Opinion: Retirees with pensions have more fun


OK, so it’s not exactly “fun”. But a new report says retirees who convert their savings into guaranteed life annuities are actually doubling the amount they’re willing to spend each year, on themselves and their families.

The assurance that they won’t outlive their savings allows them to open their wallets and have fun while they can, say researchers David Blanchett and Michael Finke. Blanchett is head of retirement research at QMA / Prudential Financial, an insurance company, and Finke is professor and chair of economic security research at the American College of Financial Services.

It’s a shame that annuity rates have collapsed along with bond yields, leaving retirees with even fewer healthy options than before.

“We find strong evidence that households with more of their wealth in guaranteed income spend significantly more each year than retirees who hold more of their wealth in investments,” they write. “Marginal estimates suggest that investment assets generate about half the amount of additional spending for an equal amount of wealth held in guaranteed income. In other words, retirees will spend twice as much each year in retirement if they transfer their investment assets to guaranteed income wealth.

They come to this conclusion by studying the investments and behavior of 725 households as part of the University of Michigan’s lengthy health and retirement study. They looked at retiree households with more than $ 100,000 in savings and spending more than $ 25,000 per year.

In fact, they compared the spending habits of those who had a guaranteed income of, say, $ 50,000 a year and those who had savings large enough to purchase a life annuity from an insurance company that would pay them an income. guaranteed at $ 50,000 per year.

It’s a great discovery to balance on a reasonably narrow basis. But even if the effect of owning an annuity is not as large as they think it is, the results are surely “directionally correct,” as the consultants like to say.

Life annuities like this, known in the industry as “single premium payout annuities,” are actually an insurance product that protects you against the risk of outliving your money. Those who die young end up subsidizing the incomes of those who live long.

They make a lot of sense in theory.

Without them, you are left with figuring out how much return you will earn on your investments, how volatile they will be, how long you will live, and how much you can spend. Of particular concern is end-of-life medical expenses, including nursing home costs.

The result, several studies report, is that middle-class retirees end up playing too defensively. They generally spend well below their income. Instead of using their savings to enjoy their old age, they end up trying to protect their money.

Yet studies have shown that the typical middle-class retiree has far less of their money in annuities than you might think.

When you eliminate Social Security, the biggest life annuity by far is even less.
Financial experts have spent decades grappling with this apparent “puzzle”. (Of course, the insurance industry has a strong incentive to sell more of these products. But that doesn’t mean they’re wrong.)

Why, they ask, don’t retirees buy more annuities?

Some blame psychology. Others say annuities are too complicated for many investors to understand. Others point out that about a third of retirees want to leave a legacy behind.

But of course there may be another reason. They may just worry about inflation. This is because inflation is the only thing that is going to devastate your annuity income. The typical annuity pays a fixed income each year for life. The payment does not change. Thus, your annual purchasing power decreases each year according to the rate of inflation. Those who lived on fixed incomes in the 1960s and 1970s, when inflation got out of hand, were completely hosed down. And once you put your money into one of these annuities, you can’t withdraw it anymore.

We have already seen how the current official inflation figures grossly underestimate real estate inflation.

You can get annuities with annual cost of living adjustments, but these adjustments are usually capped at around 3% per year. And these annuities are much more expensive than regular annuities, which translates into even lower starting payments.

For example, a 65-year-old woman with $ 100,000 could buy a fixed income annuity that will earn her about $ 470 per month for the rest of her life. That’s according to the latest issue of Annuity Shopper, the industry guide. But if she opted for an equivalent annuity that contained an annual cost-of-living adjustment, she would have the chance to get a starting payment of $ 330 per month, or one-third less.

Annuities mean a lot to retirees, but right now the payout ratios across the industry are, sadly, terrible. A 65-year-old new retiree who buys an immediate, single-premium annuity today can expect to have a monthly income one-third lower than it was at the turn of the millennium. It has even fallen by 20% over the past decade.

Annuity payout ratios are based on corporate bond yields, as insurance companies invest premiums in safe bonds. Thus, the collapse of bond yields over two generations significantly reduced payout rates.

If inflation resurfaces, future annuity buyers will likely see the benefit of higher payouts on new policies. Higher inflation will mean higher bond yields and higher payments.

But those who buy annuities today will not see the benefit. Rather, they will find that they have blocked off today’s low payment rates while also suffering from future inflation. This is not to say that inflation is coming, only that it is a risk. At present, it is difficult to see how annuity buyers, as well as bondholders, are fully compensated for this risk.

There are sound strategies often recommended by financial advisers that help alleviate the problem. One is, yes, to “diversify” your retirement account by purchasing an annuity with some of your money while leaving the rest invested in potentially earning assets. Another (related) idea to use some of your money to buy a deferred annuity that doesn’t come into effect until you’re, say, 80 years old. At this point, you just buy insurance in case you live longer. Because many people aren’t fortunate enough to last that long, insurance companies can afford to pay more to those who do.

For example, a 65-year-old man spending $ 100,000 to get started immediately would have a monthly income of less than $ 500. But if he spends that money on an annuity that doesn’t take effect until he’s 80, he’ll get $ 1,600 a month, if he does.

And the only overwhelming way to get a bigger monthly payment, adjusted for inflation? Delay the day as long as possible when you start taking Social Security.

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