Annuities not needed if you can fund a 30-year retirement

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Annuities not needed if you can fund a 30-year retirement

Post by Browser »

Here's an interesting assertion from the Mr. Money Mustache blog. He asserts that if you have enough in your retirement portfolio to fund a 30-year retirement period (assuming any SWR that is comfortable for you), then you have enough to fund a retirement of unknown, longer length based on that SWR. Ergo, you never need to purchase a lifetime annuity to sustain a given income level over your lifetime, if you have a portfolio large enough to fund at least a 30-year life expectancy. The other implication is that you can retire early, assuming that you can fund your required annual income without social security or with a reduced social security amount.
there is very little difference between a 30-year period, and an infinite year period, when determining how long your money will last. It’s much like a 30-year mortgage, where almost all of your payment is interest. Drop your payment by just $199 per month, and suddenly you’ve got a thousand-year mortgage that will literally take you 1000 years to pay off. Increase the payment by a few hundred, and you have a fifteen year payoff! In other words, above 30 years, the length of your retirement barely affects the safe withdrawal rate calculations.
http://www.mrmoneymustache.com/2012/05/ ... etirement/
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by HomerJ »

I do like this graph... Haven't seen it before...

I'll pull it out every time we get into a SWR debate again

Image

People act like 4% is the "normal" SWR, and we should go lower because things are going to be bad going forward (note that people predicted this early last year, BEFORE a 30% stock rise)

But I like how this graph shows that 5% and 6% quite often worked... 4% is the historical WORST case scenario.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by gerrym51 »

Browser wrote:Here's an interesting assertion from the Mr. Money Mustache blog. He asserts that if you have enough in your retirement portfolio to fund a 30-year retirement period (assuming any SWR that is comfortable for you), then you have enough to fund a retirement of unknown, longer length based on that SWR. Ergo, you never need to purchase a lifetime annuity to sustain a given income level over your lifetime, if you have a portfolio large enough to fund at least a 30-year life expectancy. The other implication is that you can retire early, assuming that you can fund your required annual income without social security or with a reduced social security amount.
there is very little difference between a 30-year period, and an infinite year period, when determining how long your money will last. It’s much like a 30-year mortgage, where almost all of your payment is interest. Drop your payment by just $199 per month, and suddenly you’ve got a thousand-year mortgage that will literally take you 1000 years to pay off. Increase the payment by a few hundred, and you have a fifteen year payoff! In other words, above 30 years, the length of your retirement barely affects the safe withdrawal rate calculations.
http://www.mrmoneymustache.com/2012/05/ ... etirement/

he asserts a lot of things. does not make his advice better than others.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by Rodc »

A huge difference between 30 years and infinity is the likelihood of a black swan event goes up proportionate to the length of time in question. If you assume nice Gaussian returns and better yet toss in some active reversion to the mean then he has a point, but that is not too real-world. Unfortunately the black swan that wipes out your portfolio may very well wipe out the company that issued your annuity.

For this reason I would personally be nervous about assuming an annuity will hold for very long periods of time and why it might be best if one buys one they do so later rather than earlier in retirement if possible.

The guy is correct on the larger point: the more money you have the more options you have, including skipping an annuity. The real value of an annuity is if you are only marginally capitalized and need the longevity insurance and the mortality credits (at the expense of leaving money to heirs).
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by FrugalInvestor »

Another reason for an annuity is that as we age the chances of our becoming unable to effectively manage our portfolio increase. Also, the spouse with the greater life expectancy may not have the knowledge or desire to continue portfolio self management.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by Kevin M »

FrugalInvestor wrote:Another reason for an annuity is that as we age the chances of our becoming unable to effectively manage our portfolio increase. Also, the spouse with the greater life expectancy may not have the knowledge or desire to continue portfolio self management.
Good point.

My first thought was that something like a LifeStrategy fund might be another alternative, since there's really no portfolio management involved other than selling shares as necessary. Next thought was that maybe even deciding to sell shares of one fund might be too difficult, which led to thinking about a managed payout fund.

Upon checking, I notice that two of the three VG managed payout funds are closed, including the most conservative one. Also, the ERs are on the high side for VG (0.35% to 0.51%), but that seems like a reasonable price to pay relative to the alternatives.

I've never paid attention to the managed payout funds. Looks like even the most conservative one is pretty equity heavy, and some of the underlying funds are unusual compared to LifeStrategy and Target Retirement funds (e.g., 20% in Global Minimum Volatility Fund, 10% in Market Neutral Fund, 5% in Commodities). But I assume being closed means that they are popular.

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Re: Annuities not needed if you can fund a 30-year retiremen

Post by dhodson »

FrugalInvestor wrote:Another reason for an annuity is that as we age the chances of our becoming unable to effectively manage our portfolio increase. Also, the spouse with the greater life expectancy may not have the knowledge or desire to continue portfolio self management.
buying an annuity doesnt change that. You could still take the money from the payout and blow it on H&B. If there are any problems getting payment then someone needs to deal with the insurance company. If the insurance company offers you a buyout like they are doing with VAs with income riders then you might not understand your options. If you wish to believe that an annuity even a SPIA makes this less likely then thats up to you.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by Watty »

HomerJ wrote:
But I like how this graph shows that 5% and 6% quite often worked... 4% is the historical WORST case scenario.

That is really not a suprise, there are not quite 100 period on the graph but if you look at the SWR rate numbers and look for a 99% save withdrawl rate then having the line on the chart touch 4% just once in about 100 sample is what you would would expect.

In addition to the 4% number you would get much different numbers if you looked a the average or median of all the points on the chart, but that would be for about a 50% failure rate.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by FrugalInvestor »

dhodson wrote:
FrugalInvestor wrote:Another reason for an annuity is that as we age the chances of our becoming unable to effectively manage our portfolio increase. Also, the spouse with the greater life expectancy may not have the knowledge or desire to continue portfolio self management.
buying an annuity doesnt change that. You could still take the money from the payout and blow it on H&B. If there are any problems getting payment then someone needs to deal with the insurance company. If the insurance company offers you a buyout like they are doing with VAs with income riders then you might not understand your options. If you wish to believe that an annuity even a SPIA makes this less likely then thats up to you.
dhodson, please don't misunderstand, I'm not advocating for a SPIA for anyone else, just trying to point out possible benefits that I've considered with regard to my own future situation. There are always trade-offs and everyone's situation is different.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by dhodson »

FrugalInvestor wrote:
dhodson wrote:
FrugalInvestor wrote:Another reason for an annuity is that as we age the chances of our becoming unable to effectively manage our portfolio increase. Also, the spouse with the greater life expectancy may not have the knowledge or desire to continue portfolio self management.
buying an annuity doesnt change that. You could still take the money from the payout and blow it on H&B. If there are any problems getting payment then someone needs to deal with the insurance company. If the insurance company offers you a buyout like they are doing with VAs with income riders then you might not understand your options. If you wish to believe that an annuity even a SPIA makes this less likely then thats up to you.
dhodson, please don't misunderstand, I'm not advocating for a SPIA for anyone else, just trying to point out possible benefits that I've considered with regard to my own future situation. There are always trade-offs and everyone's situation is different.

i just dont believe it does much for the issue you raised. You still need someone you trust to manage things even if its just to check that the annuity check is deposited.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by FrugalInvestor »

dhodson wrote:i just dont believe it does much for the issue you raised. You still need someone you trust to manage things even if its just to check that the annuity check is deposited.
Yes, that's possible. But I may not be to that point yet or I may be gone and the responsibility passed to my spouse who may not have an interest in dealing with investment accounts. Even if a person is helping her they may not be financially savvy when it comes to investments. In my experience watching for a check or an auto deposit is a bit different than keeping an eye on a portfolio and taking the initiative to withdraw from the proper account and possibly re-balance it. I think an annuity check could certainly simplify things.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by Kevin M »

I agree. There is a continuum of ability and interest in managing financial affairs.

Some of us are OK managing sliced and diced portfolios, but chances are our heirs are not. Perhaps something like a 3-fund portfolio would be reasonable for someone with mild interest and moderate ability. A LifeStrategy fund is even simpler, eliminating the need to rebalance or worry about which fund to withdraw from, but it still requires taking action to sell shares. A managed payout fund eliminates the latter need, as would an annuity. I see these two in the same ballpark in terms of complexity, and of course each have their pros and cons. At some point cognitive decline may require someone else to handle one's financial affairs, but I think a one-fund solution would be a reasonable alternative (as opposed to an annuity) in this situation if one prefers to retain assets to pass on to heirs.

I know I would choose a one-fund solution over an annuity given my current circumstances, but an annuity would be better for some others.

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Re: Annuities not needed if you can fund a 30-year retiremen

Post by SGM »

I am familiar with several octogenarians who could have benefited from an annuity when they became senile. Three in a local community fell for a lottery scam and took money out of their nest eggs to pay scammers. Having an income stream rather than a pot of money from which you can write a large check to a scammer offers some protection from being cleaned out.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by john94549 »

Even though we have more than enough in IRA CDs to fund an 18-year retirement (along with S/S, pension, and interest), it's not realistic if all goes to hell in a hand-basket. OK, should stocks go to zero, the American economy implodes, whatever, I suspect our FDIC guarantees might be, well, valueless.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by Browser »

LIke a lot of retirees, I've got most of my stash in fixed income (TIPS, I-Bonds, TIAA Traditional, CDs). I was thinking that down the road I might add an SPIA. But my back of the envelope calculations show that I can maintain my present annual income draw (inflation adjusted) for 30 years. Based on that, I'm considering whether I even need the annuity. Based on Mr. Money Mustache's assertion, if I've got enough for 30 years at my desired income level, I may not need the "longevity insurance" provided by the annuity. I might be able to increase my annual income with one, however, since the mortality credits would equate into a larger draw than having an equivalent sum in fixed income. But, do I need the higher income or would I rather maintain control of my money and provide a bequest with anything remaining at my death?
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by nisiprius »

By the way, how did he come up with the number "30 years?" The lady who lives across the street from us is 97. My high school physics teacher (male) lived to age 102. Living past age 95 is not some unbelievably rare ten-sigma "black swan" situation. I think you'd have to hit 100 even to get into the local paper.

Living past age 95 is a lot more common than having your house burn down. My circle of acquaintances includes three people who lived past age 95, but none who have had a serious house fire. Yet we don't consider having your house burn down to be a negligibly rare event.

The rate of extension of life span has been very slow. LIfe expectancy at age 65 has been increasing at the rate of about one year per decade. Promoters of funding retirement entirely from investment portfolios like to have it both ways. When justifying stock allocations far higher than were recommended a couple of decades ago, they say "people are living longer," even though it's only a couple of years longer. But when justifying trying to support everything from portfolio withdrawals, they assume nobody lives past age 95.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by berntson »

nisiprius wrote:By the way, how did he come up with the number "30 years?" The lady who lives across the street from us is 97. My high school physics teacher (male) lived to age 102. Living past age 95 is not some unbelievably rare ten-sigma "black swan" situation. I think you'd have to hit 100 even to get into the local paper.
I think you may have misread the quote. The point is not that people need to only expect to live for 30 years after retiring. MMM retired at 30, so is presumably planning to be retired for a lot longer than 30 years. The point is that given the way safe withdrawals work, if you have enough to fund a 30 year retirement, you probably have enough to fund an arbitrarily long retirement (if you lived to be 100 or 200 or 300, you would still have enough for your retirement, barring major wars and confiscation). That's a fact about how the markets/math work out, not an estimate of longevity.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by dbr »

berntson wrote:
nisiprius wrote:By the way, how did he come up with the number "30 years?" The lady who lives across the street from us is 97. My high school physics teacher (male) lived to age 102. Living past age 95 is not some unbelievably rare ten-sigma "black swan" situation. I think you'd have to hit 100 even to get into the local paper.
I think you may have misread the quote. The point is not that people need to only expect to live for 30 years after retiring. MMM retired at 30, so is presumably planning to be retired for a lot longer than 30 years. The point is that given the way safe withdrawals work, if you have enough to fund a 30 year retirement, you probably have enough to fund an arbitrarily long retirement (if you lived to be 100 or 200 or 300, you would still have enough for your retirement, barring major wars and confiscation). That's a fact about how the markets/math work out, not an estimate of longevity.
As a rough approximation, if you run the default entries in FireCalc, the 30 year success rate is about 95%, the 40 year success rate is about 85%, and the 50 year success rate is about 85%. That 50 year rate increases to 95% if the withdrawal rate is deceased from 4% to about 3.7%. People can quibble all they want about how to actually estimate these things and what the range of uncertainty on the results is. One could probably argue that there is no significant statistical difference among the numbers 85%-95% in success rate. Also see "The calculator from hell." http://www.efficientfrontier.com/ef/901/hell3.htm
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by nisiprius »

30 years is not infinity. For a mortgage, yes; for drawdowns from a risky portfolio, no. I get similar results from Vanguard's "retirement nest egg calculator" to those others you found with FIRECalc.
dbr wrote:...One could probably argue that there is no significant statistical difference among the numbers 85%-95% in success rate. Also see "The calculator from hell." http://www.efficientfrontier.com/ef/901/hell3.htm ...
15% failure rate?

Are you willing to take a revolver, put a blank in one chamber, spin the chamber, and fire it, with the understanding that if there is a bang, it means you run out of money in retirement through the orderly operation of capital markets alone, without any collapse of the national financial system? Before answering, take into account the historical possibility of finding yourself in a terrible situation like those experienced by tens of millions in postwar Europe.* No matter what you invested in, there is a distinct chance you could lose it all through "economic, political, or military failure modes." Considering the possibility of those failure modes, are you willing to add the additional risk of spinning the chamber and firing the gun?

I don't even insist that you point it at your head. And since you said 85%, implying a 15% failure rate, OK, assume it's a seven-chambered revolver.

I guess to make it completely fair, we need to compare situations

a): Spin a seven-chambered revolver and you run out of money if the blank fires (14.2% failure rate, 85.7% success rate)
b): Spin a roulette wheel and you run out of money if the 0 or 00 comes up (5.26% failure rate, 94.74% failure rate).

I guess I don't play enough roulette, Russian or otherwise, to have a gut feeling for that difference so maybe you're right...

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Re: Annuities not needed if you can fund a 30-year retiremen

Post by baw703916 »

Nisi,

I don't see how having an annuity could possibly help in the event of an "economic, political, or military failure mode." Not to discount that possibility, I just don't imagine the annuity contract would end up being fulfilled under those circumstances.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by freebeer »

nisiprius wrote:30 years is not infinity. For a mortgage, yes; for drawdowns from a risky portfolio, no....
Are you willing to take a revolver, put a blank in one chamber, spin the chamber, and fire it, with the understanding that if there is a bang, it means you run out of money in retirement... assume it's a seven-chambered revolver...
Of course when the calculation of 30-year failure rate is not longevity-adjusted this is not at all the situation.

What it is more like (considering a 65-year old male) is to take that seven-chambered revolver, put a blank in 6 out of 7 chambers, spin the chamber, and fire it, with the understanding that if there is a bang it means you die before reaching age 95. If it no bang, put a blank in one chamber, spin the chamber, and fire it, with the understanding that if there is a bang this time it means you are alive at 95 but out of money. I don't know about you but I'd still feel lucky in that case.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by FNK »

The article makes another point: the studies assume you don't adjust lifestyle and keep spending apace with inflation. If you find your reserves running lowish at some point, you'll downshift. Ultimately, if you're in the US and the US is still functioning, you'll land on SS/Medicaid. "Meh", but not "bang".

The tradeoff is the risk of that downshift versus working for a few more years to take your savings from 4% to 3% SWR. Hmmm, a few free years around 50-60 versus living on SS around 90-100...
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by whomever »

You still need someone you trust to manage things even if its just to check that the annuity check is deposited.

If things are set up so basic living expenses are covered by annuity+social security deposits each month, the couple or survivor can manage their expenses with fairly low risk if they can more or less keep track of the balance in the account; even an occasional bounced check wouldn't be the end of the world. When they can't do that, sadly, they will probably not be able to cope with independent living for other reasons. They also don't have a huge exposure to, say, an unscrupulous care giver.

OTOH, if basic expenses are being paid from asset drawdown and you get a bit dodgy, you could lose everything to an unscrupulous care giver, variable annuity salesman, penny stock broker, could decide to send it all to Rev. So-n-so to further his 'good works', or just make really bad investment decisions ('Gold is zooming, let's go all in'). Having it dribbling in each month limits the damage you can do to yourself.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by market timer »

I disagree with the conclusion for a couple reasons.

The difference between a perpetual income stream and 30-year income stream grows larger as interest rates decline. For example, at 0% real rates, it is infinitely expensive to buy a risk-free perpetual income stream, while a 30-year stream costs 30x annual spending. Currently, 30-year real rates are 1.39% pre-tax.

The 20th century was great for America, not only economically, but especially in asset markets. I would not expect as much in the 21st.

It seems obvious to me that one should have enough in risk-free (or nearly so) income streams to cover necessities, and only use SWRs to fund the sort of consumption (e.g., vacations) that can be cut back in bad times.
Last edited by market timer on Sat Jan 18, 2014 4:16 pm, edited 1 time in total.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by iceport »

HomerJ wrote:I do like this graph... Haven't seen it before...

I'll pull it out every time we get into a SWR debate again

Image

People act like 4% is the "normal" SWR, and we should go lower because things are going to be bad going forward (note that people predicted this early last year, BEFORE a 30% stock rise)

But I like how this graph shows that 5% and 6% quite often worked... 4% is the historical WORST case scenario.
The valuable message I take away from that interesting graph is much different. It's instructive to note just how variable the maximum sustainable withdrawal rate has been over the years. To me, it would be a misinterpretation to assume it couldn't go lower (or couldn't already be lower) than the historical low.

In 1950 or 1955 it would have been wrong to conclude the maximum SWR would never go above 7.9% just because it hadn't before. It seems just as wrong to conclude now that it will never go below 4%.

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Re: Annuities not needed if you can fund a 30-year retiremen

Post by dbr »

nisiprius wrote:30 years is not infinity. For a mortgage, yes; for drawdowns from a risky portfolio, no. I get similar results from Vanguard's "retirement nest egg calculator" to those others you found with FIRECalc.
dbr wrote:...One could probably argue that there is no significant statistical difference among the numbers 85%-95% in success rate. Also see "The calculator from hell." http://www.efficientfrontier.com/ef/901/hell3.htm ...
15% failure rate?
The real point might be that annuities are needed even if you CAN fund a 30 year retirement.

But, I think the confusion that plagues this kind of discussion is thinking that the results of studies that help us understand how portfolios behave under withdrawal are actually recommended financial plans for retirement.
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Re: Annuities not needed if you can fund a 30-year retiremen

Post by jj »

whomever wrote:You still need someone you trust to manage things even if its just to check that the annuity check is deposited.

If things are set up so basic living expenses are covered by annuity+social security deposits each month, the couple or survivor can manage their expenses with fairly low risk if they can more or less keep track of the balance in the account; even an occasional bounced check wouldn't be the end of the world. When they can't do that, sadly, they will probably not be able to cope with independent living for other reasons. They also don't have a huge exposure to, say, an unscrupulous care giver.

OTOH, if basic expenses are being paid from asset drawdown and you get a bit dodgy, you could lose everything to an unscrupulous care giver, variable annuity salesman, penny stock broker, could decide to send it all to Rev. So-n-so to further his 'good works', or just make really bad investment decisions ('Gold is zooming, let's go all in'). Having it dribbling in each month limits the damage you can do to yourself.
I completely agree. I have seen this with my mom. She is just about able, at 82, to keep up with balancing her checking account. Her SS and two small occupational pensions (both forced annuity purchases as was required in the UK a few years ago from a 401K-style pension pot built up over a career) cover all her 'normal' living expenses. She has a large emergency fund besides which affords her luxuries as she wants/needs them: Vacations, home re-modeling, landscaping, gifts, etc. If she had to manage her monthly income from her investments by cashing things in or selling investments she would need considerable help. Not to mention the worry I would have of her being swindled/scammed.

I see this as one of the big benefits of an annuity.

jj
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