SJul 10, 2012
Life Annuities Are Most Useful for People Without Pensions
Q. You recently addressed a question from a couple whose ages are 75 and 77. You replied “At a later date, you might consider buying a joint survivor life annuity.” Since the couple was in their 70s it got me wondering: what are the tradeoffs to buying a life annuity at younger ages versus older ages? And is there a rule of thumb regarding the most appropriate age to purchase an annuity?
Another question regarding life annuities. My wife and I will retire in a few years. In addition to Social Security and 401(k)s, and some additional savings, we both have defined benefit pensions. Should we consider a life annuity? Or would an annuity be unnecessary if pensions serve a similar purpose of providing reliable income that won’t vary based on market ups-and-downs? —S.H., by email
A. If the combination of your Social Security and defined benefit pensions covers a significant portion of your spending, it's hard to get enthusiastic about adding another life income tool. My own rule of thumb— and it is just that, a rule of thumb— is that if your Social Security and pension income covers your "core" expenses— shelter, transpiration, medical, household and related income taxes— then you have no need for a life annuity. This may be your situation.
But many people— most, in fact—have no pension and Social Security may cover only a small portion of their core spending. In that case, changing their portfolio to include a life annuity becomes very attractive.
At what age you should buy a life annuity is a long discussion. Most advisors suggest buying multiple life annuities over a period of years, letting the increase in age work in your favor to bring higher monthly payments.
Q. I recently graduated college and am looking for good ways to invest. I have been reading about your couch potato method and it seems like a great and easy way I could start preparing for the future. The problem is being a college graduate means I have very little money to use to start a couch potato portfolio. Are there any of index funds I can invest in without the fees or minimum starting balance? Are there any index funds I can directly use without going through a broker? I would like to be able to do monthly deposits into the fund and let it grow over time. —I.T., by email
A. I'm glad you are thinking about investing for your future but you'll need to set some priorities first. As a recent college graduate your primary asset is YOU. That means nurturing you freedom to make choices, negotiate your salary, and move your life forward. All of that requires cash, so focus on having a good cash reserve before you start to invest for a more distant future.
Remember, your ability to negotiate a $3,000 salary increase is a much larger return than you will get on a small account. It's also about the amount you need to invest in many mutual funds. So focus on having a cash reserve that will allow you to be a strong compensation negotiator.
After you've done that you can start with small investments in a low cost exchange traded fund, ETF. With a minimum investment of $1,000, for instance, you can open a brokerage account at Charles Schwab. Once open, you can buy shares of Schwab’s commission-free exchange traded funds. The Schwab U.S. Broad Market ETF, for instance, has an expense ratio of only 0.06 percent. This is less than the 0.07 percent cost of Vanguard Total Market Index ETF and one-third the expense of other competing ETFs. If you are secure in your job and can understand that a market decline is an opportunity for a young person, not a disaster, a simple start would be to go “all-in” in the Broad Market fund.
It is important that your account start with no-commission ETFs. Here's why. Even a small discount broker commission, such as the $8.95 charged by Schwab, can be a burden. On a $1,000 investment, for instance, that $8.95 is equal to a cost of 0.895 percent a year. It's a one-time cost, but it's still a burden you should avoid if at all possible.
Filed Under: Annuities
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