free lunch. For me, the assurance of a steady income no matter what made the high cost worth it. It also was and is not a primary portion of retirement. It is part of retirement, like social security.

And I understand that the payments I receive from the annuity come from the balance. If I outlive the balance, the insurance company keeps paying. If I die before the balance is exhausted, my estate receives the balance. But again, I pay a relatively high fee for this income insurance. As far as I know, and again I am no expert, this is the way all income insurance annuities today work. The OPs description is how they worked many years ago. More knowledgable folks will provide better information.

6

Risk.

Yes, you very well be able to beat the return an annuity pays you on your own. In fact, you’re very likely to. But the market is volatile, and if your investment hits a really bad stretch early in your retirement, you might find yourself in a hole you can’t recover from (and by “recover”, I mean “be able to draw an amount out that you previously thought you’d be able to”). An annuity removes nearly all of the risk at the expense of payout.

7

Yes. A rational analysis of the value of an annuity should compare it to a portfolio of bonds with similar credit risk and maturity approximately equal to your expected lifespan. If you want to keep a higher level of risk in your portfolio by keeping some of it in stocks, that’s a separate matter, and the higher expected return from stocks must be weighed against the higher risk.

It’s worth noting, however, that I think people should be much more circumspect about the creditworthiness of the annuity seller. Remember that you are lending a private corporation your money for a very long period, potentially 30 or 40 years. Annuities are not insured by FDIC or any other Federal scheme. There may be some protection at state level, but it may be quite limited.

8

In general, I agree with this but since the Op mentioned TIAA, I did a quick check by logging in to my TIAA account.

The TIAA calculator there shows that a $1M annuity with 20 years of guaranteed payments of $5259/month.

TIAA also offers a stable value investment that pays 3.25% for money invested today. This “How long can your money last” calculator says that if invested at 3.25%, that $1M will last for 22 years with a monthly withdrawal of $5259.

I have not taken advantage of any TIAA annuities yet but along with single payment immediate annuities, I consider them as reasonable options. Many annuities however, seem to be bad deals that exist to pay great commissions to the salesman that sells you one…

9

If you assume return of principal, then you get just the 3.25% per year, i.e. $2708 per month.

Obviously “the how long can your money last” option is assuming no return of principal, just like an annuity. The two calculators are just showing you that your expected lifespan in their annuity model is about 22 years.

10

Yep - but I (perhaps incorrectly) interpreted the OPs “large enough pool” point to mean that a large enough safe investment could easily return the same as an annuity.

11

I doubt insurance companies offer policies for that kind of surgery.

12

Well, any way you interpret the OP, he is clearly assuming that a portfolio could pay out the same income as an annuity, and there would always be some principal left for your estate. Which is wrong.

Your prior post showing the TIAA calculation is another way of refuting the OP, not refuting what I said. You’ve shown that the “breakeven” point, the actuarial life expectancy assumed in the TIAA annuity, is 22 years. If you take the non-annuity option (the second option that you show), then you are “betting” that you will die before 22 years. If you die early, there will still be some money left in your portfolio to go to your estate. But if you’re still alive after 22 years, you are shit out of luck, because you have nothing left - no principal, no income.

13

Canada used to require annuities for RRSP’s (tax-free “registered retirement savings plan” accounts) That stopped because many years ago, interest rates got so low that a reasonable return from a straight bond fund was no longer feasible. Now, you can keep the money in an investment account, and there is a formula for what percentage must be withdrawn after age 70.

The problem is interest rates. Also, the bet over when you will die. the answer to the OP’s question is reliability of income. Two years ago, I made 10.7% on my savings plan. Last year, I lost 3.9% (I was up 3% on Sept. 1 but then the trade wars started to bite the market.) In the last two months, I’ve gained about 5%. In the days when recessions could last a few years (2008? 2000?) You could eat up a lot of that savings pool waiting for the market to recover - the smaller your savings pool when the market finally recovers, the less overall income you get for retiring at the wrong time. And naturally, some retirement decisions in recessions are not voluntary. An annuity removed this uncertainty. But as the above discussions point out - the annuity offers are based on actuarial science, and often hedged with accountant-level caution, so like Vegas, odds are the house wins more often than it loses - at the expense of the retiree.

Another issue is lifestyle. You may not die at age 85 or 90, but odds are around there somewhere you should (or must) go into some form of assisted living. At that point, all extra income does is feed the system, not you. Perhaps it’s better to have the a higher income for the years you maintain your own household, and the years you can travel or be more active. If you can’t remember your name or where you live, someone else will be using that money.

Another problem that helped nail the coffin lid on annuities is inflation. This generation does not remember the times when prices went up 10% every year, but the people retiring now certainly must. Tying yourself into a fixed income when prices were rising fast was a recipe for disaster, leading to finding recipes for dog food.

A final problem is with spouses - what if one needs care and the other does not? Many assisted living situations are not equipped to handle this division of needs, and one spouse in case will suck up all the disposable income and then some.

And then there’s inheritance. I realize inheritance taxes are a touchy subject, but then - if the average senior eventually kicks off at age 95 or so - then the average heir is likely to be in the 70 age range. Plus, depending on special needs, there is a chance that senior care will suck up any available savings if the parent lives long enough. If your retirement plan is “mama will provide” then waiting until age 70 to finalize your retirement finances is a really bad idea.

14

Yes, this is something else that should be emphasized. When you buy a regular fixed annuity, it has a similar risk profile to buying a fixed interest bond with a long maturity roughly similar to your life expectancy. In other words, you’re locking in current interest rates. Just as the value of a long-dated bond will collapse if inflation expectations go up, so you are in serious trouble with a fixed annuity if inflation erodes your buying power. Over 30 years, this can be devastating.

There are annuities that give you varying degrees of protection against inflation, but as annuity products become more complex, so the hidden fees increase and other investment approaches become more attractive.

If your time horizon is fairly long, you could argue that buying long maturity fixed income (as in an annuity that locks in current interest rates for the rest of your life) is more risky than stocks. Stocks may be much more volatile, but they will probably recover on a long time horizon, and they do protect you against inflation in the long run. I’m 10 years shy of normal retirement age, and my own portfolio is ~65% stocks, and the 35% fixed income has a duration of ~2 years. Keeping your duration short may cost you a little bit in a normal yield curve, but it will track closer to actual inflation. There are no inflation-linked products in the U.S. that give you good treatment in a taxable account.

15

Whereas with all those “funeral insurance” schemes
that advertise on daytime TV, they’re gambling that you’ll live that much longer that you’ll have paid out way more than the “guaranteed sum”.

16

There are a lot of factors to consider. Taxes, for one.

I’m a retired college professor and so I have a lot in TIAA. The money put into it is tax-deferred. It’s like a less-limited IRA.

If you don’t do the annuity option, then at age 70.5, you have to start taking out a required minimum distribution (RMD). It’s a percentage based on overall life expectancy.

One problem with the RMD rules is that the percentage gets quite high in later years. You can easily drain the money out.

Note, again, this is about taxes. There are “lines” in taxation to consider. E.g., the one below which you pay no taxes and above which you do. Ditto lines for higher tax brackets. You may end up “earning” enough money to be over such a line early on but not “earning” money and be well below the line later on. With an annuity is it (somewhat) more balanced out. You could be below a line the whole time.

“Normal” annuities don’t run into this issue. TIAA is an example of a company with a lot of customers in this situation.

Note also with TIAA there are options: you can get a minimum 20 year annuity where it goes to your estate if you die earlier. Plus you can also do a joint annuity where it keeps paying as long as one of a couple is still alive. Such options can reduce the risk of dying a month after the annuity starts and the estate getting nothing.

Also, my annuity has a guaranteed minimum payout. I’ve actually been getting a lot more than that. TIAA is good at this. So a simple calculation comparing this to other investments will likely be too low.

Investing is all about considering the risks.

17

I shout at the TV screen when some pensioned-off presenter comes on and tries to tell me that forking over some modest monthly payment every month will take care of my funeral costs.

I am a habitual reader of small print and the problem with those plans is that a) they have to be in place for several years before they pay out, and b) (This is the sting) the plan expires if you miss even one monthly payment, even if you have been paying in for decades, the money is lost.

Once again, instead of contributing to the profits of some insurance conglomerate, keep a reasonable cash deposit somewhere safe to cover these expenses.

18

This is similar to Canadian RRSP options. For simplicity, everything you pull out of your tax-free RRSP savings is simply income, to be added to your other income. I assume the USA like Canada has a similar taxable income deduction ($10,000 or so) for being over 65, but generally the rule of thumb was you put money in and defer taxes in high-income, high-tax years and take it out when your overall income and marginal rate is much lower. The MSP here probably needs tweaking because it seems to pretty much force you to drain the RRSP by about age 95 - but then, if you still need and can use a full income at that age, good for you. Of course, nothing stops someone form saving some of their income before that into normal, non-retirement, non-tax-free savings.

Again, an important thing to tell your kids or executor or whoever (or put in will, too ). Once you bite the big one, who cares what happens? Is a big funeral and silk-lined mahogany casket necessary? Make your wishes known - be cremated, have a memorial with just an urn in someone’s private house…

What I see a lot of nowadays - speaking of dying in your late 90’s… By the time someone dies, they’ve lost touch with their friends from earlier in life, those friends who survive are not very mobile, won’t spend much time going to funerals. Many may have moved to a retirement home far form their old friends. Few people beyond family likely will show up. This isn’t like they guys who used to keel over with a heart attack in their early 60’s where all their buddies from work and all the neighbours will show up and pack a church.

19

Perhaps letting the company keep the balance allows them to pay out a higher percentage than they otherwise would be able to. The lost balances can be paid out to other annuity payments.

On average, I wonder if annuities give better results to people who might not make the optimum investment choices. Let’s face it, a lot of people are not savvy investors. A lot of people make outright poor investment decisions that cause them to lose money. A lot of old people lose good decision making ability and get outright scammed out of their money. In a lot of cases, I can see having the money locked up and providing regular monthly income being the right choice.

If you’re the type of person who thinks to ask this question, you can probably do better on your own rather than buying the annuity. But for the person who buys “Franklin Mint Commemorative Plates” as investments, an annuity might be the right choice.

20

Or that you’ll have made some misstatement on the questions that they can use to deny coverage after the fact, or that you’ll die during the waiting period before which many guaranteed acceptance policies become effective. There’s more than one way to skin an old person.