Saturday, January 30, 2010


Loving the Unloved Annuity

NYT has an article on annuities. Bush's Social Security reform failed because it failed to take into account the annuity nature of Social Security. Unlike a 'lump sum' which you will hopefully accumulate, the annuity lasts your whole life.

This is both a good and bad thing. If you're 65 with $100,000 in your 401K you can live it up for a year or two or three. Great if you die at 67 or 68...which some people do of course. But if you live to 92 you're in trouble. Not counting interest, your nest egg will give you maybe $4K per year until you die. An annuity, though, lasts your whole life. But if you give $100,000 at 65 to get a monthly payment of $600 it's not a great deal if you die at 67.

Coupled with this is the ever growing pension problem America has. On the state level and with many companies workers earn pensions for their years of service. In order to guarantee workers a lifetime payment when they retire, states and companies contribute to their own unique pension plans. Pension plans are chronically underfunded, though, opening the door to massive gov't bailouts in the future.

A solution might be to group together insurance companies and offer a standardized annuity. It will be sold in small increments, maybe $100. For $100 you will purchase, say, $0.50 a month starting at age 65 (of course this will vary with age, if you pay the $100 at age 20 it might be $1.25 a month, at age 64 $0.005 a month). The plan will be administered by insurance companies by competitive bid and fully funded at all times. Instead of trusting 50 state governments, numerous local gov'ts and multiple companies to run thousands of individual pension plans, pension benefits will be purchased directly in real time from this independent agency. Not only can employers purchase the units but so could individual workers either for themselves or as gifts. In effect you have a beefed up US savings bond.

The advantages I see are:

1. You're not tied to the economic fortunes of your employer, state or company. A company or state facing fiscal difficulties is likely to try shorting their pension plan payments. Here your pension is purchased as you go so even if your company is bankrupt your pension is not.

2. You build the annuity portion of your retirement in small increments. You don't have the psychological burden of giving up your $100,000 401K balance at 65 to buy an annuity. You can split your 401K between annuities and 'lump sum balances' as you work thereby making a balanced retirement.

3. The moral hazzard issue with pension plans is modified. Right now the incentive in place is for states and companies to underfund their pension plans and make up for it with riskier investments. If they pay off great for everyone but if they fail its the workers who get screwed as well as the taxpayers. Here the charge per unit of annuity is directly tied to what is needed to payoff the promised benefit. If a company lacks funds it will simply not be able to purchase the annuities.
Before of buy annuity, you should to know all above disadvantages and advantages for investing your money.
Interesting. I suppose one risk is inflation, but that's a risk with even investment. I'm going to run this by my cousin who is a financial expert.
Interesting. I'm going to run this idea by my cousin who is a financial expert and see what he thinks.
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