Monday, August 13, 2007

Income annuities

A study by UPenn shows that income annuities can ensure an income stream for life at a cost less than that of other assets. The study is cosponsored by a life insurance company that sells annuities, so I'm taking it with a grain of salt.

What it means is that retirees who need a nest egg of, say, $1 million, can live the same lifestyle with as little as $600,000 in an income annuity. Looked at another way, $1 million in an annuity will currently generate about $86,000 a year in income for a healthy 65-year-old male, while the same amount invested in a traditional securities portfolio would currently generate between $40,000 and $50,000 annually, depending on the annual withdrawal rate.

That news could offer hope for the millions of workers about to retire with inadequate retirement savings.

"At 65 years old, you're going to need money, on average, until you're 85," says David F. Babbel, an insurance and risk-management professor at the Wharton School who co-wrote the paper with Craig B. Merrill, an insurance and finance professor at Brigham Young University. "But the problem is that 'on average' means half of the people will need continuing income between the ages of 86 and maybe past 100. That's where [retirement-income planning] breaks down."

Outliving retirement funds is a big risk. I fail to see, however, how an insurance company is going to generate returns from your initial annuity purchase to fund the income stream it has to pay you. I'm skeptical of this study, and annuities don't have a great reputation.
Yet the study also found that consumers have been tepid buyers of income annuities to this point. Many worry about costs, illiquidity in a financial emergency and the bad reputation the industry as a whole is often saddled with because of well-chronicled and dubious sales tactics with some variable annuities.