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!