As I’ve mentioned before, if I were retiring today, my strategy would be to lock in a sufficient level of safe, inflation-adjusted income to satisfy our basic spending needs. This would be done first by delaying Social Security until age 70 (with a few years of free spousal benefits in the meantime) and, if that doesn’t provide enough income, by buying inflation-adjusted lifetime annuities to cover the balance.
One key point to understand about that plan, however, is that it is largely influenced by the fact that my wife and I have no kids and care very little about how much money we leave behind when we die.
For those with a stronger bequest motive (i.e., desire to leave behind a pile of money) and a sufficiently large portfolio, it sometimes makes sense for annuitization to be “plan B” rather than “plan A.” That is:
- Begin retirement with a typical withdrawal strategy from a typical stock/bond retirement portfolio.
- Keep an eye on how your portfolio value compares to the amount needed to purchase an annuity that would pay the desired level of income for the rest of your life.
- Then, if things go poorly and your portfolio falls to the point where it can just barely fund the purchase of such an annuity, you can buy the annuity at that point in order to prevent things from getting any worse.
The upside of such a strategy is that it gives you the chance to experience a higher level of income (and/or leave behind a larger sum to your heirs) if your portfolio performs well. In addition, like laddering annuity purchases, it leaves more to your heirs if you die early.
How About an Example?
Claire is 65 years old. Her husband is deceased, and she has two adult children to whom she would like to leave something when she dies. She wants to be absolutely sure that her income does not fall below $35,000 per year.
Based on her earnings record, Claire expects Social Security to provide $18,000 of income. She has no pension. In other words, Claire wants her portfolio to satisfy at least $17,000 of spending per year.
As I write this, the highest quote for an inflation-adjusted lifetime annuity for a single 65-year-old female is 4.25%. In other words, it would take exactly $400,000 for Claire to be able to lock in $17,000 of annual inflation-adjusted income with an annuity (thereby giving her the $35,000 total she desires).
If Claire’s portfolio is, say, $600,000, she has no need to annuitize anything right this minute. (And in fact there’s a good chance she’ll never have to annuitize anything at all.) She can invest in a typical stock/bond retirement portfolio and use a typical withdrawal rate strategy. If Claire’s portfolio performs poorly and declines to the point at which she barely has enough to lock in her desired level of spending, she can annuitize at that time.
This strategy requires that you keep a close eye on things. Not only do you have to watch your portfolio, you also have to regularly get new quotes for annuities. Otherwise, if interest rates decline and you fail to notice, you could find yourself in a situation in which your portfolio is no longer sufficient to safely provide the desired level of income.
In addition, if implementing such a plan, it’s important to go ahead and annuitize when there would still be some liquid investments left over to serve as a source of cash for satisfying unpredictable expenses (i.e., an “emergency fund”).
Finally, it’s worth noting that the psychological difficulty in implementing such a backup plan, should it become necessary, is likely to be immense. If you’re the type who finds annuitizing to be an undesirable idea even when you’d have a decent-sized portfolio left over, it’s going to feel even less desirable when:
- The necessary annuity will consume most of your net worth, and
- Buying such an annuity will require selling out of your portfolio immediately after a market decline.