Should You Annuitize Some of Your Retirement Assets?

Everyone has found out how extreme stock market volatility can be! One way to avoid the highs and lows of stock investment and to obtain a lifetime benefit, is to use income annuities.

As an example, suppose you have $1,000,000 of investments in a balanced portfolio starting at the stock market peak Oct 7, 2007. At the bottom on March 9, 2009, your portfolio is worth a lot less, about $420,000 less*. Even if the stock market fully recovers (it always has), you might not want to experience such a emotionally wrenching drop again.

A reasonable approach is to purchase a lifetime income annuity so that your Social Security income and the annuity income cover you basic living expenses. Let's assume that takes $500,000 for the annuity. You can see about how much an annuity pays by going to:
http://www.incomesolutions.com/AnnuityCalculator.asp
For a female age 65, the annuity pays $38,280. The apparent return is 7.7%. Not bad for guaranteed income for life. The income stream will be very comforting in the next bear market.

If you kept the $500,000 invested in a balanced portfolio, a safe withdrawal rate is about 4% which is $20,000. The annuity pays a lot more!

It seems like a no-brainer to go with the lifetime income annuity. But what are the disadvantages?

1. You income is dependent on the ongoing success of the underlying insurance company.
2. Once you give the $500,000 to the insurance company, you cannot get it back. If you die the next day, your heirs get nothing. If you need more cash for an emergency, the insurance company will not give it to you. You or your heirs can get everything that is left in the investment portfolio.
3. The income stream is not inflation adjusted. The withdrawal rate from the investment portfolio is inflation adjusted. At 3% inflation, the withdrawal from the investment portfolio is projected to exceed the income from the annuity in year 23 (your age 88). So if you live a long time, inflation could become a problem. However, the insurance company guarantees to pay the income for your lifetime no matter how long. The investment porfolio provides no such guarantee.
4. There is no upside potential with the annuity while the investment portfolio could do better than expected permitting larger withdrawals than we projected. Of course the investment portfolio could do worse.

Should you annuitize? As always, "it depends" on your need for stability, your need to provide an inheritance, your life expectancy, and your concern about inflation.

*using DGSIX (DFA Global 60/40) as a proxy for a balanced portfolio. It was down -42% from 10-7-07 to 3-9-09: