February 7, 2012
Generating lifetime income is the ultimate goal of retirement planning. Why is it, then, that two of the most compelling mechanisms for doing just that are shunned by the investing public, despite overwhelming support from experts? I’m talking about immediate annuities and delayed claiming of Social Security, both of which are remarkably effective at securing retirement needs.
Why these options are so often overlooked – and how the government might steer investors toward better outcomes – will be the subject of this article.
The immediate annuity is the simplest of retirement products: Pay a fixed amount up front and receive a fixed monthly payment for life. A 66-year-old male could pay $100,000 and receive a lifetime income of $598.22 per month. One can also buy the product in a form that provides inflation protection. An up-front payment of $100,000 buys an initial monthly income of $446.95 that will increase each year based on the CPI, just like Social Security. (These rates come from Income Solutions®, a program offered by Hueler Companies, which sells annuities through Vanguard and other outlets.)
Both fixed and inflation-adjusted immediate annuities are well-suited to meet retirement income needs. Most individuals or couples planning for retirement find that Social Security will not provide enough to cover basic living expenses. Unless they also have a defined-benefit pension, they will need to use retirement savings to fill the gap between income and expenses. Buying an immediate annuity provides a way to fill the gap with guaranteed income. Buying the inflation-adjusted version is essentially like buying a larger Social Security benefit.
Immediate annuities have been endorsed by the experts. Last summer, the General Accounting Office (GAO) did a study on retirement income, including input from economists and retirement planning specialists, and one of the headline recommendations was that retirees "convert a portion of their savings into an income annuity to cover necessary expenses."
But the reality is different – few retirees purchase these products. Annual sales of immediate annuities total only about $7.5 billion, a level that the GAO estimated would support only about 0.25% of Americans’ retirement income needs.
There is a huge gap between what the experts recommend and what retirees actually do.
Economists have dubbed this state of affairs "the annuity puzzle." Numerous articles and papers have examined buyer behavior in an effort to identify the roadblocks to wider adoption of annuities. I have weighed in myself, arguing in a prior Advisor Perspectives article that the puzzle cannot be explained by examining buyer behavior alone. Seller incentives may be even more important, and immediate annuities pay lower commissions than other annuity products.
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