When do annuities actually make sense?

In My Humble Opinion
1

Spinning this off of the most recent retirement thread. There I came around to understanding that delaying taking social security payments (to 67 and to 70) is very comparable to a very attractive inflation adjusted with right of survivorship lifetime annuity backed by the United States government.

My general bias is that most annuities are poor deals. But in one past thread @Hari_Seldon shared how he was offered a fairly attractive option to annuities his retirement plan and it has worked out extremely well for him. And I think it was @Voyager who has shared about taking out of a 501 or IRA during a fairly low income level (if you have one and future RMDs will put you higher) and putting into an annuity instead. Reasons being the future pay outs are not taxable, and it lowers future RMDs.

Are there any other good reasons to utilize annuities? I tend to think that in general an account large enough to buy one that provides enough income, is large enough to be able to weather market volatility and produce more stable income and do better in other ways with little risk of running out, and a greater chance of keeping income on pace with inflation.

But I am open to learning why I may be wrong!

2

My retirement annuity has done quite well for me.

One other use- a large amount of windfall $. Humans ARE gonna spend it wastefully. Period… Dont say “Not me” until you have received one. Even I- Mr Fiscally conservative-, after getting a modest inheritance- altho I started out well- paid off all bills. Bought a good, reliable and modest car- a Saturn, paid cash. Upped my contributions to retirement to max. But thenIi blew the rest. Okay, that wasnt much, true. but I did. It is human nature, and pretty much everyone here is human (No offense discourse bot).

So after doing those things, and maybe even buying a modest home (paying off the mortgage is including in paying off all the bills)- dumping 90% of the rest into a lifelong annuity is a great idea. Your $$ is now protected from your foolishness, conmen, and greedy grasping relatives.

Even a lump sum retirement. My buddies Dad got a high 6 figure lump sum. So, he bought some land, and started building his “dream house”. He ran out in the middle of it. For what he had, he could have bought a really nice house there in Kern County, and had enough to live on for the rest of his life.

3

I’m not only going to say not me, I’m gonna guess not most. Especially not if the “windfall” happens near retirement age.

Oh people will make stupid financial decisions with windfalls. My take is that buying a standard annuity to keep themselves from spending it stupidly, would be one possible fairly stupid decision.

Even lottery winners don’t usually just go and blow it.

Further, the researchers found no evidence that the winners blew their newfound wealth on extravagant purchases. Instead, they tended to spend their winnings slowly over many years. Most didn’t quit their jobs, but they did tend to work less

Can you expand on how your annuity has done quite well for you?

4

Almost. I took money out of the IRA, but I did not put it in an annuity. And it seems that you are not allowed to put it in a Roth. I don’t know what happens if you take cash from another account and put it in a Roth - not of interest. And I suspect you would not be allowed to put it in an annuity for the same reason, but I’ve never checked since that never crossed my mind.
When I discovered that my pension from AT&T was worth a lot more than I thought it would be, I moved it to an annuity since it basically was an annuity. That was like 13 years ago, and I’ve never taken a penny out if it so far - don’t need it. The cash value has dropped, but the money I could get every month has increased, as has a nice death benefit. (Well, nice for others.) But if I had to do it again I would have put it into just an IRA. It would have done a lot better.

5

Not speaking to annuities but speaking to this:

I am in a similar situation.

I have a fairly large traditional IRA whose RMDs will quickly exceed my actual annual spending needs and will also drive me into a high tax bracket in mid-late retirement. I intend to start drawing SS at age 70. Between age 65 when I retired and my cash income dropped to near zero, and age 70 when I start taking SS, I am making large voluntary traditional IRA withdrawals every year. I call them “Pre-RMDs”.

The purpose of the pre-RMD is to whittle the traditional IRA down as much as practical before the RMDs hit and I’m forced by the RMD amount into a high tax bracket. The pre-RMDs are done now at a time my income tax bracket from all other income is low so I can take a big enough bite from the traditional IRA to move its needle without overpaying in taxes. The amount of the “pre-RMD” is chosen to just fill one of the intermediate taxable income brackets.

Once I start getting SS, 85% of it’ll be taxable, so there is less “headroom” to make pre-RMDs within that intermediate tax bracket. But I will continue making those smaller voluntary pre-RMDs until I’m stuck taking real required RMDs once those kick in at age 72.


With that as background the real point I wanted to make was to push back gently at @Voyager’s last sentence.

When I take my “pre-RMDs” I take them in the form of a Roth conversion directly into my Roth IRA.


When doing all this math to decide if pre-RMDs make sense for you, one thing to consider is that by doing pre-RMDs and artificially boosting your taxable income, you’re also volunteering to pay IRMAA on your Medicare Part B & Part D. Which can itself be a hefty hunk of tax.

6

Um…this is incorrect. Annuity payouts are absolutely taxable, AND annuity accounts are subject to RMDs.

But as always in discussions about annuities, you need to clarify what kind of annuity you’re working with. There is a massive difference between a fixed annuity and a variable annuity, to the point they should probably have different names.

7

Neither my husband nor I understand or care about financial stuff, so we went to our credit union and talked to their money guy. He set us up with 2 annuities which are on the conservative side but which did very well in the 10 years since we set them up. We’re now drawing a monthly amount from each and we should be good for at least 15 years.

Maybe there were better or higher-earning options, but we’re quite satisfied.

8

To speak more to the OP, there are some situations both fixed and variable annuities may make sense.

Fixed annuities - to be clear for those who may not know the difference, a fixed annuity is where you pay a lump sum of money, and receive guaranteed* payments for a certain period of time, or for life. You can tie the lifetime payments to your own, or to you and your spouse’s. Sometimes a fixed annuity can be a deferred fixed annuity, where you don’t receive the payments until 5 or 10 years from now. Fixed annuities are essentially purchasing a pension. I would never recommend someone purchasing a fixed annuities that pay out any more than your expected expenses, plus maybe an allowance for inflation and cost of living increases. The downside to fixed annuities is that once you purchase it, your money is gone - you no longer have access to the balance.

  • “guaranteed” as long as the company you purchased it from remains solvent

Variable annuities (VAs) are investment products wrapped in an insurance “wrapper”. There are all sorts of VAs. They usually offer a guaranteed step-up in value (5-7% annually is typical), the account balance is invested in a pre-selected assortment of indexed funds or other mutual fund options, there is a death benefit, and there is (usually) an option to annuitize (start receiving guaranteed payouts).

VAs are usually extremely complicated financial instruments, I think by design so that you don’t see the hefty fees that are typical of them. You can take withdrawals from a VA without annuitizing, which can make them pretty flexible. I typically would never recommend a VA unless it really fit someone’s needs.

There is a subcategory of VAs called the indexed variable annuity. These are really the only ones I would consider. They take your lump sum, tie it to an index (S&P500, Russell 2000, etc.), and let you participate in a portion of the upside, and protect you from the downside. You’re usually locked into it for 5-6 years, so you have to ride it out. Here’s some examples of how it works:

Example 1: you purchase a $100,000 indexed annuity, tied to the S&P 500. The market is incredibly volatile, and after 6 years, the S&P 500 is down 23%. Your balance is $100,000 free and clear (indexed annuities have no fees).

Example 2: you purchase a $100,000 indexed annuity, tied to the S&P 500. The market is slow and steady, and after 6 years, is up 50%. Your balance is $150,000 free and clear.

Example 3: you purchase a $100,000 indexed annuity, tied to the S&P 500. The market is incredible, and after 6 years, is up 100%. Your balance is $150,000 free and clear, because the annuity only gives you participation in up to 50% upside. The annuity company pockets the other $50,000.

There are some similar annuities that will give you more upside participation for lower downside protection - you have to shop around a little.

9

With regard to RMD’s there is a Qualified Longevity Annuity Contract (QLAC) that is funded from a 401k and its benefit is to reduce your RMD’s and provide a steady income in
later years.
https://www.fidelity.com/viewpoints/retirement/QLAC-qualified-longevity-annuity-contract

10

We recently spoke with a financial advisor who recommended annuities, and with some of his clients who were very pleased with them. Likely the main reason for my wife and I eschewing them was that we didn’t really understand them. They essentially sounded too good to be true.

But the only real opinion we heard against them was that we would forego flexibility. And my opinion was, if they provided sufficient funds and security, why did I really need flexibility.

Complicated stuff indeed. I’m comfortable that my wife and I ended up with a sufficient strategy - readily acknowledging that ours is likely not the BEST strategy.

11

Thanks for the correction. I think I must have conflated it with Roth IRA conversion.

Is there is the option of converting into a Roth and using that to buy the annuity? Is that then taxable income?

12

There actually are Roth annuities (and just regular non-qualified post-tax annuities). Growth in a non-qual annuity is tax-deferred, and is taxed at withdrawal - but the corpus is not. I don’t know if I’d want to lock up my tax-free funds in an annuity.

13

I get confused because I don’t think of there being growth in a fixed (even an inflation adjusted) annuity? My mind pictures them as using the lump sum to purchase a pension. The lump sum in my mind is then gone from me. Instead I have regular payments for the rest of my life, possibly with an option to transfer to my wife if I die first. My simplistic imaging is as the insurance against running out in the case of longer than expected longevity coupled with much worse than historically typical market returns. The company makes money on the bet because the average person has an average life span and because they are confident that they will get a return on that money, now their money, better than the rate they will pay me likely even if we both live very long lives.

I get that financially there actually is a balance in the account though. It just seems fictive to me.

The retirement planners create some of this anxiety I think. I see even with a large balance some significant fraction of runs that I don’t have money left if I live significantly longer than actuarially expected. Other than SS payments which again I now think of as an inflation adjusted annuity with a solid company backing it. Annuities assuage that anxiety. But to me, rationally, expecting returns very much less than historical averages over several decades seems like something to not worry about?

14

As a former prof, the colleges I worked at mainly had retirement systems set up with TIAA (formerly TIAA-CREF). You could assign certain amounts of your salary to go into your TIAA fund. Some (but not all) would match your pay-in up to something like 20%. These were pre-tax dollars.

Later, when you want the money (I think something like 62) you can start taking money out. One option is an annuity. They have several types: fixed term, lifetime, lifetime with a minimum term guarantee, joint, inflation protected, etc.

Annuities get a bad rap because there are a lot of companies whose ROI is ridiculously low. These are the ones you commonly see advertised, pushed by financial advisors, etc.

TIAA gives a decent guaranteed rate. Even better, if their investments do well, you get a bonus extra amount. For the time I’ve had it has been really great. So it has been outdoing the listed rate. (For TIAA, the teachers are the people they need to please, not stockholders.)

I do pay taxes on such annuity payments. Pre-tax funds went in, remember?

I do not do an RMD on such an annuity. I do not have a personal account to withdraw the RMD from. I have $0 invested in TIAA. My money went into their coffers when the annuity was set up along with a lot of other people’s. There’s nothing there to take a percentage of.

This RMD aspect is a factor to consider when deciding if an annuity is for you. Once you really get up there in age, your annuity payment stays the same. With an RMD it will eventually start to decline then finally your account approaches zero. In terms of taxes, an annuity can spread things out more evenly.

A person in their 90s who needs extra care could be in better shape with an annuity than something like an IRA as there is money still coming in. The problem is you can’t be certain you’ll live that long.

(Note that anyone, not just teachers can invest with TIAA. But the setup for pre-tax retirement investments are more restricted. E.g., you can do an IRA but the annual cap is there.)

15

There is no growth in a fixed annuity, because there isn’t a balance any more in a fixed. You gave a lump sum to Company X, and they agreed to pay you $Y every year until you die.

16

Then how is an annuity, at least a fixed one, account subject to RMD if there is “balance” in it for the calculation?

17

I’ve always made it a policy not to invest in anything I don’t understand (Bitcoin, anyone?), and annuities fall into that category. Seems like a case of I pay someone else to give me my money? Luckily, we have enough income from SS, military retirement and a couple of other retirements that we don’t have to touch the windfall from our home sale, and since we traveled so much in our working lives, we have no pressing desire to do a lot of that. Since we’re more than able to manage our own finances, I see no need for an annuity.

18

NO balance in it. Sorry.

19

It’s not - variable annuities are subject to RMDs.

20

Got it. Your statement of

confused me. But I understand that it was my confused statement it was responding to that caused it!

Hence the QLAC option that @chela linked to? It lowers RMDs and only provides taxable income if you make it to the future age date when there is possibility of decreasing RMDs.

Given that the main utility of annuities seems to be insurance against longevity risk, ISTM that there would be a large market for QLACs, a product that allows only paying out at an advanced age, one at which a prolonged period of poor market conditions, or a particularly horrifically timed crash, would lead to not having enough income at approaching or exceeding 90. The confluence of both that sort of longevity and that sort of market performance over a fifteen to twenty plus year time frame seems highly improbable, but insurance is generally for improbable events. And if either doesn’t happen, the consumer dies before the age is reached or the market does okay, the company does very well. An advantage of having that insurance is allowing greater comfort with higher risk and volatility instead of positioning conservatively out of fear of longevity risk.

I guess the value depends on the numbers involved. But I could imagine being interested in such a thing. Just enough that it with SS and other safe income streams I’d have enough to get by (accounting for inflation).

I’d think these would be pushed more!