If I were turning 65 and retiring today, I could lock in a 5.5% annual return on my savings, plus a reasonable inflation adjustment each year, to last me for the rest of my natural life.
But how long that opportunity is going to last is another matter.
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If I had to bet on it, I’d say: Not long.
That rate of return is what you can still get right now from the annuities market for a single-premium immediate annuity, or SPIA. An SPIA is an insurance product that converts a pile of savings into a stream of income that will last until you die, whether it’s in four years or 40.
Think of it like an old-fashioned pension that you can buy off the shelf.
Actually, if you are 65 you can buy an immediate annuity right now that pays around a 7.5% rate of interest, meaning if you have $100,000 you can generate a guaranteed income of around $620 a month. (It’s a little more if you’re a man, because they tend to die earlier, and a little less per month if you’re a woman, because they tend to live longer.)
But that comes without any annual adjustment, which leaves you wide open to the ravages of inflation. As we’ve just been reminded, this can be hefty.
This is why, when I look at SPIAs, I typically look at those that offer a 3% annual increase. This beats the Federal Reserve’s 2% inflation target by enough to offer at least some margin of safety — just in case, you know, the Fed suddenly loses control of prices.
And these annuities with a 3% annual bump are currently paying 5.5%, for men and women.
Someone with, say, $300,000 in retirement savings could be sure of a retirement income of $1,400 per month for life — plus an extra 3% every year.
To put this in context, these income levels are about 25% more than they were for someone who bought a similar annuity just three years ago, before the big surge in inflation and interest rates.
Annuity rates are closely related to the interest rates on Treasury bonds and top-rated investment-grade corporate bonds. My fear, or worry, is that today’s annuity rates are going to plunge with bond rates.
Wall Street already thinks the Fed’s Big Pivot is finally here. The Street expects the Fed to cut short-term rates by a quarter or half a percentage point next month, and by a full percentage point or more by the end of the year. It sees the Fed cutting rates by 2 points over the next 12 months.
That doesn’t just affect short-term rates. The interest rate on 10-year Treasury notes BX:TMUBMUSD10Y, which was 4.3% a month ago, is now down to 3.8%. The Fed needs it lower, too, to free up the housing market.
That’s good news for home buyers, but not so good for those who need retirement income.
Christine Benz, director of personal finance at Morningstar and author of the new book “How To Retire,” tells me that single-premium immediate annuities are less popular than you’d expect.
“What’s interesting and disheartening is that despite all of the enthusiasm for them in academic circles, they enjoy very little uptake in the real world,” she says. (One reason, she notes, may be the lack of a perfect inflation-protection component. Picking an annual percentage increase, such as 3%, is about the best you can do.)
She’s right, of course.
SIPA sales totaled just $13.3 billion last year, or less than 4% of total annuity sales. Much of the rest consisted of high-fee investment products that are typically better for the person selling them than the client.
When it comes to retirement, the No. 1 money challenge is how to squeeze the maximum amount of secure income out of your savings. Nothing does this like a SPIA, because of what they call “the mortality credits.” This is “insurance-ese” for the simple fact that you get your money for as long as you live but no longer.
Some people will die early. Some people will live to 100.
And the only way annuities can maximize your lifetime income stream is because the people who die early subsidize those who live to 100 (or longer). It’s an insurance product.
Annuities are hardly perfect. When you buy one, you lose the benefits of “liquidity.” You exchange your pile of money for an income stream. You also take some theoretical risk on the insurance company surviving, although if you stick to insurance companies with strong credit ratings you should be OK. Insurance companies and their products have typically been very heavily regulated, especially at the state level.
On the other hand, while new retirees shun annuities, they are grappling with the challenge of generating enough income out of their savings. The benchmark figure in the personal-finance industry has traditionally been the so-called 4% rule — meaning that if you hold a balanced portfolio of stocks and bonds, you should be OK in retirement if you start out withdrawing just 4% of your portfolio in the first year, and then raise the amount each year in line with inflation.
Historical data on stocks, bonds and inflation suggest that someone who does that runs a very small risk of outliving their money, at least so long as they don’t live longer than about 30 or 35 years.
Meanwhile, if you are 65 you can buy an annuity that lets you withdraw 4.4% in your first year and then raise it a thumping 5% a year, every year. And unless the insurance company fails, there is zero risk you will outlive your money.
Make of that what you will.
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