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Cheat Sheet Q & A:
I enjoy your show and listen daily before work. I was wondering what you thought of annuities, either fixed or variable. I am 53 years old and saving for retirement, and thinking of transferring an IRA into an annuity to keep it safe from the volatility of the stock market. I haven't heard you talk about them on the show. If you don't recommend annuities, what other places would you recommend for retirement savings?
Bottom Line: I’ve received many questions regarding annuities of late and I’m going to tie them all together with today’s entry. There is a reason I haven’t addressed annuities previously. The investor and retirement planner in me doesn’t care for annuities generally. That’s not to say that they don’t make sense for you. I’ll begin by outlining my retirement plan best practices:
Those first two rules are designed to protect you from worst case scenarios in retirement. It’s terribly sad to see seniors live long healthy lives only to outlive their money and potentially become homeless. So with those principals established are annuities an option? Yes, they could be. The reason you haven’t heard me address annuities, is that I’ve always been intellectually conflicted by them. Why?
It begins by addressing what an annuity is? In its simplest form it’s an investment insurance product. You provide the company with your money and they promise a rate of return that’s reliable (either in a lump sum or payouts that could last for your entire retirement). So how is it that a company is able to take your investment dollars and pay out a return? They are profiting off of your investment dollars of course, and making more from your money on average than you are.
The average fixed rate annuity return is currently in the 3-4% range. Like all insurance companies they take the premiums and/or investment dollars you provide them with and invest them. Most commonly in equity investments (stocks) which ironically they often purport to protect you from.
The average rate of return in the stock market is over 8% per year. Paying out 3-4% per year enables even the average annuity company to potentially earn an average of 4-5% off of your money per year (and that’s if their investment advisors are only average). Intellectually I’d rather have a top notch investment advisor working on my behalf. A typical investment advisor fee is around 1% per year. That could lead to you maximizing the benefit of your investment dollars rather than enabling the annuity company to do so. Now there is a trade off of course. In years in which markets are lower you’re protected and will still receive your rate of promised return. If the rate of return is enough to meet your retirement objectives that might just make the annuity approach the right one for you. Now on the Fixed vs. Variable rate options.
I don’t recommend variable rate annuities period. Yes your upside potential can be higher with a variable rate of return but for retirement purposes it doesn’t make good sense. Having a varied income stream that is unpredictable is less than ideal when entering retirement. Some years you may have little or no income from that investment. Additionally variable rate annuities generally carry additional annual fees that fixed rate annuities don’t (often 1.5% per year) that can be higher than higher than obtaining an outstanding investment advisor.
So what have I done to construct retirement portfolios? I’ve constructed portfolios of equities that pay reliable, stable and often growing dividends along with occasionally bonds or other investments that provide income.
I track the income stream performance of those portfolios more than the stock price performance. In other words regardless of what the financial markets are doing at any given time, as long as the income produced by the retirement portfolio is stable or growing it’s on the right track…
Hopefully that’s helpful.
If you have a topic or question you’d like me to address email me: firstname.lastname@example.org
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