Even if a couple retires with a nice chunk of money, it is very likely not enough to easily last them for the rest of their lives. Say a couple retires with $500,000, and plans to live modestly on an annual sum of $25,000 (above social security etc.). At that rate they’ll run out of money in 20 years (and because of inflation, much sooner). While investing all the money in bonds can supply a few more years of withdrawals, it still may not be enough. A couple in their upper 60’s who are in good health have a decent chance of living well into their 80’s and 90’s or longer, meaning this couple could run out of cash when they’re very elderly and can least afford to. Everything is relative, and while $500,000 may sound like a fortune, in the context of replacing a steady salary it’s not that much. The challenge is how to use the $500,000 to generate at least $25,000 in additional income in a permanent and secure fashion. Buying a portfolio of bonds would earn too little income, and risking their nest egg in volatile stocks or real estate investments is well, a risk. So, can retirees securely generate cash for life?
Living well while living long
The blessing of arichas yamim is much degraded if spent in poverty, which makes financial planning for seniors vital and challenging. One of the best and most underutilized tools to avoid running out of money in old age is a fixed-income annuity, also known as a SPIA (single premium income annuity). A SPIA is a type of insurance policy where in exchange for a one-time payment, a life insurance company guarantees an income for the life of the person or couple protected. For example, a retiring couple can give their $500,000 to an insurance company which would then be obligated to send them $2,500 monthly for as long as either one of them lives. (The larger the amount put into the SPIA the larger the income.) If this $30,000 in annual income (about 6% of the $500,000) is more than they require, they can invest the extra money to offset inflation and perhaps leave over a modest yerushah. Compare this with the guaranteed income from a bond portfolio which would yield just $15,000 annually (about 3.3%), half of what a SPIA does, which is likely not enough to live on. As long as they choose a reliable insurance company, a couple can enjoy their retirement with a secure SPIA income, guaranteed for life.
But, “Double the guaranteed income?! OK, what’s the catch?”
But…the big catch
The massive difference between a $500,000 SPIA and a $500,000 bond portfolio is that once handed over to an insurance company, the premium of a SPIA is gone! Should the retiree be hit by a truck on the way home from the insurance agent’s office, his descendants would get nothing, whereas had he bought a portfolio of bonds, every penny would be left to his estate. Even if a couple enjoys a long life, they may need access to cash for an uncovered medical need or to help a child, and because all their retirement money was placed into an irrevocable insurance policy, they can’t do anything about it. Most people can’t get past the thought of losing control of all their money and the possibility of the life insurance company making “a killing” should they pass on quickly. Because of this emotional but understandable perspective, SPIAs are not popular despite their significant capabilities to minimize elder poverty.
SPIA: life insurance in reverse
The life insurance companies aren’t being greedy when taking control of the principle of a SPIA; it’s what they require to provide the valuable security retirees seek. Consider the opposite case, where instead of dying right after buying their $500,000 SPIA, the retirees live until 120, collecting a total of $1,650,000 in annual payments from their SPIA policy ($30,000 x 55 years). Generating that much guaranteed money from $500,000 isn’t easy for the life insurance company. Bonds just don’t pay that much, and even if they wanted to, insurance companies aren’t allowed to base their guarantees on higher-potential but risky investments like stocks and real estate. It’s only by taking the excess money earned from people who die sooner than expected that the companies have money to pay those who live longer than expected. This arrangement sounds like life insurance in reverse because that’s precisely what it is! Although it can be painful, the best bet for a secure retirement income is probably putting a good chunk of money into a SPIA.
Complicated annuities require a second opinion.
Annuities are the mirror image of life insurance: one protects from the financial problems of dying early, and the other from dying “late” (i.e., outliving available assets). A SPIA is the annuity equivalent of term life insurance, simple and transparent, leaving little room for errors or hidden commissions. In addition to SPIAs, insurance companies offer a dizzying array of other annuities with investment and “rider” options, which sometimes make financial sense but literally require an actuary to comprehend. As with cash-value insurance, agents make much larger commissions for the bells-and-whistles type of annuities, and there is little transparency as to the fees hidden within them. Due to their complexity and the potential for biased pitches, any potential purchase of these products requires a second opinion from an unconflicted insurance expert.