I’ve been hoping for a Brett Arends column I could say something nice about, and last week I got my wish in the form of Baby Boomers to Kids: Kiss Your Inheritance Goodbye. The theme of the article, or the first few paragraphs anyway, is the trend of dropping a nice inheritance for the kiddies from the retirement plan in reaction to the market swoon.
I myself am just a bit too young to be a Baby Boomer and my parents just a little too old, so I am merely an outside observer on this one. But I have to ask those kids of Boomers out there: you were expecting to inherit something? From the Me Generation? Really?
A few paragraphs into Arends’ column he abruptly starts talking about annuities. This may seem like a non sequitur, but it follows nicely from the idea that retirees may be jettisoning the legacy for the children from their planning.
One of several big challenges in planning for retirement is what is known as longevity risk. You don’t know how long you will be around to draw from your retirement kitty, so there is no way of knowing how much you can draw. Draw too quickly and you will run out of money, too slowly and you will miss opportunities to enjoy the material world.
This being a sophisticated capitalist society, there is a product specifically designed to solve this problem. It is called an annuity. To be more precise, you could buy a single-premium immediate lifetime fixed annuity on the day you retire. It will pay a set amount of money each month for the rest of your life, no matter how long that is.
An annuity is like a backwards life insurance policy. Instead of making periodic payments until your estate gets one large payment when you die, you make one large payment to begin with and receive periodic payments until you die.
Considering what a near perfect solution annuities are to a common and serious problem, it may be that the most remarkable thing about them is that they are not very popular. Most annuities sold in the US today are an entirely different animal, something called a variable annuity, a complex beast invented in the 1950s which is really a tax deferred savings scheme and offers no help with longevity risk. The centuries old kind of annuity that pays out for a lifetime is a comparatively rare item.
There are several reasons annuities are not more popular, but a big one is that, when you get down to it, retirees do not want to die broke. They may not say that out loud. Most mainstream retirement advice politely assumes that the goal is to avoid running out of money, but says nothing of the obvious side effect, that if you do not run out of money you will leave some to your heirs.
Perhaps people find it embarrassing to say that they would like to leave money to others, presumably their children, when they go. They may think it sounds un-American or implies that there is something lacking in their offspring. But, recent events notwithstanding, most do want to do it and that is why the generally preferred solution to longevity risk is not purchasing an annuity but saving more money than is likely to be needed in retirement. Longevity risk for many is one-sided. There is the worry of outliving savings, but having money left over is a good thing, not a missed opportunity.
When the markets go down and amassing more than will probably be needed in retirement looks unlikely, annuities enjoy a vogue, at least in as much as they get talked about more. But those are exactly the times in which annuities are expensive, because those are periods in which long-term risk free interest rates, which drive annuity prices, are low.
Better wait a few years for things to return to normal. Of course, by then you will have enough optimism to believe that you can build up a nest egg too large to outlive, which will leave the little dears a little something after all.
[Photo: Binary Ape]