What happens when you stop accumulating cash and start spending it
Being an ex-college athlete, many of my financial correlations and analogies seem to always drift to sports. All former players yearn for the past when we were in top shape and could run, jump and compete at a high level. Those days are fleeting, and eventually end, even for the Michael Jordan’s of the world.
The same type of “handwriting on the wall” happens for the majority of us concerning our portfolio. For most, there comes a time that the chase for growth and portfolio accumulation needs to be exchanged for a guaranteed income stream using a customized annuity solution. Let’s look at some of the real-world hurdles in coming to grips with this decision.
Missed growth opportunities
All of us hate looking back on missed stock buys or growth “no brainers” in retrospect. Hindsight is always 20/20 in the investment world.
The possibility of missing opportunities is the hardest pill to swallow for any long-term stock-market investor thinking about transitioning to income. First and foremost, annuities are not growth products, and should never be purchased as a replacement for real market growth strategies.
When you make the decision to transition to income, you can’t go back or have market growth in addition. That’s just a contractual annuity reality.
A major downside to an annuity used for income is the liquidity aspect. When you create payments using “annuitization,” this is an irrevocable choice, and the only way to get your money back is through payments if the contract is structured properly.
Most deferred annuities (like variable and indexed) allow 10% free withdrawal on an annual basis, but anything above that comes with high penalties during the surrender charge period.
It’s important to know the liquidity rules of the annuity type you are considering for income so that you can make an informed decision.
Leaving a legacy
Annuities can be set up for a guaranteed death benefit without having to go through any type of underwriting. However, when utilizing an annuity for income and depending on how you structure the policy, there is a possibility that no money will be left if you outlive your life expectancy.
The fact that you can never outlive the money is really the true value proposition of a lifetime income guarantee using an annuity.
This is the gorilla in everyone’s room, and there is no product on the planet that can properly solve for it. With some annuities, you can choose to contractually attach a cost-of-living-adjustment (COLA) or consumer-price-index (CPI-U) increases to your guaranteed income stream. However, if you attach one of these contractual increases, the payments will start at a lower level when compared to the same annuity without that COLA or CPI-U rider.
By the way, you already own the best inflation-adjusted annuity on the planet. In fact, everyone does. It’s called Social Security.
Rates and actuarial tables
Interest rates seem to be stuck at these current low levels, and by now everyone should know better than to try to time future changes. In the annuity world, the primary pricing mechanism for your lifetime income stream is your age at the time you take payments. Current interest rates do play a role, but albeit a secondary one.
In my opinion, actuarial table changes in the very near future pose as big of a concern as interest rates.
Proportion and allocation
When transitioning from accumulation to income, it’s very important to implement any annuity strategy in proportion and treat the allocation as non-correlated (i.e. non-market). The biggest mistake that I see when people buy annuities is that they put too much money into one strategy or with one company. I blame many annuity agents and advisors for this, but the consumer has to take some responsibility as well.
There is nothing wrong with laddering the purchase amount over time, which I call annuity dollar-cost averaging. This a prudent way to implement the accumulation to income transition.
All pros have to eventually hang up the uniform
For most college athletes, their careers end after their four years of NCAA eligibility expire. For pros, not many have their playing days last even 10 years. In fact, the typical NFL career is less than four years.
The transition from athlete to an aging non-athlete is an eventual certainty that is hard to swallow. The same can be said for transferring the risk from portfolio growth to income.
You need to feel comfortable with the fact that the move from accumulation to income is all good, normal, and OK … and just part of the retirement game.
Originally published 9.22.15 by MarketWatch.com – http://www.marketwatch.com/story/what-happens-when-you-stop-accumulating-cash-and-start-spending-it-2015-09-22