Fixed annuities are popular and getting more popular. Beaten down by the bear market, many investors suddenly like the safety of fixed annuities. A tax-deferred yield of 5% looks good compared to recent stock market returns. Fixed annuities can be a valuable of any portfolio, as I’ve said for years.
Years ago most retirees could rely on a fixed pension from an employer to cover a large part of their retirement expenses. Those defined benefit retirement plans largely are disappearing, and retirees are on their own for funding retirement. A good replacement for these plans is an annuity. Shifting part of your retirement nest egg into an annuity gives you that safe, guaranteed lifetime income. A price is that you give up some potential stock market returns in exchange for reducing risk.
A recent study shows that a fixed annuity also can make your wealth last longer. An article in the December 2001 Journal of Financial Planning examined the odds of different portfolio combinations lasting at least 30 years of retirement. The study examined four portfolio combinations, from conservative to aggressive. The conservative portfolio was 20% stocks, while the aggressive was 85% stocks. Using a technique known as a Monte Carlo simulation, the study found that for each type of portfolio, putting 25% or 50% of the fund into a fixed annuity increased the odds of success.
The greatest improvement was in the conservative portfolio. While the annuity also improved the odds of success for the aggressive portfolio, the existence of a lot of stocks in that portfolio already gave it over a 90% probability of surviving. Adding the annuity increased the survival odds only a bit. The odds of survival for the conservative portfolio, however, were 32.6% with no annuity. They improved to 53.3% when 25% of the portfolio was moved into an annuity, and to 81.3% when the portfolio was 50% in a fixed annuity.
An annuity offers advantages you won’t get from bonds. The payout on the annuity is fixed once you start regular payouts. Bond yields can decline as interest rates decline, or the bond principal can decline as interest rates rise. A bond acts like an annuity only if interest rates are fairly stable for 30 years.
Probability Portfolio Will Last 30 Years
Portfolio Type | No Annuity | 25% Annuity | 50% Annuity |
Conservative | 32.6% | 53.3% | 81.3% |
Balanced | 76.3% | 85.1% | 94.5% |
Growth | 87.4% | 92.2% | 96.7% |
Aggressive | 91.6% | 94.6% | 97.5% |
The lesson seems to be that if you are not prepared to invest aggressively all through retirement, consider adding an annuity to your portfolio.
But the strategy won’t help you if you buy the wrong annuity. There are many insurers offering annuities with many different terms. You need to know how to compare them and get a good deal.
In this visit I’m going to show you how to buy a fixed deferred annuity. The fixed deferred annuity will earn interest on your account each year. The interest income will compound tax-deferred until you withdraw it. At retirement, you can begin a payout schedule (annuitize the annuity), withdraw money as you need it, take the entire annuity as a lump sum, or transfer the account tax free to another insurer to buy an immediate annuity. (I covered immediate annuities in the December 2001 visit.). Here are the factors to consider when shopping for a deferred fixed annuity.
Annuity Sources
Web Sites
annuityscout.com immediateannuity.com
brkdirect.com tiaa-cref.org
fidelity.com troweprice.com
topannuities.com masterquote.com
quotesmith.com quickquote.com
annuityshopper.com vanguard.com
National Brokers
Annuity & Life Insurance Shopper 800-872-6684
Quotesmith 800-556-9393
At payout time, your best option might be to use the annuity balance to buy an immediate annuity from another insurer. This move might increase your yield by 20% or more. I’ve covered this strategy in the past, and it is included in the article on immediate annuities in the December 2001 issue. Be sure you have maximum flexibility when it is time to take distributions.
There are hundreds, perhaps thousands, of insurers offering annuities. Get quotes from several sources before you make a decision. I’ve listed some national annuity sources in the box.
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