Brad and Jonathan tackle a listener question about annuities and discuss some updates to the travel rewards landscape.
Second Generation FI
Many people in our community struggle with how to pass along the lessons of FI to their children. Brad shared stories about passing FI lessons along to his children.
The little things really are the big things in life.
Brad and Laura take the opportunities to teach their kids about the FI lifestyle as they come up. Although they aren’t lecturing their kids about FI every day, they are teaching them the thought process that makes it possible.
Whether you are answering their questions or talking through a problem, these are teachable moments that your kids can learn from.
Brad’s challenge to our community is:
Find those little lessons in life that you can pass on to your kids. I think that these little things go a long way.
You can even try to make a game out of it. Take any opportunity and make sure to not gloss over teachable moments.
Travel Rewards Update
Playing With FIRE Update
The documentary will be airing these seven cities in early June:
- San Diego June 1st 2019 – Buy Ticket Here
- San Fransico
- Seattle
- New York City
- Detroit
- Washington D.C.
- Atlanta
As the tickets become available, we will provide links. For now, keep an eye on the Playing with FIRE website for ticket information.
If you don’t see your city on the list, don’t worry! Connect with a ChooseFI local group to get more information about a potential showing in your area. It could be a great way to introduce the concept of FI to a friend.
Question From Jean About Annuities
My name is Jean and I just recently found ChooseFI and I’m really grateful I’ve found you guys. I’ve actually been looking for you all my life. I just finished listening to J.L. Collins’ series on stocks and investments, particularly, episode number 36, and listened very closely to his comments on annuities.
Well, I am just sick to my stomach because I had a financial advisor sell me an annuity last year for $150,000 which was more than half of my assets. I’m 61 years old and I have been seeking answers on the best way to invest for a secure retirement.
I can’t tell you how many people I’ve asked and how many other advisors about whether or not an annuity was a good option for me. And what I kept being told by the advisor that sold it to me is that it would provide a long term pension for me. You know, I anticipate living to be into my 90s just because I’m basically healthy and my parents and grandparents have lived long lives. I thought this would be a good option for me.
So, my question to you all, so that I can sleep better at night, what can I ask my advisor who sold me this (but is no longer managing my equities because I realized that he was getting everything he was getting out of me from the annuity and I was not going to continue letting him siphon off my equities account.) So my question to you all is, how can I reconcile this choice that I made of purchasing an annuity. I guess my biggest fear is that when I’m 85 this company will go bankrupt. Any thoughts on this are appreciated.
Answers With Big ERN
Big ERN, from Early Retirement Now, was on the show today to answer Jean’s question. Based on his research, this is his take on annuities
Types Of Annuities
- Immediate Annuity. With an immediate annuity, you will hand over a certain amount of money to the insurance company. Immediately, they will start to pay you a pension-like “salary.”
- Deferred Annuity. With a deferred annuity, you hand over a certain amount of money to the insurance company but the payments do not start right away. The advantage of this waiting period is that your payments will be larger.
Both types of annuities will tie up your money at the insurance company forever. Plus, if your death is untimely, there is no way to pass this money along to your family.
With the sheer amount of bells and whistles offered on annuities, it is impossible to delve into each component. An annuity could include a cost of living adjustment, a minimum number of years, a joint annuity between spouses, and a multitude of other options. You would need to take a closer look at the type of annuities offered to you before you make a decision.
In general, Big ERN recommends against an annuity. Unfortunately, Jean has already signed up. So, she should check with the insurance company to see if she could get out of it, but it is an unlikely option.
Either impossible, extremely difficult, or disadvantageous to get out of the annuity now.
Advantages Of An Annuity
Once you sign up for an annuity, you are likely stuck with it forever.
I usually advise against going with an annuity. But there is one advantage of an annuity that I have to concede, there is something to it… The advantage is that this is a safe and efficient and simple way of turning one big chunk of money into a stable cash flow.
The one advantage is that you can turn a large chunk of money into a fixed income. Stable cash flow is an envious way to live your retirement. It is just not as simple to produce a steady stream of income through your net worth.
With the 4% withdrawal rule, it is possible that you could run out of money.
The 4% rule is also, in the worst possible case you exhaust the money after 30 years. That’s actually one of the reasons why I believe we shouldn’t use the Trinity study results and expand them from 30 years to 60 years… because in the worst possible case the 4% rule would also exhaust the money after 30 years. Of course, in the best possbile case you have tons of money left over after 30 years.
As our retirement years grow, it is a good idea to withdraw a little less than that to preserve capital over a longer term.
The insurance company is able to hedge its longevity bets in a way that the individual investor cannot. You do have the ability to create a CD ladder or bond ladder that simulates the fixed income of an annuity. However, you cannot predict when you will pass, so if you live past the horizon of your fixed income ladder then you will be in a tough spot. The insurance company is ensuring that you have a fixed income for the rest of your life, no matter how long you live.
Disadvantages Of An Annuity
The most obvious disadvantage is the money is in the control of the insurance company. The money is completely gone as soon as you sign over your rights. It is an extremely illiquid asset, even though you will be receiving a monthly income from it.
The fees associated with an annuity are also difficult to justify. Many of the fee structures are not transparent but it seems that the salesperson could be taking up to a 10% commission off of the lump sum. However, it is likely there are many other levels of fees that we cannot see. The high fees might negate the advantage of longevity payments by the insurance company.
If You Already Have An Annuity
The best part about the annuity is the fixed income.
The volatility of equities is balanced by your ability to weather the storm.
You can build your drawdown plan around this stability. On the equities side of your portfolio, you should be comfortable with higher risk exposure. As you make more contributions to a retirement account, they should be made aggressively. Avoid a target date fund if you have most of your portfolio in an annuity.
Big ERN would not be very worried about the potential bankruptcy of the insurance company. These companies are very heavily regulated, so that should be a minimal concern.
If You Still Want An Annuity
If you are intrigued by the idea of a lifetime income, then you might still consider an annuity. The most important thing to do is to compare plans.
People shop around for a $500 TV. You definitely want to shop around before you put $150,000 into an annuity.
Look into Vanguard or Fidelity, they might offer a lower fee structure. Do a baseline comparison with a minimum amount of extras to effectively compare your options.
Also, make sure to look into the ratings of the insurance company offering these annuities. You will likely want to stick with an immediate annuity if you choose to go this route because the numbers don’t make sense for a deferred annuity.
Big ERN would wait until 68 before committing to an annuity. If you are still interested in annuities at that point, then you can make your purchase then. At that age, an immediate annuity would be the way to go. Also, if you choose this path then you likely will want to delay Social Security as late as possible.
The deferred annuity is a riskier move because there is the unfortunate possibility that you could pass away before the payments start. You would not be able to pass along that money to your loved ones.
Alternatives To An Annuity
An annuity is a high cost and illiquid asset. Instead of an annuity, you could build a CD ladder or bond ladder that can carry you the first five to ten years into retirement. The fixed income of these CDs or bonds could help you sleep better at night.
A CD ladder is an alternative to tying up six figures of cash for many decades.
If he built a CD ladder, then Big ERN would create is around the average length of a stock market cycle. The rest of his assets would be invested 80/20 in equities/bonds.
Essentially the CD ladder would create a “glide path” into retirement. If you want to learn more about glide paths, then check out these articles on Early Retirement Now.
As a first approximation, just say you divide up the lump sum by the number of years and spread it out equally.
Once the glide path has completed, then hopefully you’ll have enough money left in stocks to run from there. If you want to learn more about building a CD ladder, then check out this resource.
The Golden Albatross
If your job offers a pension, then this book is a must-read. Easily learn how to calculate your pension’s objective value and weigh it against the subjective benefits of leaving for more fulfilling work.
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