Publication: Investor's Notebook
HOW TO USE A LIFE ANNUITY | |
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Investor's Insight - Monday, March 6, 2006
"A Digest of Investment Opinion From the
World's Leading Financial Advisers"
Comment The Post Below...
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HOW TO USE A LIFE ANNUITY
by Scott Burns
Q: How should single-payment, immediate annuities be
considered in a retiree's portfolio? Due to their cash-
like risk, should they replace a large share of cash
and short-term bonds in the design of the investment
portfolio? -- D.K., by e-mail
A: Lifetime annuities, where you exchange your principal
for a guaranteed monthly income for life, should be con-
sidered as fixed-income investments in your portfolio of
financial resources. Because the monthly income is con-
sidered to be both interest and return of principal, the
monthly payments are likely to be higher than any yield
you could find in the fixed-income markets.
This does not mean they should replace fixed-income in-
vestments altogether.
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Why?
Simple. A life annuity offers monthly payments. It does
not offer liquidity. You can't sell your lifetime annuity
to raise cash the way you can redeem a CD, sell a Treasury
note or write a check on a money market fund. As a con-
sequence, it would be unwise to have a portfolio that was
50 percent stocks, 50 percent lifetime annuity.
A better strategy would have a portfolio that holds equit-
ies, short-term fixed-income and annuities. You can view
the equities and annuities as the long-term power sources
of the portfolio. The short-term fixed-income holding is
a buffer against bad markets or personal disasters.
Q: My wife and I have been using a fee-based financial
planning group. They charge about 0.75 percent annually on
the total portfolio of tax-deferred and taxable accounts.
If we plan to take out no more than 4 percent of our port-
folio annually, would you adjust that down to 3.25 percent
to allow for the management fee? Or is it reasonable to
assume that their management gains me at least an addition-
al 0.75 percent, and stay with 4 percent of my portfolio?
We have been with this group for five years and are reason-
ably pleased with their management and our total returns.
-- J.M., by e-mail
A: You need to take that a step further. Your annual with-
drawal rate should include three items: what your financial
planning firm charges, the annual expenses of any underly-
ing investment such as a mutual fund, and (finally) the
money you intend to withdraw for your personal use. All
three withdrawals come from the return your money is earn-
ing.
Money management is a service that is done for a fee. It
is something you may not want to do. It could be something
you may not be able to do. Either way, if we have someone
else do it, we should expect to pay for the service.
The question is, how much should we pay? Money management
may, or may not, add return to your portfolio -- just as
a haircut may or may not e
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