Jason and his wife face a crucial decision: whether to purchase an annuity or pursue traditional investments as they prepare for a full-time, slow-travel retirement.
With a diverse array of income sources, including pensions, 401k, property sales, and Social Security, they estimate their monthly expenses at $7,500. James analyzes their situation, emphasizing the balance between annuity stability and investment flexibility.
He highlights the security of annuities and explains their limitations, guiding the couple towards a tailored approach that aligns with their goals and circumstances.
Questions Answered:
What are the pros and cons of annuities?
How can I effectively balance the stability of annuities with the flexibility of traditional investments?
Timestamps:
0:00 - Jason’s question
3:07 - Pros and cons of annuities
6:32 - Assessing Jason’s situation
9:52 - The role of Jason’s portfolio
11:40 - Annuity alternatives
13:23 - Support your retirement vision
16:54 - Integrate financial plan and portfolio
Create Your Custom Strategy ⬇️
Jason and his wife face a crucial decision: whether to purchase an annuity or pursue traditional investments as they prepare for a full-time, slow-travel retirement.
With a diverse array of income sources, including pensions, 401k, property sales, and Social Security, they estimate their monthly expenses at $7,500. James analyzes their situation, emphasizing the balance between annuity stability and investment flexibility.
He highlights the security of annuities and explains their limitations, guiding the couple towards a tailored approach that aligns with their goals and circumstances.
Questions Answered:
What are the pros and cons of annuities?
How can I effectively balance the stability of annuities with the flexibility of traditional investments?
Timestamps:
0:00 - Jason’s question
3:07 - Pros and cons of annuities
6:32 - Assessing Jason’s situation
9:52 - The role of Jason’s portfolio
11:40 - Annuity alternatives
13:23 - Support your retirement vision
16:54 - Integrate financial plan and portfolio
Create Your Custom Strategy ⬇️
On today's episode of Ready for Retirement, we're going to explore whether it makes sense for Jason and his wife to purchase an annuity as they prepare to retire and more than just retire. They're ready to embark on a full-time, slow travel adventure and they're really looking for guidance and navigate some of those options in front of them. They have a pension, 401k, property sale, social security all of these different things that they're contemplating and they're wrestling with the decision between securing a steady income through an annuity or investing in a more standard portfolio for better long-term growth potential. We're going to help Jason with this question as we jump into today's episode. This is another episode of Ready for Retirement. I'm your host, james Cannell, and I'm here to teach you how to get the most out of life with your money. And now on to the episode. So Jason submitted a question and this question says the following James, thank you for the podcast. I love your balance between the financial aspect of retirement and the personal search for meaning in retirement. I have learned so much In six years.
Speaker 1:My wife and I plan to retire to a life of full-time, slow travel. We're excited to learn about new cultures and explore a different way of life, a life of less stuff and more experiences. As far as money goes, our sources of income and retirement will be the following Number one, my pension, which is $4,000 per month pre-tax, with a 3% cost of living adjustment. Number two, my wife's 401K, which we hope will be approximately $500,000 in six years. Number three, money from the sale of our house and art gallery, which should give us another $500,000 because the mortgage is already paid off. In number four, we plan to delay social security until age 70, and we should each receive at least $2,000 per month each. We estimate that our expenses for full-time, slow travel will be no more than $7,500 per month pre-tax. This includes the cost of travel, health insurance and all other expenses. My question is what should we do with my wife's 401K and the cash from the sale of the property? Together, they should total about $1 million.
Speaker 1:My conservative side wants to turn that $1 million into an annuity and have a steady source of income for the rest of our lives. However, I know the annuity won't increase with the cost of living. Of course we could leave it in the market and use the 4% rule or 5.5% with guardrails. At this point I'm leaning towards turning half of it into an annuity and keeping the rest in the market. What are the pros and cons in this situation, and does it look like we would have enough money per month to cover our slow travel lifestyle? Thank you, jason. Jason, congratulations on some upcoming, exciting plans, it sounds like, in the next few years. Thank you for your question.
Speaker 1:Let's absolutely take a look at this, because what you'll tend to find and I'm probably guilty of this sometimes as well is an advisor will either think an annuity is the best thing in the world and is always recommending annuities, or will tend to discourage annuities in every situation they even possibly come up in. The reality is, there's great instances in which annuity can be great, and there's horrible instances in which an annuity is absolutely the wrong tool or isn't the best thing to help you accomplish your goals. So, really, where I want to start has nothing to do with annuity or not an annuity. It has to do with everything else. How do we start with understanding your goals, the income sources. You have to meet those goals, and then we can back into your portfolio, and what's the best option for you at that point to supplement your other income sources? To start today, let's talk, though, about why would you purchase an annuity and why wouldn't you purchase an annuity? And then we'll go into that conversation that just outlined.
Speaker 1:One of the hard things about annuities is there's many different types of them. There's variable annuities, fixed annuities, equity index annuities all these different types of annuities that they're talked about as if it's just the same thing. It's like saying, should I invest in investments? Well, what investment? There's all these different kinds of investments and so if you're that broad, or if you're speaking that broadly, you're going to miss some of the nuance. So there's multiple types of annuities.
Speaker 1:I'm going to, for the sake of this conversation, be talking about a fixed annuity and in general, annuities can be beneficial because, number one, they provide guaranteed income. Number two, going along with that, guaranteed income alleviate some of the worry about what's going on in the stock market. Stock markets never going to be this calm, steady thing that just grows your money. There's always going to be a lot of uncertainty embedded in it. Number three, you don't really have to manage it, so you don't have to worry about what your withdrawals are. How is your money being rebalanced, how is it being taken care of? The annuity just handles that for you and it sends you a paycheck once a month and at the end of the day, the bottom line is you are buying an income.
Speaker 1:If you put $100,000 into an annuity, or you put $1 million into an annuity, think of that like buying a pension. You're buying an income source. You are telling an insurance company I'm going to give you this lump sum of money and you're then going to give me an income for the rest of my life, or at least for some period of time. So those are some of the upsides of annuities. But what are the downsides of an annuity? Number one you could potentially and I'd even say probably do a lot better investing in the market with a diversified portfolio than you could with an annuity. In other words, you could replace the income benefits and probably even do a little bit better in most cases.
Speaker 1:Another downside is many annuities don't come with a cost of living adjustment. So if you get an annuity that's paying you $2,000 per month, $4,000 per month, $10,000 per month, that stays consistent. So the dollar amount stays the same, but because it doesn't go up with inflation, your purchasing power is slowly starting to diminish over time. Number three they're not liquid. It's not as if you can and again I'm talking about immediate annuity. So an annuity that you give a lump sum and you just receive a series of payments for the rest of your life.
Speaker 1:You can't take more out of your annuity in some months and less out of your annuity in others. It's just a paycheck that you're getting. And the same way you can't go to Social Security or your pension provider and say, hey, this month I might want more and in the following months you can take a little off to make up for that. It's not how an annuity works. There's not the flexibility of how much you can take out, there's also less flexibility in tax planning. So for those of you who are implementing a tax strategy throughout retirement, an annuity makes it a little bit more challenging sometimes to do what you otherwise could do because of the flexibility with other investments of when you draw from certain accounts and then finally there's really nothing left to airs after you and or a spouse pass. So if you have a liquid portfolio and you don't spend it all, well then your kids or grandkids or heirs get whatever is left. With an annuity, it's a contract with a life insurance company and that contract ends upon your passing or your spouse's passing if it's a joint life annuity, so it's not something that you'd be using for our state planning purposes.
Speaker 1:So, as we start to go through this, in my opinion there are many, many good reasons not to own annuity. So to me, if the question is, should I purchase an annuity, just trying to look for a good reason to own the annuity, so let's go through Jason's situation, his spouse's situation, say, is there a good reason to purchase an annuity? And that's not to say my list was comprehensive by any means. But I like to start from the perspective of why should we? What is that good reason, before making a decision to purchase that annuity? So let's jump into Jason's situation. But again, the last point I want to make, or I want to reiterate before we jump in, is buying an annuity is like buying another pension and buying another income stream. So let's keep that in mind as we go through Jason and his wife's situation.
Speaker 1:So, to start, let's look at what annuity like income can Jason already plan for, and by annuity, like, I mean income that's just going to show up. He's just going to get that payment. His wife's just going to get that payment, regardless of what he does with his portfolio or any choices he makes after that. Well, in their case, it's pension and social security. Jason has a pension of $4,000 per month pre-tax, so that's like an annuity. Now the difference is his pension will receive a cost of living adjustment, so once a month, $4,000 will be direct deposited into his bank account very similar to an annuity. Another annuity like investment is social security. Now, there are certainly some differences, but social security it's like an annuity. You just start to collect it and once a month you're going to get a paycheck direct deposited into your bank account. And each of them.
Speaker 1:In Jason's question, he said that they'll each receive about $2,000 per month at age 70. So $4,000 per month combined from social security. So here's what I'm seeing At age 70, they'll have $8,000 per month combined in pre-tax income. And now the beautiful thing about the $8,000 per month is that we'll receive a cost of living adjustment. Social security receives a cost of living adjustment, and his pension will receive a cost of living adjustment. So that's money that's going to preserve his purchasing power. That's income where the purchasing power will be preserved, at least to some extent over time. What we need to do next, though, is we need to compare that that $8,000 per month from pension, his social security benefit and her social security benefit to what Jason and his wife will actually need. Well, he said that, even including health insurance and other costs, they'll probably need $7,500 per month pre-tax. Well, right off the bat, here's what I go to. They're going to have $8,000 per month coming in pre-tax from their annuity-like income sources, so from his pension and from both of their social security benefits, and then they'll compare that to, or they'll have the $8,000 per month to spend on, the $7,500 per month that it's actually going to cost to fund this lifestyle. So, right off the bat, without too much analysis, you can start to see they're sitting in a pretty good spot. They're actually projected to have an excess of $500 per month coming in based on these numbers that we're looking at Now.
Speaker 1:Notice we haven't actually talked about their portfolio at all yet. Too often the first question people ask is hey, should I buy an annuity? Should I invest in stock? Should I invest in bonds? It's a wrong question to ask first. It's an important question, but it's wrong to go there first. First you should go through analysis like we just did Now. This was very simplified. We didn't account for things like taxes, inflation, spending changes, all these other details and nuances that are actually relevant or actually applicable, I should say, in most retiree situations. Go through that first.
Speaker 1:First understand the role that the portfolio is going to even play in the overall situation. Notice for Jason and his wife. What role does the portfolio play? In a way, you could say it's extra when you look at the fact that they've got a joint and survivor pension of $4,000 per month. They're both going to have $2,000 per month coming in from Social Security once they turn 70. Their needs are covered. Their needs are covered even if they had $0 in their portfolio. So that's a far different situation. It's a completely different picture than if they really depended upon their portfolio to meet all or even most of their income needs. Each of those different scenarios there would be a different implication in terms of what investments are best to meet these needs. But now that that framework is there, now we can turn our attention to the 401k and other assets. So they expect that she'll have $500,000 in a 401k by the time that they retire. They anticipate $500,000 from selling a home in an art gallery, so there's a million dollars.
Speaker 1:Should they do an annuity? They could, but I really struggle to see the value there. Remember the income when you purchase an annuity, you are buying income, you're buying a guaranteed income source and you are foregoing flexibility, you're foregoing potential better returns. You're foregoing some other things that you could do with that annuity by purchasing it, given that income's good income squared away assuming that their numbers are right, meaning the 7,500 per month that they want to live on, assuming that's right and assuming the income sources they provided are accurate. Now, obviously there's also other contingencies of what? If they don't sell the art gallery for what they think they might sell it for, or if they don't sell the home for what they might sell it for? But even those contingencies are separate from their income. If these numbers are accurate, do they really need to purchase another guaranteed income source on top of the guaranteed income sources they have from social security and appention? I really struggle to see the value in them doing that.
Speaker 1:So what are the alternatives? Well, even if they don't buy an annuity, that doesn't mean there's only one way to invest it. They could keep this money really conservative. They could keep this money more growth oriented. One of the unique things about not quote unquote needing the money to meet your goals is you have flexibility in investing the way you want to invest. If you tend to be more conservative by nature, well great, invest in a more conservative portfolio. If you tend to be more growth oriented by nature, with your risk tolerance and what you want under your investments, well great, invest in a more growth oriented portfolio. And because you don't need that portfolio to meet your needs, you're not really presenting yourself with a lot of risk by doing so.
Speaker 1:So even if they just invested this, say, in a portfolio of stocks and bonds, they could probably expect $20,000 to $30,000 per year just in dividends and interest that those stocks and bonds and funds are creating. So that's a nice extra bonus that if they want that money, hey, take it as cash. Take that dividend income, take that bond income, take it and supplement the $7,500 per month that you already are accounting for and do more with it, live more with it or reinvest it. And that's the flexibility. That's the beauty of investing is you're not forced to take some of the income that's being created. You can always turn around and reinvest it if you desire, or they could invest it and use some of the withdrawal strategies that Jason mentioned.
Speaker 1:He mentioned the 4% rule. He mentioned the guardrails approach, where you can take a little bit more out of the portfolio. So using one of those approaches maybe gives them $40,000 to $55,000 extra per year, pre-tax, on top of what they need. So that's a situation where, look, if there's more expenses or greater expenses in one year or you really want to live it up for one year, great, take more out. But you're not on the hook for having to take that out every single year, like you might with an annuity.
Speaker 1:So that's, I think, the nice thing to me about the investment option in Jason's specific situation is there's some flexibility embedded in it. Let your portfolio grow and if you need it, take it. If you don't need it, let it keep growing. But really, you can look at that million dollars, or that expected million dollars that they might have, and really start to ask yourself the question how could this best be used to support our vision for a great retirement, to support our vision for what's most important to us, where that spending giving, doing a number of different things they've got that in the flexibility involved with an investment portfolio could really help to support a lot of that. This, then, is really where the non-financial side comes into play. So, as I mentioned, what does that million dollars represent to you? Is it more income? Is it security? Is it legacy? Is it more trips, more memories? It's not needed, quote, unquote, needed for them to meet their needs. So that's where they can really have a lot of fun with that. What do we want this to do for us that will really enhance our quality of life, enhance our ability to do what we want to do.
Speaker 1:Now, other notable planning points. As I'm going through this, I recognize that in this, in really most podcast or videos, I do. I oversimplify it on purpose just to really focus in and hone in on the key planning points. One of the things that sticks out to me first and foremost if hey, why this actual simplified planning strategy wouldn't work exactly like we're talking about it is I don't know what ages they plan to retire by, but he mentioned that social security won't actually start until age 70, based on what they're planning for. So will they be 70 by the time that they start retirement? I guess is no. They talk about a lot of slow travel. They talk about a lot of things that they want to do. I'm guessing they're retiring before the age of 70. So if that's the case, well then there's going to actually be a gap between the time that they retire and social security kicks in.
Speaker 1:They'd have the 4,000 per month from Jason's pension, based on the way I'm reading this. So they have 4,000 per month coming in, but they'd need $7,500 per month total. So in other words, they'd need 3,500 per month or $42,000 per year from investments, whether that's annuity or stocks or bonds or some other combination of these things. They would need that from the time that they retired until turning 70, at which point social security would kick in. Now the nice thing is, if you look at a million dollar portfolio, a million dollar portfolio could support a $42,000 pre-tax withdrawal for 30 plus years, assuming that you are investing that money in a reasonable investment strategy, investing it the way it should be, and that money could last for 30 plus years, just even based upon initial research done by Bill Beggin in that 4% rule white paper. So if it can do that for 30 plus years, it could certainly do it for just a handful of years Between the time that they retire which, granted, I don't know what age that will actually be and 70, which is when social security kicks in, assuming, of course, that money's invested the right way to be able to generate that.
Speaker 1:So on top of that, jason, there's going to be some other planning points too and nuances and, like I even said, we want to account for taxes, we want to account for inflation, we want to account for how will spending actually change at different parts over the course of your retirement. So so many things that would want to be taken care of. But as we go through just a high level analysis of what are your income sources, what are your expenses and how do your investments fit in, what should you do with your investments between annuity and, say, a more traditional investment portfolio? When we take a look at your plan without the investments involved first, it becomes much easier to back into what your investments look like. To say, does an annuity best fit the bill for what needs to be done with this asset or to something else? Best fit the description of what we need this to do for us as we're looking at the role that the portfolio plays in the plan. One of the biggest mistakes people make because they separate their financial plan from their portfolio should not be doing that. You should have your financial plan, you should have your income plan and then see how do your investments support that, how do your investments tie into that and integrate into that, so that everything is working together. So, jason, thank you very much for that question.
Speaker 1:I hope this was helpful. Thank you to all of you who tune in. If you're enjoying this and you're listening on Apple podcast, if you're listening on Spotify, would really appreciate it if you left an honest review. It helps more people to find the show. More people find the show helps more people get good information so they can prepare to have a comfortable retirement. If you're watching on YouTube and haven't done so already, please make sure that you subscribe. Please make sure that you hit that like button if you've liked this episode and make sure that you share this with someone that you think might benefit. So many wonderful people, so many wonderful comments come in that saying, hey, this has been so helpful, as we're preparing to retire Really love getting those messages, and so the more people you share this with, the more people will be best equipped to retire or prepare for retirement so they can make the most of what they are doing financially. So that is it for today. Thank you, as always, for tuning in and supporting the show and I'll see you all next time.
Speaker 1:Hey everyone, it's me again for the disclaimer. Please be smart about this. Before doing anything, please be sure to consult with your tax planner or financial planner. Nothing in this podcast should be construed as investment, tax, legal or other financial advice. It is for informational purposes only. Thank you for listening to another episode of the Ready for Retirement podcast. If you want to see how root financial can help you implement the techniques I discussed in this podcast, then go to rootfinancialpartnerscom and click start here, where you can schedule a call to one of our advisors. We work with clients all over the country and we love the opportunity to speak with you about your goals and how we might be able to help. And please remember, nothing we discuss in this podcast is intended to serve as advice. You should always consult a financial, legal or tax professional who's familiar with your unique circumstances before making any financial decisions.