• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar

Jon Luskin, CFP® ● Hourly Advice for Do-It-Yourself Investors

Hourly Advice for Do-It-Yourself Investors

  • Home
  • About
  • Work with Jon
  • Blog
  • Bogleheads® Live
  • Publications
  • Speaking
  • Reading List

Annuity Rule of Thumb

October 23, 2017 By Jon Luskin Leave a Comment

As a fee-only financial adviser and fiduciary, much of what I do at Define Financial involves unwinding new clients from the garbage they were previously sold by commissioned salespeople. (Naturally, I have a strong opinion about this!)  Sometimes, this means trying to figure out how to get a client out of a non-traded REIT. Other times, it means figuring out if it makes any sense to keep a variable universal life insurance policy in place.

Recently, I had the opportunity to analyze several annuities for different clients. My conclusions yielded what may be a helpful rule of thumb for analyzing future annuities:

“Annuitize for today. Surrender for tomorrow.”

Surrender for Tomorrow

As a fee-only financial planner, I live in a world where annuities are not only frowned on, but actually made fun of. That is, when hanging out with a group of like-minded fee-only fiduciaries, a joke will be made more than once about what poor financial products annuities are for clients. (Usually, it’s me making the joke!)

And the humorous critique is justified. Because of either the high fees or the limits on growth, it usually makes little sense to put money into an annuity. This idea is even more applicable as the complexity of the annuity product increases. That is, while a single premium immediate annuity (SPIA) may make sense in certain circumstances (because of the low fees involved), more complex annuities such as variable annuities, are rarely a helpful solution.

For this reason, the common approach taken by fee-only advisors billing via AUM to creating a client’s financial plan is for that client to roll over any existing annuity product into a low-cost, globally-diversified investment portfolio. Over time, the growth available via a low-cost investment portfolio will outpace the growth available in a complex annuity product – despite any surrender fees that a client may have to pay for exiting said complex annuity product.

(future portfolio value – surrender fee) > future annuity value

In short, for a fee-only fiduciary, the gut reaction when seeing an annuity is to get the client out of it. (Naturally, there may be a conflict of interest here if that adviser is billing for a percentage of assets under management.)

Annuitize for Today

While it usually makes sense to surrender an annuity if a client has a long timeline, the opposite may be the case if the client has a short timeline until distribution. That is, if a client is retiring today or in the very near future, then it may make more sense to keep the annuity in place – and annuitize for cash flow. This makes sense if the client has a need for cash today. If the client does not need money in the near future, then investing the surrender value of the annuity may be appropriate.

The reason why it sometimes makes sense to annuitize an annuity instead of surrendering it is because the annuity company may just offer an annuitization rate that is more favorable then what a low-cost investment portfolio could provide in terms of a sustainable distribution rate. In a recent example, I was analyzing a client’s annuity with MetLife / Brighthouse. Due to the client’s age, a roughly 10% distribution rate was being offered by the annuity company. Especially considering the client’s relatively conservative risk tolerance, there was no way an investment portfolio would be able to generate a similar level of sustainable distribution.

The one caveat with this approach is that annuitizing an annuity will only be a successful strategy if said annuity company stays solvent. This is why checking a company’s credit rating should be a consideration in your analysis. (The same can apply to pension solvency.)

Rule of Thumb for Annuitization

In conclusion, consider annuitizing an annuity if the annuity company is offering a favorable annuitization rate for clients who need immediate cash flow. For those clients with a longer timeline, surrendering an annuity and investing the proceeds for future growth in a low-cost diversified portfolio may make sense. Of course, running the precise numbers is always important to determine which strategy is best for the client.

Reader Interactions

Leave a Reply Cancel reply

Your email address will not be published. Required fields are marked *

Primary Sidebar

Is a One-Day Financial Review Right for You?

Get Your Free Assessment ➔

Get in Touch with Jon Luskin, CFP®

  • Email
  • LinkedIn
  • Twitter

Sign Up for New Blog Posts & Podcasts Delivered to Your Inbox

What I’m Reading Right Now

Recent Posts

  • Bogleheads® Live 37: Christine Benz on ‘How much can I spend in retirement?’
  • Bogleheads® Live 36: Mike Piper on ‘After the Death of Your Spouse’
  • Bogleheads® Live 35: Bill Bengen on the 4% Rule of Thumb
  • Bogleheads® Live 34: Cameron Huddleston on talking to your parents about their finances
  • Bogleheads® Live 33: Colleen Jaconetti on Rebalancing Your Portfolio

Categories

  • Bogleheads® Live
  • Bonds
  • Financial Planning
  • FIRE, FI, Early Retirement
  • Investing
  • Practice Management
  • Real Estate Investing
  • Tax Planning

Jon Luskin, CFP® Follow

Hourly Advice for Do-It-Yourself Investors. '@Bogleheads® Live' host. Advice-Only #CFP®. #fiduciary. @SDFLC volunteer. Tweets ≠ Advice. https://t.co/GJqMxem3Cr

JonLuskin
Retweet on Twitter Jon Luskin, CFP® Retweeted
bogleheads John C Bogle Center for Financial Literacy @bogleheads ·
4h

Taylor Larimore, one of the original Bogleheads and a living legend, celebrated his 99th birthday on Wednesday.

Happy birthday, dear Taylor, and thank you for your service! You inspire us to live well, help others, and be kind. Sign Taylor's "card" here: https://www.bogleheads.org/forum/viewtopic.php?t=395758

Reply on Twitter 1618725218478071814 Retweet on Twitter 1618725218478071814 3 Like on Twitter 1618725218478071814 27 Twitter 1618725218478071814
jonluskin Jon Luskin, CFP® @jonluskin ·
4h

"Back-door Roth IRA" is a verb, not a noun.

It's a process for high earners to get money into Roth IRA accounts, offering tax-free growth.

#investing #taxes

Reply on Twitter 1618715442821963798 Retweet on Twitter 1618715442821963798 3 Like on Twitter 1618715442821963798 4 Twitter 1618715442821963798
Retweet on Twitter Jon Luskin, CFP® Retweeted
iraownersmanual IRA Owner's Manual @iraownersmanual ·
12h

Bogleheads® Live with Bill Bengen: Episode 35 #PFshare via @JonLuskin https://boglecenter.net/bogleheads-live-with-bill-bengen-episode-35/

Reply on Twitter 1618601426103533570 Retweet on Twitter 1618601426103533570 1 Like on Twitter 1618601426103533570 Twitter 1618601426103533570
Load More

Is the One-Day Financial Review right for you?


Get Your Free Assessment ➔

Disclosures & Legal

Jon Luskin is a registered investment adviser in the states of Arizona, California, Florida, Louisiana, Massachusetts, New York, North Carolina, Pennsylvania, Texas, Virginia and Washington. The Adviser may not transact business in states where it is not appropriately registered, excluded or exempted from registration. Currently, there are no states where the adviser is not appropriately registered, excluded or exempted from registration – allowing the adviser to work with anyone in any state. Individualized responses to persons that involve either the effecting of transaction in securities, or the rendering of personalized investment advice for compensation, will not be made without registration or exemption.

Copyright © 2023