Should Annuities Be Part of Retiree Toolkits?

Christine Benz: Hi, I'm Christine Benz from Morningstar.com. I am here with Harold Evensky. Harold is President of Evensky & Katz Wealth Management. Harold, thanks for joining us.

Harold Evensky: Thanks for inviting me.

Benz: So Harold, we have been hearing a lot about annuities for several years now, maybe because a lot of investors were panicked about the market environment and looking for something that could deliver a safe payout during retirement. Can you address whether you think annuities should be part of retiree toolkits?

Evensky: We need to distinguish what are called deferred annuities and immediate annuities. Most people are familiar with an annuity that is an investment to a sheltered piece of an insurance product.

Immediate annuity is where you take a chunk of money, give it to the insurance company and say, hey this money is yours, what I want is a check every month the rest of my life.

I have changed dramatically over the last decade. I think that's going to be the single most important piece of most retirement plans in the future because it has a unique return. Any traditional investments, stocks, bonds, you have got dividends, you have got an interest, you got capital gains. And annuity has a fourth component, it is called the mortality return.

It sounds really good, but it means you take 10,000 females aged 65, you put 10,000 in a pot, insurance company says well in average they have 20 years to go, let's take out a fair profit and what's left we will divide by 20 and pay it out.

Well some people die early; if they do they don't get the money. Those that live beyond that get that extra return. So it provides something nothing else does.

Now the problem is it's very sensitive to what current interest rates are because the insurance is going out and making investments.

Benz: Exactly.

Evensky: Because rates are historically low, we don't feel the pressure to recommended it right now, but I think within the next few years as interest rates get more historically normal that it will become an extraordinarily important part of everyone's planning process.

Benz: So how would you know, though? How much would raise have to go up to make annuities an attractive investment?

Evensky: No sort of good magic answer, but if intermediate term bonds historically are paying say 5%, you know when it hits that range. One of the issues is each year you wait, you are older, therefore your mortality return is going to offset some of the risks that the rates don't go up or takes a long time.

The other thing is it really doesn't make a lot of sense until someone is probably is in their 70s. That mortality return is not very significant at 65. It starts becoming significant at about age 70.

Benz: So one thing I have read, though, is that there is kind of a negative bias in terms of who is in the annuity pool, so you might have people who think they will live a good long time, those are the people buying single premium immediate annuities.

Evensky: There are really two things to look at; one is the quality of the company because you are looking for someone to be around for the rest of your life. So our criteria is only the very strongest. Once you have narrowed down that universe, it is real simple, which one is going to pay you the most.

But the insurance company worry about their pool or whatever it is because there is nothing else to compare. One says we are going to pay you $100, one says $105, that's the right answer. So it is pretty easy to pick once you are ready to do it.

Benz: OK. Thanks Harold, great advice.

Evensky: Thank you.

Benz: For Morningstar.com, I'm Christine Benz.