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What’s the Safer Choice: An Annuity or Investing Your Retirement Funds?

Category: Financial and taxes in retirement

June 7, 2011 — Before you answer that question, consider this situation. Assume for a moment that you are age 65 and could have two retirement choices. In the first you get a portfolio that, conservatively managed, would generate $4,000 per month until it runs out of money at age 85, or $3,000/mo. until you run out of money at age 100. If you die before the age in each scenario, your heirs get whatever is left. With the second choice you get the same amount of money invested in an annuity that would also produce $4,000/mo. – except that you would get that income for as… long as you live. Your heirs get nothing, no matter when you die. Which option would you choose?

The New York Times ran an interesting article last Sunday on this situation, “Annuities and the Puzzle of Income“. The Times asked a similar question with the first option the same (lump sum managed to produce either $4,000 or $3,000). But to illustrate a point they offered a different hypothetical second option – a pension that pays $4,000 a month for the rest of your life, nothing upon death. Almost everyone took the pension option. The Times article was trying to make the point is that the very popular pension example is really the same as an annuity – a very unpopular choice. The illustration has merit in this day of disappearing defined benefit pension plans. With no pensions to comfort us in our old age, we have become the default managers of our retirement funds and options.

We think most people avoid the annuity and choose to manage our own money. A big reason for that is because we feel like we will get cheated if we die before our break even point: our heirs will get nothing with an annuity, but inherit the remaining principal if we manage the money. Other important reasons for the unpopularity of annuities are that they are complicated and hard to understand, and there has been some unscrupulous marketing in the past.
Annuities – So Unpopular
Richard Thaler, who wrote the article, wanted to call attention the undeserved unpopularity of annuities. He believes people fail to pay enough attention to the scenario described in our first paragraph – what happens when you run out of money at age 85. That is a dire situation, and not all that unpredictable. A man age 65 has a 30% chance of living to age 85, and a 20% chance of getting to age 90. Women have even longer life expectancies. His point: consider the annuity option – it’s probably the safer option and most like a pension. He also makes a good point for why annuities can manage to keep making payments after the typical investment portfolio runs out of money: if you are lucky enough to live to a very old age, the earlier deaths of people in the annuity pool provide the money for your extended benefits.

Comments: What would you do, and why. Please share your opinions in the Comments section below.

Posted by John Brady on June 7th, 2011


  1. Financial planning for retirement has never been easy. Maybe that’s why, after the Depression years, it was cash in the mattress for Grandma. Maybe she had a point, or lesson there. Banks fail. Insurance companies (annuity-fund holders) fail. Both are loaded with MBA’s who’ve been taught to maximize profits. Risks taken to create profits are only to their bonuses for performance; there’s but a light ‘fiduciary’ duty to protect the nestegg of the retiree. Should mismanagement (greed) or natural events (tornados, fires, hurricanes, etc.) drain an insurance company to ruin, the nest egg may evaporate to a few pennies on the dollar.
    Some may comment that the states often have a ‘failed insurance company’ fund which may offer partial reimbursement. But as with any current financial program within our income-stressed states, all are subject to a rewrite of ‘benefits’, or the state program defaulting as well.
    These are difficult times for retirement planning for a number of reasons. And the article gives alot of helpful information. But maybe I’ll follow Grandma’s example of me watching the cash in CDs or other self-managed ‘mattress’ investments, instead of turning it over to the financial mercenaries.

    by Cary Mebach — June 8, 2011

  2. Im not sure why they keep saying that the heirs get nothing. Our minor children were the beneficiaries of annuities in the 90s and I’m pretty sure the ones we purchased go to our sons when we die. We didn’t like them and still don’t understand them but have made them a PART of our retirement planning. I would NOT put ALL my monies in one but it is another vehicle for future income. Our financial mercenary is making us a nice little nest egg – nothing extravagant but we should be able to survive comfortably. I don’t have the energy to do it myself!
    That said – DO NOT name any minor children as beneficiaries!!! We had to go to court (which cost money) to become court appointed guardians for our own children when they inherited. That was followed by annual accountings and a petition to put the monies in mutual funds – all which cost us. Make plans with your sons or daughters for them to put the money away for college funds before hand. We appreciated the gesture – all three sons got through college with degrees and minimal loans but it would have been eaiser had it been set up differently.

    by Holly F — June 8, 2011

  3. Like most things in life – too much of anything is not good. Index Annuities do offer guaranteed income with the ability to pass along any remaining balance to your heirs at death. They are also protected investments for the purposes of qualifying for nursing home care. But they should only be a piece of the puzzle. No one should put all their savings into one type of investment or retirement vehicle. Every portfolio should contain a few sources of guaranteed income to give you a basis on which to plan.

    by Genie — June 8, 2011

  4. I’m going to hear Richard Thaler (author of the NY Times piece) speak this weekend. He writes, teaches (he’s a professor at the University of Chicago) and talks about “behavioral economics” – why humans act as we do – a melding of psychology and economics. I’d recommend his book – Nudge, as well as Freakonomics and Superfreakonomics by Dan Ariely.

    Much of the behavioral economists’ research can be applied to retirement decisions – concepts such as sunk cost, loss-aversion, anchors, too many choices being a negative thing…the list is extensive.

    Jan Cullinane, The New Retirement: The Ultimate Guide to the Rest of Your Life (Rodale)

    by Jan Cullinane — June 9, 2011

  5. I think that it’s bad for the retiree to just sit and wait for the Angel of Death to take their lives. I think they should find something to do. The elderly usually prefer farming. They can invest some of their money in a farm. This will keep them busy enough. And there are many other benefits for this.

    by Janett Brown — June 10, 2011

  6. Annuities can be a piece of the puzzle. But most do not increase with the cost of living/inflation. If they do you receive a dimished amount monthy. Stock funds, bond funds, IRAs/401ks, CDs and maybe annuities should be the standard for any retirement plan.

    by Erbfour — June 10, 2011

  7. Annuities are for those people who have trouble sleeping at night, worrying about whether they will have enough money to live out their life. However, with interest rates low at this time, the return you will be locked into on an annuity for a lifetime does not make it a viable investment. After all, their is no adjustment for inflation. Even your social security payments increase by an inflation factor. Find a reliable financial planner or gain some (actually a lot) of knowledge about investing in your future if you want to survive the “Golden Years” or they may not be so Golden.

    by Dale — June 11, 2011

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