New Here? Get the Free Newsletter

Oblivious Investor offers a free newsletter providing tips on low-maintenance investing, tax planning, and retirement planning. Join over 21,000 email subscribers:

Articles are published Monday and Friday. You can unsubscribe at any time.

Implementing and Refining the “Spend Safely in Retirement Strategy”

A couple of years ago, we discussed a paper by Steve Vernon, Joe Tomlinson, and Wade Pfau, which looked at an assortment of retirement spending strategies and evaluated them based on several different criteria. The authors then put forth a strategy that they referred to as the “Spend Safely in Retirement Strategy,” which generally does a good job of satisfying the various (often competing) criteria.

Broadly speaking, the strategy involves creating two sources of retirement income:

  1. A safe floor of guaranteed lifetime income. The authors refer to these as “retirement paychecks.” This includes Social Security, pensions, and annuity income. These retirement paychecks would be used to cover the necessities like housing, utilities, food, transportation, medical care, etc.
  2. A liquid mutual fund portfolio, from which you pay yourself a “retirement bonus” — used for discretionary expenses. The level of spending from this portfolio varies with investment performance.

And again speaking broadly, the strategy has two steps:

  1. Implement the safe floor of income. Usually this means delaying Social Security if you are single or the higher earner in a married couple. Sometimes it means delaying for the lower earner in a married couple as well. And sometimes it means buying an annuity for additional guaranteed income.
  2. For the remainder of the portfolio (the “retirement bonus” portion), invest in a low-cost stock index fund or all-in-one fund (e.g., target-date fund, balanced fund, or LifeStrategy fund). Then use the IRS’s RMD tables to determine how much to spend from this part of the portfolio each year.

This strategy tends to work well as a rough-draft plan, for a few reasons:

  • Satisfying basic needs via guaranteed income minimizes your exposure to investment risk, longevity risk, investment mistakes, cognitive decline, fraud, or mistakes that might otherwise be made after the death of the more financially knowledgeable spouse.
  • To the extent that the guaranteed income is made up of Social Security, your exposure to inflation risk is minimized as well.
  • Using the RMD tables for discretionary spending accounts for the facts that it is wise to adjust spending based on investment performance, as well as the fact that you can safely spend a greater percentage of the portfolio per year the older you are.
  • The plan is reasonably simple and can in many cases be implemented without needing a financial advisor.

Real-World Implementation

But the basic, two-step plan described above (and in the original report) leaves an assortment of open questions. And when it comes time to actually implement the strategy in a real-world situation, you must come up with answers to those questions.

So I was happy to learn recently that the authors released a follow-up paper that addresses those real-life implementation questions one-by-one. (To be clear, the follow-up paper was published last year. I only recently learned about it though.)

The newer paper addresses questions such as:

  • How would you implement the RMD portion of income before the normal RMD age? (In brief: use the same life-expectancy-based calculation that the IRS uses. The authors provide a table with per-year spending percentages.)
  • How would you select an asset allocation for the RMD portion of the portfolio? (In brief: if your basic needs are completely satisfied by guaranteed sources of income, you can afford a stock-heavy allocation with remaining assets. Whether you want to use such an allocation is up to you and your preferences.)
  • How can you plan for the fact that the portfolio-funded level of spending has to vary as the level of income from other sources (e.g., work income or Social Security) changes over time? (In brief: create a “retirement transition fund” — a portion of the portfolio that has been carved off and invested in something like a bond ladder that will be used to fund the additional spending over the years in question.)
  • How can you plan for an uneven desired amount of total spending, such as a desire to front-load spending in the early years of retirement? (The authors propose a few options here. One such proposed method is to multiply the RMD for each year by a factor such as 1.25 or 1.5, which would increase spending early — and thereby result in less spending later, since you’d be spending a percentage of a portfolio that is smaller than it otherwise would have been. They run through a few examples of how such adjustments would have played out, given various assumptions.)

If you have the time, I’d encourage you to give the newer follow-up paper a read — or at least bookmark it for future reading. As I’ve written previously, I think the strategy that the authors describe is a great rough-draft approach to funding retirement spending (i.e., a sort of “cookie cutter” plan, which you can then adjust based on your own circumstances and preferences).

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Inflation-Adjusted Annuities No Longer Available: Now What?

A reader writes in, asking:

“I’ve read on Bogleheads that the last insurance company stopped selling annuities with a CPI adjustment, meaning that there’s no nowhere to buy an annuity that has inflation protection. What are the implications for somebody nearing retirement?”

It’s true: sometime in the second half of 2019 (I’m unsure of the exact date), Principal stopped offering inflation-adjusted lifetime annuities, so they’re now unavailable commercially at all, as the other insurance companies that had been offering them stopped a few years ago.

So what impact does this have on retirement planning?

The first thing that comes to mind is that delaying Social Security is now the only option at all to buy an inflation-adjusted lifetime annuity. But I’m not sure how much this actually changes any decision-making, because it was already the case that delaying Social Security was the most desirable option available for somebody looking for safe lifetime income (with the possible exception of the lower earner in a married couple).

If I personally were in that critical stage of “just about to retire or recently retired” my overall plan for funding retirement spending would have looked something like this, back when inflation-adjusted annuities were available:

  1. Higher earning spouse delays Social Security to age 70,
  2. Lower earning spouse delays Social Security until the point at which our safe income satisfies what we consider to be our “necessary” spending,
  3. Buy an inflation-adjusted lifetime annuity if we needed more safe income than what we would get from Social Security if both of us were already planning to file at age 70,
  4. Use primarily stocks for any remaining assets, since such assets would be intended for discretionary spending (i.e., non-necessities).

But, step #3 is no longer an option.

The primary options to consider as alternatives would be Treasury Inflation Protected Securities (TIPS), a nominal annuity (i.e., one with no cost of living adjustment), or some combination of the two.

This is probably a good time to point out that annuities with a fixed annual cost of living adjustment (e.g., 2% per year) are still available. But as we’ve discussed previously, that doesn’t really protect you from inflation. (And in fact they perform worse in inflationary scenarios than annuities without any COLA at all.)

Creating a TIPS ladder would work well in that it creates a predictable, inflation-protected source of spending. But it has the downside of leaving you exposed to longevity risk (e.g., you build a 30-year TIPS ladder but end up living beyond 30 years).

A nominal annuity eliminates longevity risk, but it leaves you with inflation risk.

As for me personally, I have to admit that if I were recently retired, or just about to retire, I’d have a hard time devoting a particularly large chunk of my retirement savings to a nominal lifetime annuity. But it’s worth pointing out that some researchers have found that nominal annuities tended to be a better deal than inflation-adjusted ones anyway (see Wade Pfau’s An Efficient Frontier for Retirement Income, or David Blanchett’s article in Advisor Perspectives last year, for example).

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Monte Carlo Analysis: Understanding What You’re Dealing With

A reader writes in, asking:

“What are the pros and cons of using the Monte Carlo tool for retirement planning?”

I wouldn’t focus so much on the pros and cons of Monte Carlo simulations, because there’s so much variation among how the Monte Carlo simulation concept is applied. Instead, I would focus on knowing what is going into (and coming out of) a specific Monte Carlo tool — or a study based on such.

For instance, what assumptions are being made about returns? Is the analysis using historical mean return as the mean return for each asset class? Or is it making a downward adjustment to account for today’s relatively low interest rates and high valuations? And what type of distribution is being assumed about returns? (For instance, many Monte Carlo tools assume a normal distribution for stock returns, which significantly understates their risk.) And what assumption is being made about reversion to the mean? That is, are the simulations assuming that several bad years in a row increases the likelihood that the next year is a good year? A set of simulations that does include such an assumption will have fewer very bad scenarios than a set of simulations that does not include such an assumption.

And what assumptions are being made about mortality? Are you (and your spouse, if married) assumed to live precisely to your life expectancy but no longer? Or is age at death one of the variables that the simulation is allowing to fluctuate? Or is mortality completely ignored, and the analysis is simply looking at a fixed length of time, such as 30 years?

And what assumptions are being made about spending? Most analyses don’t account for the possibility of spending shocks (i.e., an unanticipated and unavoidable large amount of spending in a given year). That’s fine, but it is important to recognize then that the analysis is leaving out one significant type of risk that exists in real life.

Overall point being, if you don’t know what assumptions are being made by the tool (or if you’re reading a study/article based on a set of simulations the writer performed and you don’t know what assumptions were made), it’s hard to get a lot of value out of the conclusions.

And what metrics are coming out of the simulations? For instance, if the simulations are regarding retirement strategies (i.e., a combination of spending decisions and asset allocation decisions — and possibly Social Security/tax decisions), does the tool give us something other than simply “likelihood of running out of money”? For instance, a few other metrics that are useful to know are:

  • In scenarios in which the portfolio is depleted, when is it depleted (e.g., does the average/median depletion occur 15 years into retirement or 25 years into retirement)?
  • In scenarios in which the portfolio is not depleted, what is the average/median bequest?
  • If the strategy allows spending to fluctuate based on market performance, how much does it end up fluctuating?

(See this excellent paper paper from Wade Pfau, Joe Tomlinson, and Steve Vernon for a more thorough discussion of useful metrics for evaluating retirement plans.)

In short, one Monte Carlo analysis can vary significantly from another. So I wouldn’t worry so much about the pros and cons of Monte Carlo analysis in general, but rather make sure you understand what you’re dealing with when you use a given Monte Carlo tool or read about a Monte Carlo-based study. What types of risk are being excluded from the analysis? And what information is being left out of the output?

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Getting out of the Market in Retirement?

A reader writes in, asking:

“An acquaintance emailed recently to ask input on her portfolio. She said her ultimate goal is to get out of the stock market. This woman and her husband are both retired and in their early 70s I think, with no extreme wealth. I assume they are comfortable enough but live simply and likely need to watch expenses.

When I asked what her concerns were about the market, she replied ‘political objections, volatility, ignorance..lack of control..risk aversion..Would consider investing in something I could believe in..’

Can you point me to any resources (articles, books, charts) that clearly explain why getting out of the market probably isn’t a good idea?

Any thoughts about how to respond to something like this?”

The idea of getting in and out of the stock market necessitates a belief that the market is predictable in the short-term. And it is not.

People are always looking for ways to predict short-term market movements — a reliable such method is basically the holy grail of investing. Of course, nobody ever finds it. For example, here is a well known study that looked at over 5,000 different trading rules and found that they “do not add value beyond what may be expected by chance.”

The best stock market predictor I am aware of is the concept of valuations (which can be measured in an assortment of related ways). It’s useful (though not at all perfect) for longer-term predictions, but essentially useless for short-term predictions. Here’s a recent article from Larry Swedroe on that topic.

But a separate question is whether a retiree might want to permanently get out of the stock market (i.e., not attempting to move back and forth between stocks and bonds at advantageous times, but rather simply electing to have a permanent 0% allocation to stocks).

And that isn’t necessarily such a bad idea, depending on circumstances. Many experts think it’s entirely reasonable (wise even) to prioritize building a sufficient pool of safe assets to fund retirement before allocating any part of a retirement-stage portfolio to stocks.

For example, the following two quotes come from Bill Bernstein’s book The Ages of the Investor.

“As one approaches the end of one’s human capital and hopefully has accumulated enough investment capital to safely offset the expense of retirement living, it makes little sense to put at risk the funds earmarked for retirement living expenses. In other words, once the game has been won by accumulating enough safe assets to retire on, it makes little sense to keep playing it, at least with the ‘number’: the pile of safe assets sufficient to directly provide or indirectly purchase an adequate lifetime income stream.”

“If, at any point, a bull market pushes your portfolio over the LMP [liability matching portfolio] ‘magic number’ of 20 to 25 times your annual cash-flow needs beyond Social Security and pensions, you’ve won the investing game. Why keep playing? Start bailing. After you’ve put enough TIPS, plain vanilla Treasuries, and CDs into your mental LMP, you’re free to start adding again to your RP [risk portfolio].”

Or as many people have quoted him since: “if you’ve won the game, why keep playing?”

When comparing various stock/bond allocations, this 2015 paper/article from Wade Pfau may be of interest. In that paper, we can see that once we look at horizons greater than 20 years, it becomes clear that having some stocks is helpful relative to an all-bond portfolio, in the sense that those stocks will reduce the likelihood of running out of money.

But there are important caveats:

  • Probability of portfolio depletion is not the only relevant metric here. In the failure scenarios, we don’t just care that a failure occurred (i.e., portfolio was depleted), we want to know when it occurred. That is, in the scenarios in which the portfolio is depleted prior to death, it makes a big difference to the retiree whether the depletion occurred 15 years into retirement or 25 years into retirement. And a risky allocation can result in depleting the portfolio sooner than would be the case with a super safe allocation.
  • If the goal is just to maximize spending over their lifetimes in as safe a way as possible, a boring (likely inflation-adjusted) joint lifetime annuity is probably the best tool for the job rather than stocks.

With regard to that first caveat, this paper from Joe Tomlinson may be of interest.

Key questions that could help determine how much of their portfolio should be annuitized (and how to allocate the non-annuitized portfolio) would be:

  1. What type of health are they in (i.e., what type of planning horizon is necessary)?
  2. How much (what percentage of the portfolio) is the couple hoping to spend per year?
  3. How flexible is the answer to #2?
  4. How strong is their “bequest motive” (i.e., desire to leave behind money to heirs)?

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

A Rough, General-Purpose Retirement Plan

For a few years now I’ve been talking about a basic “cookie cutter” sort of Social Security plan (i.e., an approach that works reasonably well in most cases) and about factors that would suggest that a person or couple should make adjustments to such a plan.

I’ve been thinking recently that it might be fun/useful to extend that same type of thinking to a broader range of retirement planning areas. So here’s my attempt to do just that.

And just to be super clear about something that is hopefully obvious given the brevity of this article: there are many, many cases in which the suggestions below would not be the best approach for an actual person, due to their personal circumstances. I have mentioned some of the circumstances that would suggest alternative approaches, but in each of the topics below there are plenty of potential factors that I have not mentioned.

Social Security

If you’re single, delay claiming benefits until somewhere in the 68-70 range. If you’re married, the spouse with the higher earnings record files at 70, and the spouse with the lower earnings record files as early as possible (62 and 1 month in most cases).

Some of the circumstances that would suggest an adjustment to such a strategy include:

  • You are single and are in very poor health (in which case you should file earlier),
  • You are married and both spouses are in good health (lower earner should file somewhat later) or very bad health (higher earner should file somewhat earlier),
  • The lower earning spouse is working beyond age 62 (in which case they should usually wait to file until they quit work or have reached full retirement age),
  • You have minor children or adult disabled children (may be a reason for the higher earner to file earlier), or
  • You or your spouse will be receiving a government pension (could affect the decision in either direction).

Tax Planning (Retirement Account Distributions)

Try to “smooth out” your taxable income over the course of your retirement.

For example, if you retire at age 60 but don’t plan to take Social Security until 70, you have a 10-year window during which your income will be markedly lower than it has been in the past (because you’re retired) and lower than it will be in the future (because neither Social Security nor RMDs have started yet). So it’s likely wise to spend from tax-deferred accounts and likely do some Roth conversions during that 10-year window — with the goal being to shift income from future years (which would otherwise be higher-income years) into the current lower-income years (i.e., smoothing out your taxable income over time).

To be clear, that’s somewhat of a simplification. In reality you want to try to smooth your marginal tax rate — rather than taxable income — over time. That is, if your marginal tax rate now is lower than it will be later, try to shift income from future years into this year. (And it’s key to remember that your marginal tax rate is often quite different from your tax bracket, especially during retirement.)

Spending Rate

Firstly, set aside (in something safe, such as a short-term bond fund) enough money to fund any Social Security delay that will be happening. For example, if you are forgoing $150,000 of Social Security benefits by waiting from 62 until 70, set aside $150,000 in something safe in order to fund the extra spending necessary until age 70. Then, from the remainder of the portfolio, use the IRS RMD table (i.e., “Uniform Lifetime table“) to calculate a spending amount each year. And for years prior to 70, use the same overall age-based approach — with a lower rate of spending the younger you are.

We discussed this overall strategy last year, and you can find a paper here from Steve Vernon that discusses it in more depth. Broadly speaking though, basing spending on RMD percentages has two main advantages:

  • It adjusts spending over time based on portfolio performance, rather than spending a fixed inflation-adjusted amount each year of retirement, and
  • It adjusts spending based on your remaining life expectancy (i.e., it accounts for the fact that you can afford to spend a larger percentage of your portfolio per year when you are age 90 than when you’re age 60).

Circumstances that could suggest an adjustment to such a strategy:

  • You have an unusually long or short life expectancy,
  • Real interest rates are very high or very low,
  • Market valuations are very high or very low, or
  • Your portfolio makes up a relatively small part of your overall financial picture. (For instance if you have a government pension that covers all of your major needs, you can spend from your portfolio at a faster rate, if you so desire — because, unlike many retirees, you would not be in an especially bad situation if you depleted, or nearly depleted, your portfolio.)

Asset Allocation

There’s a huge range of asset allocations that could be reasonable for a retirement portfolio (i.e., the portfolio that does not include the fixed sum that is set aside for the purpose of delaying Social Security).

  • Want a 70% stock, 30% bond portfolio? Go for it.
  • Prefer a 30% stock, 70% bond portfolio? That’s cool too.
  • Want to exclude international stocks completely? Sure.
  • Prefer to have a heftier 30-50% international stock allocation? Knock yourself out.
  • Want to use only Treasury bonds for your fixed-income holdings? That’s reasonable.
  • Prefer to use a “total bond” fund instead? Super.

One key point — something that surprises many people — is that a higher stock allocation (or any allocation decision that shifts things toward more risk and more expected return) tends to result in only a relatively modest increase in the amount you can safely spend per year early in retirement. The higher expected returns are, to a significant extent, offset by the increased unpredictability. (For related reading, here’s Wade Pfau’s 2018 update to the Trinity Study — though of course that has to be considered with all the usual caveats about using historical returns to try to plan for the future.)

The more dramatic impacts of higher-risk, higher-expected return allocations are that they tend to mean more volatility (duh) and a greater chance of either a) leaving a large sum to your heirs or b) increasing spending later in retirement.

Insurance

If you are retired, you probably don’t need life insurance, as it’s likely that you have no dependents anymore. One noteworthy case in which you likely would want life insurance as a retiree would be if you still have minor children or if you have an adult disabled child. Another case in which a retiree might want life insurance is if they’re married and a major portion of their total income comes from a pension with a small survivor benefit amount.

If you are retired you almost certainly don’t need disability insurance. Disability insurance exists to replace income that you’d be unable to earn if you’re unable to work. But if you aren’t working anyway (i.e., you’re retired), you don’t need it.

Health insurance is a must-have. If retiring prior to Medicare eligibility, make sure you have a very specific, well-researched plan for health insurance. The Affordable Care Act makes it possible to get insurance, but make sure you have a good idea of the cost, and make sure you have researched plans to know what they cover — though of course it’s subject to change every year.

Long-term care insurance is a genuine predicament, regardless of what decision you make. If you don’t buy it, you could potentially be on the hook for huge costs. If you do buy it, you might be faced with premiums that rise rapidly and unpredictably. (Other related products to consider are “hybrid” long-term care annuities or long-term care life insurance, but those both have their problems as well.)

Having proper liability insurance (including an umbrella policy, in many cases) continues to be important. In fact, it’s likely more important than at any prior point, given that during retirement you are more dependent on maintaining your assets than you are at earlier stages.

As far as longevity risk (i.e., the risk of outliving your money, because you live well beyond your life expectancy), lifetime annuities (whether immediate or deferred) can provide protection. The downside is that they reduce your liquidity/flexibility, reduce the amount you’re likely to leave to your heirs, and usually come with significant inflation risk. Delaying Social Security provides the same type of protection at a much better cost — and with an inflation adjustment. So purchasing such an annuity generally only makes sense if you are already age 70 and still want additional longevity protection (or if you are already planning to delay Social Security to 70 and still want additional longevity protection).

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."

Lifetime Annuity: Avoid the Period Certain

A reader writes in, asking:

“Can you please write an article about SPIAs with guarantees of a minimum payout period?”

For those who are unfamiliar, a single premium immediate lifetime annuity (sometimes referred to as a SPIA) is an insurance product where you give the insurance company a lump sum of money (which you cannot get back) and in exchange the insurance company promises to pay you a certain amount of money every month for the rest of your life. In short, it’s a pension that you purchase from an insurance company.

Such annuities are useful because they protect against longevity risk (i.e., the financial risk that comes from living very long and therefore having to pay for a very long retirement).

One thing that stops many people from buying such annuities, however, is the fear that they’ll die soon after purchasing the annuity. For example, if you spend $100,000 on a SPIA that pays you $6,000 per year for the rest of your life, but the rest of your life only turns out to be a couple of years, you will have had a net loss of $88,000.

And that’s why insurance companies offer the option to purchase a “period certain,” whereby the insurance company promises to pay out for at least a given period of time. For example, for a lifetime annuity with a 10-year period certain, the insurance company promises to pay out for the rest of your life but no less than 10 years. (So if you died after two years, the insurance company would continue to make payments for another 8 years to your named beneficiary.)

Of course, because of this guarantee, a lifetime annuity with a period certain will cost more (i.e., will require a higher premium) for a given level of income than you would have to pay for a lifetime annuity without a period certain.

Why a Period Certain Is a Bad Deal

The whole point of insurance is risk pooling. For example, consider 1,000 people who purchase homeowners insurance from a given insurance company. Most of those people will not have their homes destroyed by a fire or a tornado. And that fact — the fact that the insurance company is going to collect money from all of those people without ultimately having to make a huge payout to them — is how the insurance company can afford to make a huge payout to the person whose home is destroyed by a fire.

A key point, however, is that for every dollar that an insurance company receives in premiums, they keep some part of it to cover their administrative costs and to provide profit to shareholders. So only some of the money spent on premiums ultimately goes to pay for claims to people purchasing the insurance product in question. So in general it is unwise to purchase an insurance product unless:

  1. There is risk pooling going on (i.e., many people are going to ultimately get a bad deal so that some people can get a very good deal), and
  2. You need such risk pooling (i.e., you cannot reasonably afford to cover this risk out of pocket on your own).

With a lifetime annuity, risk pooling occurs because some annuitants will die prior to reaching their life expectancy (i.e., the insurance company will pay less than the “expected” amount to those people — which is how it can afford to pay more than the “expected” amount to the people who live beyond their life expectancy).

But if the insurance company is providing a period certain, it knows it must pay out for that entire period. In other words, the annuity then offers no risk pooling for that period. Instead, what’s occurring for that period is just the insurance company gradually paying your money back to you — after taking a piece off the top for profit and expenses — without any actual net insurance effect.

In most cases you would be better off investing the money yourself for the period certain, then buying the annuity at the end of that period. (Of note: if you would be considering a 10-year period certain, don’t buy 10-year bonds. Instead buy longer-term bonds to offset the interest rate risk that you face with the annuity purchase. See this prior article and this Bogleheads discussion for a more thorough explanation.)

Retiring Soon? Pick Up a Copy of My Book:

Can I Retire Cover

Can I Retire? Managing a Retirement Portfolio Explained in 100 Pages or Less

Topics Covered in the Book:
  • How to calculate how much you’ll need saved before you can retire,
  • How to minimize the risk of outliving your money,
  • How to choose which accounts (Roth vs. traditional IRA vs. taxable) to withdraw from each year,
  • Click here to see the full list.

A Testimonial from a Reader on Amazon:

"Hands down the best overview of what it takes to truly retire that I've ever read. In jargon free English, this gem of a book nails the key issues."
Disclaimer: By using this site, you explicitly agree to its Terms of Use and agree not to hold Simple Subjects, LLC or any of its members liable in any way for damages arising from decisions you make based on the information made available on this site. I am not a financial or investment advisor, and the information on this site is for informational and entertainment purposes only and does not constitute financial advice.

Copyright 2020 Simple Subjects, LLC - All rights reserved. To be clear: This means that, aside from small quotations, the material on this site may not be republished elsewhere without my express permission. Terms of Use and Privacy Policy

My new Social Security calculator: Open Social Security