Annuities are a fairly simple concept. You give an insurance company money now and then they promise to give you a payment for either a fixed period of time, for the rest of your life, or for the longer of your life or your spouse’s. The most common annuity is run by the government. It’s called Social Security (although technically it’s a Ponzi scheme – but it’s run by the government so they get to call it “security”).
The problem with annuities, and virtually all of retirement planning, is that it can get very complicated and the math is very confusing. As I mentioned in last week’s blog, one of the most fascinating and rapidly developing fields in economics is the study of behavioral finance. One of the (not surprising) findings is that it’s difficult for people to meet vaguely defined, far off goals. Perhaps the vaguest, most far off goal for most people is how much money they will need for retirement.
As I thought about this, it occurred to me that perhaps what we need is a more concrete way to look at using low-cost annuities to get people to save for retirement. Instead of saying to an investor that they should work toward saving 20 or 25 times what they think they’ll need each year in a retirement that may be decades away, there should be a reasonable investment alternative that allows them to buy “chunks” of income.
Here are two examples. First, you could set up a savings program where if you give an insurance company a specific amount of money, they could report back to you how much they can guarantee you in income for the rest of your life starting at a given age. Your Social Security statement gives you that information in pretty clear language (one caveat – the number on your statement will adjust upward for inflation).
You should be able to do the same thing with an annuity company. For every dollar you hand over to them, they should be able to tell you the amount of income you can expect from that dollar amount starting at a specific age. You can add this amount to your Social Security and know that you have $X in guaranteed income for life in addition to Social Security. While there may be a way to actually find out this information for some annuities, they usually just tell you how much money you have in the account, not the income that it can generate. My guess is that they do this because it’s somehow more lucrative not to tell you about the income component of the annuity, but maybe that’s just my tin-foil hat talking again. Like Social Security, this information should be on a simple report that you get at least once a year, not buried in some footnote, or worse, in a computer stored in a giant mayonnaise jar on the porch of Funk and Wagnall’s.
The second way to do this is to buy “time periods” of income. Again, technically you can do this with today’s annuities, but they aren’t really presented that way. There are a few annuities that will allow you to do this with later periods of income, for example guaranteed for life after the age of 80 or 85 (known as ‘longevity insurance’), assuming I live that long, but why not do this for earlier periods? Why isn’t there an easy way for me to “buy” $50,000 in income (adjusted for inflation) for 5 years starting at age 67? Or age 70? Or age 75? There are many investors that would not only love this kind of guarantee, but greatly benefit from the certainty it provides, the lower cost of buying this income for those starting to save at an earlier age and the defined shorter term goal that can likely be measured in years rather than decades.
The insurance companies should analyze this. The numbers can always be adjusted until they work. Then they should make things easier on people and just annuitize that!