Tuesday, March 19, 2013

Use annuities instead of bonds

Pairing the most plain-vanilla type of annuity—called a single-premium immediate annuity—with stocks, retirees can generate income more safely and reliably than if they use bonds for that piece of their portfolio, says Wade Pfau, a professor who researches retirement income.
To arrive at that conclusion, he plotted how 1,001 different product allocations might work for a 65-year-old married couple hoping to generate 4% annual income from their portfolio.
Using 200 Monte Carlo simulations for each product allocation, and assuming returns based on current market conditions, the winning combination turns out to be a 50/50 mix of stocks and fixed annuities, Mr. Pfau says. If inflation accelerates more than the markets now expect, inflation-adjusted annuities would become more attractive, he adds.
"There is no need for retirees to hold bonds," he says. Instead, annuities, with their promise of income for life, act like "super bonds with no maturity dates," he says.
But immediate annuities have one big drawback: The buyer loses access to his or her savings in exchange for those guaranteed payments. In other words, if you have a sudden long-term-care need or some other type of emergency, there's no way to recapture a large chunk of cash. As a result, some retirees and their advisers are using variable annuities with guaranteed income benefits instead. These annuities allow investors to withdraw more than the set annual amount in an emergency.
Mark Cortazzo, a certified financial planner, typically recommends that people preparing to retire figure out their basic, nondiscretionary annual expenses and use a variable annuity with guaranteed benefits to make up for whatever portion of that total won't be covered by Canada Pension Plan, Old Age Security, and any pensions. That way, they can pay their bills throughout retirement and afford the risk of investing much of the rest of their savings in stock funds, he says.
"If they've got a guaranteed cheque that's covering their needs, it's a lot easier for them to stick it out when there's a storm coming" in the stock market, Mr. Cortazzo says.