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Knock, Knock!
Who’s there? Just kidding. The Deaf person didn’t hear the knock. 🙂 Lame joke aside… I’m here to talk about ‘annuitizing’ your life. Could I have 15 minutes of your time? Let’s fast forward through some basics.
Traditional Annuities
They’re shilled by travelling salesmen pressing doorbells everywhere. 🙂 You agree to give the insurance company a huge lump sum, and in return, you’ll get monthly payments for a fixed duration or the rest of your life.
They come in all different flavors. Insurance companies want your business and they will package up their annuity products to meet your needs. I cannot cover them all in a single article. This is truly a rabbit hole should you decide to research further.
For the sake of simplicity, here’s the ‘Single Premium Immediate Annuity’ or SPIA for short. You agree to pay a lump sum, and in return, you get monthly payments. No life insurance on top of it. No stock market index, mutual fund products, or risk reduction features. One nice feature about SPIA’s is that they usually carry little or zero commissions.
Defined Benefit Pensions
If you can get this via your employment, then this is a sweet score! I have access to this with my employer, but it requires a hefty buy-in. Still struggling to decide on whether to buy-in or not. But, I digress…
A pension is similar to an annuity, except that there’s usually no lump sum payment up front. A person simply makes regular contributions via payroll deductions to the pension plan. And when the person leaves the employer, this person can start the pension plan monthly payments. Some pension plans even allow for a single large lump sum distribution instead.
One thing I like about pension plans is that they usually have a cost of living adjustment (COLA) built-in into the pension regime. This way, the periodic monthly payments will be adjusted for inflation on a yearly basis. This is a valuable feature of most pension plans.
The downside is that you need a certain number of years or a suitable retirement age (usually 55 years old) to qualify for pension plan monthly payments. You need to pay in over a long period of time. The pension plan may restrict your freedom of employment somewhat. (Golden handcuffs, indeed!)
Social Security Income
This is the OG of annuities. The GrandPappy of them all. It is a vital safety net for everyone. Basically, everyone funds the SS program via their payroll. In return, hopefully SS will be there when they retire or become disabled. There are too many exceptions/rules to delve into Social Security. Rather, I wish to focus on the annuity aspects of SS payments.
You make regular contributions from your payroll into the SS program. Then, if you become disabled or retire, you can elect to start SS payments. The SS payments you may receive is largely computed from your work history. You get SS payments every month for life. And the payments increase yearly, as COLA increases take effect.
So far, so good. What’s the downside with these annuities?
The Flip Side of Annuities
When you annuitize, you are giving up a huge chunk of your assets. You’ve lost control of this specific chunk forever. Since you opted to annuitize your life, it is a safe bet to say you’ve no longer are working. You will lose out on future earnings from your employment. And you will get a monthly income that is more or less fixed for the rest of your life.
Let’s take a personal example; I quit my job in the early aughts. I decided to sign up for Social Security as my 401(k) was miniscule and had no other income options. I was awarded SSDI based on my work history and disability. I got a monthly SSDI income of roughly $815 a month. My thinking was that I needed some secure monthly income as I reoriented my life towards something else.
Looking back, I can see that this could have been a huge mistake. I am grateful that I was able to obtain further education and change to a more rewarding and satisfying career. I was able to secure a great job as an educator and eventually stopped my SSDI monthly benefit.
Inflation Has Entered The Chat
I decided to do a what if? exercise. What if I decided that my monthly SSDI benefit was good enough? At that time, I was living with a relative and my overall costs of living were low enough. I could see myself living just on my monthly SSDI benefit for years to come. Yes, life would be difficult, but I could manage.
I used one of those inflation calculators and computed my theoretical monthly SSDI benefit amount today (as of 2022) – roughly $1,282 a month. That’s an monthly SSDI benefit amount with COLA’s included. Looking at my living situation today, there is no way I could continue living like this. I would have to move elsewhere or take in roommates.
The COLA’s simply do not keep pace with real-world inflation. Rents have skyrocketed past any stated COLA value imputed to rent. Food prices have shot up. Gas, too! From the perspective of the SS Trust and various pension plan providers, COLA’s are expensive. Even private insurers do not offer immediate annuities with COLA’s. I think they are incentivized to keep COLA’s artificially low as possible.
A Better Way?
It bears repeating; the monthly benefit is pretty much set, even when COLA’s are factored in. This arrangement may be good in the first few years, but may be unworkable later. The annuitant may be faced with unpleasant choices, i.e., return to the work force, cut back consumption, move elsewhere, or take in alternative living arrangements.
If you need to annuitize your life, it needs to be a part of your overall portfolio. My mistake back in the aughts was that I didn’t have anything and just collected SSDI benefits. (I even had negative net worth!) You need to have savings, stock/bond portfolio, and other income-generating assets.
If a monthly benefit is a part of your overall investment portfolio, then the inflation risk is minimized. Sure, your monthly benefit payments will continue to lose their purchasing power every year. But, if you have other assets to drawn upon, such as stocks, bonds, etc., then the inflation impact has been mitigated.
Conclusion
That said, if you are not able to work, retired, etc. You should go ahead and obtain a monthly benefit amount from your pension provider or Social Security. Obtaining an insurer-backed annuity requires thought and planning – I recommend you check Wade Pfau’s books on Amazon. You need to be prepared eventually for the impact of inflation that will occur to your monthly benefit.
Disclaimer
This post is for entertainment purposes only. No warranty, express or implied, is offered in this posting. No client relationship is created between the author and reader. Federal and state laws vary widely when it comes to personal finance. I am not offering investment advice. You are encouraged to read more information on personal finance by different authors to gain the education you may need to manage your finances.
