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Lucky old grandma. When she retired all those years ago, her income security needs were pretty simple. She could convert a large part of her lump-sum savings into a guaranteed steady income stream for life by purchasing a single premium immediate annuity.
Today? You’re right out of luck.
Such annuities continue to be offered by insurance companies, but the monthly payouts they generate has collapsed to the lowest levels on record, according to ImmediateAnnuities.com.
In 2000, a 65-year old woman with $100,000 in savings could buy an annuity guaranteeing her income of $744 a month.
The equivalent figure now? Just $469.
This level is actually less than half that in 1990, according to Immediate Annuities’ archives.
(The role of inflation is irrelevant in comparing the numbers, because these are payout rates per dollar purchased.)
“They’re a function of interest rates,” says Rob DeHollander, a financial adviser with DeHollander & Janse Financial Group in Greenville, S.C. “I remember when you could go to the bank and get a CD [certificate of deposit] that was paying 5% or 6%, but those rates are long gone.” If you buy a single premium annuity here, he says, “you’re locking in rates that are as low as they’ve ever been.”
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“For people who want steady income, and want safety, annuities have usually been pretty good,”” says Chris Chen, a planner with Insight Financial Strategists in Newton, Mass. “But with interest rates pushing to zero, there isn’t that much advantage any more. You’re locking away your money and you’re not getting any return.”
Single premium annuities were a neat insurance solution to the problem facing every retiree.
Each of us wants to make sure we don’t outlive our money and die in penury. But we don’t know how long we’re going to live. Insurance companies, by pooling the savings of many clients, were able to pay out guaranteed monthly incomes based on average longevity.
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The problem is that the money paid in has to be invested by the insurance company, generally in a portfolio of conservative bonds. In 1990, the yield or interest rate on top quality, AAA-rated corporate bonds was nearly 10%.
Today, it’s 3%.
Collapsing inflation and low interest rates have brought many good things for society, but for savers they’ve been a tough pill to swallow.
It’s possible to find more complex, non-insurance products that attempt to square the circle. Investment banks, for example, frequently offer products which offer you some gains if the stock market rises in return for protection if it falls. But experts will say that as a rule, the more complex the financial product, the worse a deal it is likely to be. Complex products typically hide a lot of costs. (Some cynics suggest that’s the point.)
Many planners instead advise clients heading into retirement to use a strategy they call “time segmentation,” or “bucketing.”
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You split your savings into the money you’re going to need in the next five years, and the money you’ll need after that. The short-term money you park in low-rate but low-risk vehicles like certificates of deposit or short term bonds. “That money, you don’t have to worry about,” says Chen.
The rest, he says, you can invest more aggressively in stocks. That’s because although the stock market returns can be very volatile over the short-term — as we have just seen — the longer term returns tend to be better and less volatile. “I think you can get a decent return in equities over 20 years,” says DeHollander. “Twenty months, I don’t know.”
And it’s a strategy that also fits with some of the advice from the life insurance industry itself.
Todd Geising, annuity research director for the Secure Retirement Institute, an arm of the industry’s Life Insurance Marketing and Research Association, says one workaround for the current annuity crunch is hold off buying.
That’s not just because interest rates might rise (they might, or they might not, he notes).
It’s because the older you are when you buy an annuity, the less the payouts depend on interest rates, and the more they depend on your remaining life expectancy.
To understand this, consider an extreme example: If a group of people aged 100 buy single premium life annuities, the interest earned on the invested money won’t matter that much, because it won’t be invested for long. They’re simply pooling their longevity risk, so that the ones who die at 101 are effectively subsidizing those who live to 105.
Geising says the average buyer of a single premium immediate annuity these days is 72, and many are still older.
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So if you’re nearing retirement and you’re looking at collapsing annuity payout rates, you have an alternative strategy. Park some money in cash or short-term bonds to carry you through to your early 70s. Invest the rest in a more aggressive portfolio to try to earn a reasonable return. Then, when you make it to your early 70s, think about using that portfolio to buy an annuity. You’ll have more money, and you’ll get a much better income.
