Canadian Finance Professor Moshe Milevsky (Are You A Stock Or A Bond?) has teamed up with CFP Alexandra Macqueen to write a book called Pensionize Your Nest Egg: How to Use Product Allocation to Create a Guaranteed Income for Life. I reviewed the second edition, published in 2015.
The book has a fancy cover, is well-edited and reasonably well-written. It covers an extremely important subject (how to turn part of your portfolio into a pension.) I had very high hopes for the book, and it is still useful for the right person, but it left me somewhat disappointed in what it did not cover.
For those for whom the title of the cover is not intuitive, the concept of pensionizing your nest egg means purchasing a pension, i.e. a Single Premium Immediate Annuity (SPIA), at about the time of retirement in order to put a floor under your retirement income. I agree with the authors that is a great idea for someone who does not have a pension and who does not have oodles of money (i.e. only needs a 2-3% withdrawal rate.) If you do not understand why it is a good idea to have some guaranteed income in retirement, this book is for you. If you've already got that concept down, well, you're probably not going to get a ton out of the book.
Issues With The Book
When I saw the subtitle, “How to Use Product Allocation to Create a Guaranteed Income For Life” I thought there would be some material in the book about cash value life insurance. Not so. While the authors were probably right to leave it out, there are thousands of life insurance agents who wish they would have put it in as another “product” to allocate to. In 
reality, the only products discussed in the book are these:
- A systematic withdrawal plan from a standard stock/bond portfolio
- Fixed annuities, either immediate or deferred
- Variable annuities with a guaranteed income rider
The authors discuss each of these, but really fail to make a convincing argument for including variable annuities in my opinion. Monday's post will explore more about product allocation and offer some specific criticisms about these VAs. But basically, in my view, the simpler the financial product, the better it is for the consumer. I prefer term life over permanent life. I prefer immediate annuities over deferred annuities. I prefer single premium annuities over multiple premium annuities. I prefer index funds over actively managed funds. I prefer flat annual retainer or hourly fees over commissions and AUM fees. The list goes on and on. When someone wants me to use something MORE complicated, they had better have an awfully strong argument for doing so. I didn't think Milevsky and Macqueen had one, and I'm not alone.
A variable annuity with a guaranteed income rider is certainly far more complicated than a SPIA. That means more costs, less transparency, more places for the insurance company to slip in some extra fees, and a lower likelihood of the consumer actually understanding what they are buying and being able to determine if it is a good deal. Milevsky and Macqueen describe these VAs as a hybrid between a traditional portfolio and a SPIA, giving you the best of both worlds. In my view, you're much more likely to be getting the worst of both worlds. If you want to annuitize (or “pensionize” in their apparently now trademarked words), then annuitize. If you don't, then don't. It's that simple. This idea of delaying the decision or leaving that option open seems like a measure that might leave the unsophisticated client feeling good, but actually worse off financially.
At the only point in the book where the costs of these VAs are mentioned they are described as about “1% a year.” Vanguard's VAs, which are run “at-cost,” run 0.45%-0.75% per year. In my experience, you will be unlikely to find a for-profit company willing to not only provide the VA structure, but also provide a significant income guarantee rider for 50 basis points more than Vanguard. More likely you'll be paying 2-3% for it, in which case your performance won't be even close to what a traditional portfolio will do. A quick shopping trip to annuityfyi.com reveals that the cost of the riders alone ranges from 0.35% to 1.5% with most being over 1%, and that's on what the site considers the “top riders” in the business.
At any rate, my big beef with VAs is that the VA itself is the wrong type of investing account most of the time. Aside from additional costs, you're converting long-term capital gains and qualified dividends into fully taxable income, and it takes a long time (decades) for the tax-deferment feature of a VA to make up for that, unless you are investing in a particularly tax-inefficient asset class. So now you're forced to buy something you don't really want in order to get something you do (the income rider.) I was disappointed to learn more about how these income riders work from a simple investopedia article than from Milevsky's entire book.
Again, more on these variable annuities and product allocation in the next post.
The Two Big Questions With Annuitizing
At any rate, if you, like me, have decided you're not really interested in these financially complex products, and really only want a SPIA, you really only have two questions to answer. The first is how much of your portfolio you should annuitize. The book tiptoes around this point a few times (I'm left with the impression that 20-40% of the portfolio would be wise), but never really comes out with any kind of a solid recommendation. The second is at what age you should annuitize. Again, the book is too vague for my taste, although if you read carefully, you'll see the correct answer is age 65-70.
Three Questions The Book Didn't Answer
There were three annuitizing questions I've wrestled with that the book didn't answer. The first is how to deal with inflation. Is it best to simply buy an inflation-indexed SPIA (and if so, which one) or is it best to buy a standard SPIA while allowing the traditional portfolio to provide the inflation protection, and perhaps buying additional SPIAs 5 or 10 years later? The second question is whether longevity insurance is a good idea. Longevity insurance is a deferred annuity. You purchase it at perhaps age 65, and it doesn't start paying out until age 85, if you get there. Like with term life insurance, many purchasers would never get paid anything for that purchase, reducing the cost of the insurance for everyone. The third question I wish he had addressed is whether to buy a single life annuity on each spouse or joint life annuities or some combination of annuities and permanent life insurance.
Company-Specific and State-Specific Annuity Risks Not Discussed
The book also never deals with the risks of the insurance company providing the annuity going under. Especially for doctors and other high income professionals, the statutory limits for the state insurance guarantee organizations seem highly relevant. For instance, if your state only guarantees $250K per annuity, perhaps it would be better to buy two $250K annuities from two separate companies rather than one $500K annuity.
I appreciate that the book brings out language that allows this subject to be discussed further- “Pensionize,” “Retirement Sustainability Quotient,” “Wealth to Needs Ratio,” and “Pension Income Gap.” I just wish it had done more with that language. The book ended up being too general where nitty-gritty was needed. If you weren't already convinced that a significant portion of your base retirement spending should come from Social Security, pensions, and annuities, this book will convince you. If you were looking for a practical walk through the world of annuitization, you may be left wanting.
Have you read the book? What did you think? How much of your portfolio do you expect to annuitize? What age(s) will you do it at? Would you consider longevity insurance? Do you own a VA with a guaranteed income rider? Why or why not? Comment below!
I’m only 50, but plan to retire in the next 10 years. While I expect to have enough assets based on a 3% SWR, I do anticipate annuitizing about 20-30% of my portfolio using SPIAs. In my case, the main driver is extreme longevity in my bloodlines (multiple centenarians). So assuming that I’m still in good health by age 70, I will start laddering SPIAs.
Of course, retirement planning is very fluid these days, as it seems likely that there will continue to be changes to Social Security, entitlements, health care, and taxes in the upcoming years.
I was told by vanguard not to annuities because of the size of my pension and personal accounts
Never read much where annuities were recommended
Annuities are sold not bought
Vanguard told you that because you have $5M and no need/desire for a guaranteed life-long income. While most annuities are products made to be sold, not bought, many smart people buy/recommend a SPIA to put a floor under your retirement income, especially if you’re on the edge as far as how much income you need from your portfolio. Read more here:
https://www.whitecoatinvestor.com/spia-the-good-annuity/
Far too many negatives about annuities to convince me otherwise as I want to leave money to my kids
What is the rate of return today?
Depends on when you die. Think of a SPIA as a way to spend your money, not make money. Returns to your life expectancy will be low, in the range of bonds. But your yield is higher, because it includes return of premium.
But you don’t buy a SPIA so much for the return as for the guarantee of never running out of money. Think of it as giving you permission to spend your money. On average, you’ll be better off investing rather than purchasing guarantees, but you don’t get the average return. You get what you, personally, get over your own, personal, investment period.
Great post, would love to hear more about SPIA vs. inflation protected SPIA. I would also like to hear more about companies that actually provide inflation protected SPIA as they are difficult to find just using google.
Not many of them, I agree. You can provide yourself some inflation protection by buying several SPIAs between 65 and 75. Your portfolio also provides some protection.
I won’t annuitize because we already have at least one inflation indexed pension- husband’s military and hopefully of course social security. However an inflation indexed account is such a good deal I have bought into both the UK NHS (I’ll see how to get that out when I hit 60) and if I ever do a few more years federal civil service, the FERS system. Hopefully I’ll get more from these, since they will have held my money many years, than the £4000 and $3000 put into each (FERS though not if I never do civil service work again). Haven’t yet seen an SPIA as cheap as those two systems hold out to be. They must be paying too much…
Excellent reasoning. Those with pensions are less likely to need/want a SPIA. That’s the reason my parents weren’t interested.
in regards to the 3 questions the book didnt answer…
Insurance companies dont have magical investments and thus they dont have a good way of predicting inflation either. Purchasing an inflation adjusted product just means less money at first (talking about SPIA).
Longevity insurance in my view isnt a good product for someone 65. Reason being is that there are few mortality credits at that point. Thus your “gains” are from the insurance company’s investments. You can do a lot better on your own over those 20 years and then purchase a SPIA if at that point you still want the guaranteed income. Only good reason to purchase one in my view is if the investment horizon is very short such as you are 68 and wanting income to start at age 70. Over those 2 years the investment part isnt a big deal. Insurance companies can pool risk and thus give mortality credits. You cant do that on your own but you can do all the rest on your own and much better.
We have already discussed here the lack of evidence supporting adding in permanent insurance. Both here and at Bogleheads, the only “evidence” shown has been non peer reviewed, industry sponsored with ridiculous assumptions such as very high fees for the non insurance investing and zero lapse rates for the permanent insurance but still getting illustrated results (completely unrealistic).
I have not read the book and from the review I guess I will not. I am wondering what the WCI thinks about QLACs. I read a fair amount of financial planning literature and this was okayed by the IRS about one year ago. Basically you can take up to $125000 to buy a deferred annuity (longevity insurance). You buy this at 60-65 and it starts paying at 80-85. The positive is money is not subject to RMDs. I have 1.5 mill in a SEP-IRA that is going to cause me a tax problem at 70.5. This concept seems to be one way to handle this along with roth conversions in my 60s (I am 58.5). It also seems a good alternative to LTC insurance to me. The negative is that these products are new and not inflation indexed. My thought on SPIAs is they can also make sense in extreme old age as one can no longer make good financial decisions.
same issues. if purchased at age 60 then you are missing out on 20-25 years of much better returns by NOT using an insurance company for your investment piece. Reason why SPIAs and term life insurance can “make sense” is they are much more “pure insurance” for what an insurance company actually has good data on and can actually pool risk on. Once you add in any investment component, makes less sense.
I guess the point is another way to get money out of a sep-ira to avoid bumping my tax rate in retirement. I will not need the rmd money. I have a net worth of 6.5 mill.
U r paying less taxes because of inferior returns. I’d rather pay more taxes.
You also have no need for longevity insurance because you are so wealthy. So now you’re buying unneeded insurance.
Longevity insurance is a reasonable thing to buy. I love that it is much cheaper than a SPIA. I don’t love how it adds additional complexity and makes it harder to shop for one. I don’t think I’d necessarily buy one mostly to lower RMDs though. It’s also not the same thing as LTC insurance. In fact, if you buy a QLAC that doesn’t pay until 85, and then need LTC at 75, you now have less money available to help pay for that.
Always thought to get a SPIA for fixed costs in retirement such as health insurance, rent, prop tax, food/travel etc and once that is taken care invest the rest a way your comfortable with and based on market that year decrease or increase travel, fun, other expenditures. Obviously its best to get an SPIA when interest rates are a bit higher, which are not now. I have a friends dad who got one in the 1980’s and still getting 18% …
Of course, as you get older your age matters much more than current interest rates as the mortality credits make up a larger portion of the payments.
This is a subject I have been thinking about, as I have a pension which I plan on ‘de-annuitizing’ in the form of a 5 year payout into an IRA from age 65 to 70. I calculate that in order to achieve an annual return that will equal the pension’s joint life payout, I need to earn 5% beginning at age 70, or 7% beginning at age 65, without touching the principle. I think those targets are achievable. Then I can have my cake and eat it too, in the form of more money for my heirs. Regardless, that money isn’t crucial to my needs, so I can tolerate a lower return for while.
I do understand that a SPIA is insurance, and that insurance comes at a price. It just doesn’t seem like you get that much for your money. If someone’s finances are really that precarious that they need a guarantee beyond Social Security, they should probably just work a little longer. In a worst case scenario, sell the house ( 2009 notwithstanding).
If the money is in a pension/defined benefit plan and is going into an IRA then just move it all at once as a lump sum. There is no taxes on the move. The 5 year payout doesnt really help anything in this case. Id decide what i plan to do with the money if it were me. Sounds like you dont need it and thus dont really have a plan. Id probably move it all into the ira and then roth convert over time but depends on what i was actually going to use the money for.
Sorry I wasn’t clear. That’s the fastest option I have for moving the money, a single lump sum isn’t an option with my plan. However, that option changes my potential return over the first five years, which is why I mentioned it. Thanks anyway for the suggestion. I agree with your other suggestions. I do plan on converting some low bracket money to my Roth from 65-70, although in my case due to other income in those years there isn’t much space for a low bracket Roth conversion. I do have a plan for that money, of course, but it’s not relevant to the topic of annuities.
My point was that I just don’t see where the benefits of a SPIA outweigh the costs, to the extent that I’m going the opposite route.
Your plan for the money absolutely would be relevant especially since most of this post is about lifetime payment annuities which means you arent giving it to your kids. Even if we werent talking about lifetime payouts, from a taxable account annuities dont get a step up basis at death if one were considering annuities with time specific payments or just deferred annuities in general. In your case, doesnt sound like you have any “real options” for transferring the money faster/better and it doesnt appear you need lifetime income (besides SS) nor want whatever lifetime options your pension offers.
All insurance products are NOT worth the expense unless you need or possibly want the insurance component. All insurance products are “better” if you can purchase just the insurance component. There just are too many costs. The SPIA is “worth it” IF you really really need that floor. Thats not likely to be common amongst those reading this blog. Still since it is pretty much just a pure insurance product without a bunch of other additional pretend benefits, some people may chose to purchase it for basic needs. Makes them feel better. If done correctly meaning first defer SS until age 70 and then get one later on as mortality credits rise, then its not that much of a waste. Some people have a slightly lower or higher % of bonds at any given age. While likely the folks with a higher percent of stocks are going to get a better return, sometimes the difference isnt that big a deal if it makes you happy or easier to sleep. Im personally thinking of a SPIA at age 80 IF my health is good for basic needs. I wouldnt consider any of the other “combo” income products bc the costs are even greater than with the SPIA and then in my opinion it changes the situation from not a big deal to just wasting money.
It’s only a waste on average. But for the individual, there’s a huge benefit. If you live a long time past average, you make out well. If you die early, you didn’t need the money anyway.
that kind of true but IF you live a long time then your investments very likely also had a long time to compound. This doesnt even consider the inflation piece. It provides a better deal if you live longer, im sure we both agree on that.
I understand that a SPIA should be seen as a form of insurance, but it seems to me that we don’t get much for our money here. If a SPIA is giving you a 5% annual payment, which includes return of principle, and we expect the market to return 7% in the coming years ( all nominal, since this SPIA is not inflation indexed ) we would be unlikely to do worse on our own. I don’t know how much of the SPIA is return of principle, but I’m guessing the actual earnings are probably about 3% or less. And unlike insurance products that protect against catastrophic events, such as fire, death, and disability, in this case if your investment income is dropping, it will be incremental and partial, not total, so you can adjust your spending accordingly, making the insurance aspect less attractive.
I’m really willing to be convinced, but it’s not happening. I guess in the end it’s just what will let you sleep better at night. For me, I think I’ll sleep better without the worries of dying early, inflation, and insurance company failure.
It’s not so much the average return, but when the returns come. You’re protecting yourself against sequence of returns risk.
The best way to think of a SPIA is a way to spend your money, not a way to make money.
“The best way to think of a SPIA is a way to spend your money, not a way to make money.”
That is a great description!
Anyone consider using income or assets from Ira to buy second to die life for possibly state or estate taxes and to leave money tax free to kids
Only if you want to leave less money for your kids and tie the payment to the timing of death.
Also stocks get a step up basis at death so income tax free isn’t so special.
In essence bad idea.
Sure, it’s a good solution for someone with an estate tax problem.
Just to be clear. Permanent insurance is still part of the estate. You have to put it in an irrevocable trust for it to be outside the estate and of course you can put other things in irrevocable trusts. It’s only advantage is guaranteed amount of cash to pay the estate tax.
?-If you leave your home to a child is that inherited at its present value? thanx
Yes.
Wait until we have another large financial crisis such as 2008-2009.
With the new laws prohibiting the government from bailing out “to big to fail” individual companies such as those that offer annuities, you will lose all you put down to buy the annuity.
Turn your portfolio into an annuity and it will be infinitely safer and less expensive.
I also read the book and agree with WCI. I took away that the optimal time to purchase an annuity (SPIA) is in the late 60’s tearily 70’s as one gets an improved “implied interest” from return of capital as well as mortality credits. I prefer SPIA’s over variable annuities, due to their simplicity. I am undecided with riders such as inflation protection, and joint spousal benefits. Individual state insurance commissioners have varying levels of insurance coverage in case of default. This can vary from $100k to $250k. The authors of the book introduce a concept of wealth to needs ratio (p121) where a ratio of 30 or greater does not require an annuity product. This translate to a withdrawal rate of 3.33% or less.
I struggle with various methods of funding a retirement. The classic model of Bengen’s 4% withdrawal rate to sustain 30 years’ of retirement, may need to be revised downward. Another attractive concept is that of building a “floor” to cover essential costs of living by funding with bond ladders or SPIA’s. Wade Pfau proposes utilizing SPIA’s in place of bonds, as this results in a shift to the right of the efficient investment frontier for any given stock/bond allocation.
http://retirementresearcher.com/an-efficient-frontier-for-retirement-income/