Using Annuities as Part of a Retirement Plan

Annuities have a bad reputation, with a history that makes that bad reputation sensible. The main problem is the high costs (and often hidden costs) of many annuity products. Combine with large sales incentives this has led to annuities being abused by sales people and financial companies while providing poor returns to investors.

However the attributes of annuities fit a specific part of a retirement plan very well. Overall I am a big fan of IRA, 401(k), HSA – all of which provide the investor with control over their own financial assets. And I still believe they should be a large part of a financial plan.

In order to save for retirement, we need to start young and save substantial amounts of money to live off of in retirement. Retiring early requires that investments provide income to live off of for an even longer time.

Pensions provided an annuity (a regular payment over time). Social security (in the USA, and other government retirement payments internationally) provide an annuity payment.

A rough rule of thumb of being able to spend approximately 4% of the initial retirement investment assets (given a portfolio invested in USA stocks and bonds) gives a starting point to plan for retirement. That 4% rule however is not guaranteed to work (especially if you live outside the USA or retire early). In fact relying on it today seems questionable in my opinion (not only even if you retire at 67 in the USA (given the current seemingly high values in the stock market).

The best roll for an annuity in retirement planning in my opinion is to serve as a protection against longevity. The longer you live the more risk you have of outliving your investment savings. Life annuities have the benefit of continuing for as long as you live.

One of the disadvantages of a life annuity is that the principle is not yours to leave to heirs. That is a fine trade-off for protection that you have enough to live off of in most cases. And I wouldn’t suggest having all of your money put into an annuity so if leaving assets to heirs is important you can just factor that into the balance of how much you put into the annuity down payment.

John Hunter with lake and mountains in the background

John Hunter, Bear Hump trail, Glacier-Waterton International Peace Park

It is possible to have the annuity pay for as long as either spouse lives (so if that is a concern, as it would likely be for most married couples, that is a good option to use). The payment will obviously be less but not by a huge amount (though if one spouse is many decades younger, then the amount can be substantial).

An annuity payment is calculated based on projected investment returns and your life expectancy. The older you are the larger a percentage of the initial deposit you can expect as an annuity payment. Something like 5.5% if you are 65 today may be reasonable (this will change as investment projections, especially interest rates, change). So one thing you will notice right away is that is much greater than 4%. And that shows one advantage of using annuities.

Why is the annuity able to provide payments greater than 4%? A big reason is that the insurance company can balance the payment based on a large number of people. And many of those people will die in 10 or 15 years. That allows them to retain the assets they were investing for those individuals and still continue payments for those people that live for 25, 30+ years.

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A Tiny Housing Take on Multi-Generational Housing

Housing is a critical aspect of any financial plan. Many alternatives have become more popular in the last 10 years: nomad (digital nomads etc.), tiny houses, mobile living (RVs, vans…), etc.. I think such housing alternatives are important and should be given more consideration by more people.

As these options become more popular they begin to be used in specialized ways. As I have written previously I think multi-generation housing is an interesting concept that deserves more attention. It is not a new idea but in many countries (such as the USA) it has gone out of favor but it may well come back into favor, I believe.

One recent trend combines multi-generational living and tiny housing into tiny houses in a backyard for grandparents.

The 12×24-foot prefabricated house starts at $85,000 — less than the cost of traditional long-term elder care — and includes innovative safety features like webcams and cushioned floors that allow the family member privacy and the caregiver freedom.

‘Granny Pods’ Help Keep Portland Affordable

Seattle, Austin, Washington, D.C., and San Francisco also recently made it easier to add a second unit or granny flat.

These Accessory Dwelling Units (ADU) require zoning flexibility in most places (in the USA at least, I am not sure about zoning issues globally). Hopefully more localities will create options to allow more flexibility.

ADU for Medical Caregiving

MEDCottages will be fully assembled at a manufacturing facility and trucked to a site to be plugged in, like a recreational vehicle, to the electrical and mechanical systems of an existing home by a local contractor.

Related: Tiny Homes are a Great AlternativeHousing Savings by Living as a NomadFinancial Independence Retire Early (FIRE) and Location Independent Working