The most effective way to compare an annuity to alternative retirement income strategies is by examining the returns necessary in the alternative when we are planning for income. This entire discussion is centered around an income strategy, which is crucial to understand from the outset.
When planning for income, it’s important to include management fees in the evaluation of alternative retirement income investments because you will inevitably encounter these costs. To illustrate this point, I analyzed a scenario involving a 65-year-old couple who decide to fund an annuity with $100,000 and wish to start receiving income immediately. The calculations remain consistent regardless of the investment amount, ensuring the math is applicable to various financial situations.
At the time of this recording, a 65-year-old couple would receive $7,980 per year in guaranteed joint lifetime income from an A-rated company. This means they would receive this payment every single year, regardless of how long they live. It is crucial to note that these annuities are from reputable companies, not from lower-rated entities. Therefore, we must acknowledge that no other investment strategy can guarantee a lifetime income as annuities do.
While bonds, preferred stocks, and CDs might guarantee a certain interest rate for a specific period, they do not offer the assurance of lifetime income. Consequently, these also come with the concern of reinvestment risk. Furthermore, we must consider the management fee that is almost inevitable with alternative investments. I have used a conservative estimate of 1.5%. Some may argue their advisor charges only 1%, but in reality, there are numerous other fees—such as fund fees and 12B-1 fees—that can add up. Therefore, a 1.5% management fee is a fair assessment.
So, for a 65-year-old couple investing in an alternative strategy with a 1.5% management fee, they would need to achieve a consistent return of 9.75% every year without any losses to match the guaranteed income provided by an annuity. This required return is substantial and highlights the challenges of relying solely on retirement income alternatives to annuities.
And keep in mind that this isn’t preserving the principal in the alternative retirement income investment. The 9.75% return is merely to ensure they do not run out of money while drawing the same income as they would from an annuity.
Do you actually believe that is a reality somewhere? A 9.75 percent return every single year with no losses ever? It’s important to be realistic about the feasibility of achieving such high returns consistently over a long period.
To further illustrate this point, let’s consider the actuarial tables used by insurance companies to calculate these income guarantees. According to these tables, a 65-year-old couple has a significant likelihood of at least one partner living a long life. Specifically, one member of the couple has a 25% chance of living to the age of 98, and a 50% chance of living to the age of 94.
These statistics underscore the need for a reliable and sustainable retirement income strategy. Given these probabilities, the chances are high that one member of the couple will live into their mid-90s. Therefore, it’s crucial to ensure that the income stream does not run out before then.
In the podcast episode, I go pretty deep into the numbers for this case study, even showing what an alternative retirement income strategy would require JUST to get the couple to their 90s.
The bottom line:Â No other investment strategy can guarantee a lifetime income like an annuity. While other financial products like bonds, preferred stocks, and CDs can offer guaranteed interest rates for specific periods, they do not provide the assurance of lifetime income.
With an annuity, we can effectively eliminate concerns such as reinvestment risk. This guaranteed income stream is a unique feature that differentiates annuities from other investment vehicles. So right out of the gate, we have to accept the fact that no other investment strategy is going to guarantee you an income for the rest of your life.
If you have any questions or need help analyzing your ideas or current strategy, schedule an appointment on my calendar!
Podcast Episode 29: Annuities vs. Alternative Retirement Income Strategies
Download Episode 29: Annuities vs. Alternative Retirement Income Strategies on Apple Music