Is Using an Annuity Really a Retirement Investment Blunder?

 

Last week I merely introduced my blog and asked everyone to join my retirement journey.  It didn’t seem right to start out of the gate with anything controversial.  But now that this is week 2, it seems like a good time to enter into the debate as to whether an annuity should be part of a retirement income plan.  Spoiler alert – I spent my entire 42-year career in the annuity industry, so it won’t come as any surprise to anyone where I will land in this debate. 

But first, a quick update on my new grandson Calvin Jack (CJ).  He was 3 weeks premature, so he was only 5 lb. 1oz at birth and wasn’t able to breath on his own.  He remains in NICU but is now breathing on his own and continues to make good progress.  We’re all hopeful that he will be able to come home early this week.

I own 3 annuities.  Each were bought at various times for different purposes.  But now, they all have one primary goal – fill the gap between Social Security (when I start getting it – more on that in the future) and expected expenses.  These 3 annuities will eventually pay $65,000 per year for as long as either my wife or I live.  Effectively, these annuities are providing the pension I never got at anyplace I worked.

For the last 2 years I’ve regularly received e-mails and Facebook notifications from Fisher Investments offering to help me in my retirement planning.  Anyone that is involved in the annuity industry knows that Fisher Investments is not a fan of annuities.  In fact, buying annuities is Blunder #9 of their “13 Retirement Investment Blunders to Avoid”.  Essentially, Fisher Investments believe that annuities are not necessary.  Since they can construct a retirement portfolio that will meet my income needs, there is no reason to utilize an “expensive and complex” annuity.  Fisher Investments is far from alone with this point of view.  It’s been estimated that less than 1/3 of all Registered Investment Advisors utilize annuities.  And you know what, they are probably right.  If I were to construct a diversified portfolio and follow the 4% rule of withdrawals, it’s highly likely that not only would my retirement portfolio provide income for as long as I live, but the overall value of my portfolio will likely grow over time.  But here’s the thing.  I had to use the word “likely” twice in that statement.  I don’t know about you, but I will sleep better if I can replace the word “likely” with the word “guaranteed”.

I mentioned in the first blog that there are 3 things no one can know when doing retirement income planning:

1.      How long I will live

2.      What unexpected expenses will I have (and how big they will be)

3.      The specific returns I will earn on my retirement portfolio each year

I’ll cover each of these in more detail in future blogs.  For now, I’m just going to say the following about these 3 things:

1.      A retirement income plan that says I will be “OK” and assumes I will live to the age of 90 can have a very different expected outcome if I change the life expectancy assumption to 95 or 100.  In short, there’s a big difference between assuming your retirement portfolio can sustain your lifestyle for just 25 years versus 30 or 35 years. 

2.      We all know there will be unexpected expenses in our retirement years.  A health issue will be the most likely cause, but if you live in Florida like I do, a hurricane can create one as well.  If this expense happens shortly after you retire and/or is particularly large, it can put a huge hole in your retirement income portfolio.  Such a hole may make it necessary for you to choose between cutting back on your allowable retirement income or hoping your portfolio grows enough to fill the hole.  And as Hollywood action heroes like to say “Hope, is not a strategy”.

3.      Prior to retirement, it doesn’t matter much what I earn on my retirement portfolio each year.  The only number that matters is my average return over time.  But once I start taking money out to cover my retirement expenses, each year’s returns matter a lot.  Someone who retired in 2007 just before the S&P dropped 57% during the financial crises of 2007-09 had a very different retirement experience than someone that retired in March of 2009 and saw the S&P increase by 88% by the end of 2010.  While every retirement income plan assumes there will be fluctuations in stock prices, they aren’t built to withstand a significant drop in prices shortly after retirement.  If you are unlucky enough to retire at the wrong time, you can quickly find yourself in a very deep hole.

The bottom line is that while the Fisher Investments of the world can indeed build you a retirement income portfolio that will give you an 85%-90% probability of providing you with the retirement income you desire for your lifetime, they can’t, and they won’t guarantee it.  And that’s why I own 3 annuities.  I’m perfectly capable of building a retirement portfolio that will likely sustain me during retirement.  But, I don’t want to have to peek at the stock market each day to see if I’m still going to be “OK”.  I don’t want to have to worry when the people on the news report that stocks “plunged” today.

And here is one final thought.  The reason the Fisher Investments of the world have to recommend a diversified, relatively conservative retirement portfolio to most of their clients is because they have to reduce the chances that one of the 3 unknows blows up the plan.  My 3 annuities plus Social Security will pay my wife and I over $100,000 per year for as long as we live no matter how well or how poorly my retirement portfolio performs.  Since I’m not relying on the growth (or lack thereof) of my retirement portfolio to generate my desired retirement income, I can choose to invest my portfolio more aggressively if I want.  Rather than the traditional 60% equities and 40% fixed income, I can move to 70/30 or even 80/20.  And that is likely to make my portfolio grow even more over time. 

So, explain to me again why adding an annuity to a retirement income portfolio is such a blunder?