Are we crazy to buy annuity?

A few years ago, I had a strong dose of skepticism about purchasing an annuity. There seems to be a consensus that annuity and annuity sales people are less than upfront. So why did I purchase an income annuity recently?

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Retirement planning is hard and complicated. Even if you are fairly confident that you will have enough money. I have read many financial planning books and blogs, but I rarely see retirement income streams and withdrawal strategies covered in detail. 

There are many regulations and legal requirements about how and when the money is to be withdrawn. If you withdraw from the wrong account, too early, too late, too little, too much, etc and then the IRS will hunt you down and severely penalize you even if you correct the mistake. (I exaggerate a bit, the people at IRS would make allowance for minor and first time mistakes.) After getting the regulations correct, you still want to legally minimize the amount of tax paid by optimizing the type of withdrawal from various sources to hit the right tax bracket. 

For my retirement planning, I modeled the various sources that I can draw from and categorized each source. I plan to have 3 types of retirement income streams: (1) semi-passive income (rental, consulting, part-time job, etc), (2) market dependent income (bond, stocks, dividends, money market, etc), and (3) “guaranteed” income (social security). 

The key insight for me is the need for more income from #3 to have higher confidence in my retirement plan. In the long run, it’s difficult to predict and have certainty around the amount, timing, and duration of money from sources #1 and #2. First, much of my expenses are fixed, and must be paid on a schedule. But income sources from #1 and #2 are variable, depending on things that are completely out of my control. One unlucky event with bad timing can dramatically impact my retirement quality of life. Second, I don’t want to assume the level of mental and physical fitness needed to manage money effectively to ensure steady income from #1 and #2. Third, the possibility of out-living my savings is an emotional tax that I want to minimize so I can better enjoy my golden years. Finally, social security is a huge can of worms that the government keeps kicking down the road. I don't have much confidence in our divided government to get their act together to sustain my retirement. 

Annuity is one possible solution. A private insurance that provides guaranteed income for the rest of my wife and my life when I pay a one-time upfront fee. A good annuity would solve many of the risks: minimal market dependence (if I want), minimal requirement for physical or mental effort (I can out-source to a financial advisor), payment for as long as we live, and not dependent on the government. Annuity, of course, is not a panacea. There are still many other risks involved (see here). But as part of a portfolio of income streams, annuity seems like a sound option. 

There are 3 key steps to selecting an annuity that works for you. First, find a trust advisor. Second, determine your retirement expenses and sources of income, then decide how much guaranteed income would help you enjoy your retirement years. Finally, shop around with your advisor to find which type best fits your personal situation.