Annuities in Retirement Portfolios: My Perspective and Expert Insight

When it comes to the allocation of funds in one's retirement portfolio, especially for those planning for post-65 life, the question of how much to have in annuities arises. In my opinion, the answer is a simple and resounding zero. This stance is shared by many like-minded financial experts and planners, and is grounded in various factors including the high costs, lack of value, and potential scams associated with annuities.

The Verdict: Zero

As a Certified Public Accountant (CPA) who has been in practice since 1985, my advice is unequivocal. Annuities are not suitable for a significant portion of retirement portfolios. They are guaranteed insurance products, not true investment vehicles. The likelihood of achieving a reasonable rate of return while ensuring the insurance company does not lose money is highly compromised by the extremely meager rates offered. Furthermore, the insurance industry incentivizes agents to sell these products through extremely high commissions, which equate to pure greed. Therefore, my recommendation is to avoid annuities if possible.

The Risks and Fees

The critique against annuities extends to their high fees and expenses. Unlike well-diversified low-cost index funds, which have slashed costs often to zero, annuities have remained relatively unchanged in terms of cost and benefit for decades. This means that adding annuities to one's portfolio could end up being a significant financial loss over time. The fees associated with annuity contracts often represent a substantial portion of the returns, which is a non-negligible risk. Moreover, the mortality protection offered by these products is often of little practical value for most investors.

Alternative Investment Strategies

Instead of investing in annuities, a more prudent and effective strategy would be to invest in low-cost total stock index funds. For instance, a fund like FZROX offers broad market exposure at minimal cost. The amount to be invested annually can be adjusted based on risk tolerance, with 2-4% being a reasonable range. For those who can tolerate a slight risk of depleting funds, 4% might be appropriate, while 2% would provide a higher degree of certainty.

International Context: UK Experience

Switching to a UK perspective, the historical experience with annuities as the primary source of retirement income starkly contrasts with current practices. Historically, annuities were the norm, with many retirees, including those receiving state pensions, relying on these products for income during retirement. However, since 2015, the UK has embraced 'pensions freedom,' allowing retirees to manage their pension funds more flexibly. Despite these changes, many individuals have prematurely opted out of defined contribution pension schemes in favor of defined benefit schemes, which provide a more predictable and stable income stream.

It is essential to consider that defined benefit pensions often align closely with the recommended portion of earned income, typically around two-thirds. In line with this, many experts suggest aiming for an optimal retirement income mix of around 66% of pre-retirement earnings. State pensions play a significant role in this mix, and while the current stock market shock due to the coronavirus pandemic has impacted defined contribution schemes, defined benefit pensions have typically been less susceptible to such dramatic drops in value.

Conclusion

In conclusion, while annuities can serve a niche purpose for some individuals, especially older, higher-income individuals with specific needs, they are generally unsuitable for the majority of retail investors. This stance is supported by the high fees, minimal returns, and contemporary alternatives that offer significantly greater value. By opting for diversified, low-cost investment vehicles, investors can achieve a more secure and financially sound retirement plan.

Keywords: annuities, retirement portfolio, financial advice