I am retired and 73 years old, where can you park

[progree]

40. Some may compare annuity yields to those of bonds and CD's without understanding the differences

They are incredibly safe, are paying out far more than those bonds or savings bonds being discussed.

Some of an annuity's yield (the regular monthly or quarterly or annual payments when one begins to collect payments) is return of principal.

Whereas with a bond (or CD), the yield is the interest part only. The entire principal is available (without penalty) at the end of the term.

I know you understand this, but I fear some might decide between annuities and other fixed income investments based largely on which has the higher yield.

The yield on an annuity, and especially a deferred annuity is and should be a lot higher than bond and CD yields --

Speaking of the simplest annuity, a simple fixed income annuity that ends with the annuitants death (the life-only option) --

For example, for a 65 year old female, and using Fidelity's annuity estimator, which is based on insurance companies' quotes, the yield for an immediate annuity (payments begin a month after purchase) is 5.63%

Currently (May 2021 dividend), the Vanguard Long-Term Corporate Bond Index Fund Admiral (VLTCX) is yielding 3.26%

Yeah! annuities win, and bonds suck eggs.

But not so fast. The bond's yield is just the interest part.

Whereas the annuity's yield effectively includes return of principal, since with such an annuity (Life-only option), there's no return after death of any of the initial cost.

Unlike a bond, where one's entire initial principal -- like in the case of a new bond that is held to maturity -- you get your entire initial outlay back (less commissions).

(I'm comparing to long-term bonds, since an annuity is inherently a long-term investment because of heavy surrender charges. I know I'm not supposed to call an annuity an "investment", since it's an insurance product. But plunking down tens or hundreds of thousands of dollars up front on an annuity sure seems a lot like an investment to me).

(In this post, I use the term "yield" or "annual yield" for just the regular annual payments from the annuity or the bond (Or the monthly payments times 12). If the yield is given as a percentage, it’s the annual yield as a percent of the initial $100,000 investment. Similar to the dividend yield of a stock. It is *not* a total return or annualized total return number -- that (in dollars) would be the annual yield times the number of years the regular annual payments are received PLUS whatever one gets back at the end).

A deferred annuity's yield should be even higher than an immediate annuity's yield -- a lot higher. For example, for a 65 year old female, and using Fidelity's annuity estimator, based on insurance companies' quotes (obtained June 6), the yield for an immediate annuity (payments begin a month after purchase) is 5.63% as stated previously.

But deferring the income stream for 8 years results in a 9.54% yield, a 1.69-fold increase, according to the same Fidelity annuity estimator which is based on insurance company quotes. That big increase in yield is because one collects for 8 fewer years of their life. So yeah, anyone with a deferred annuity like that, and looking only at annual yields, is going to beat the pants off the interest rate of any bond.

If comparing an annuity bought in 2011 or 2012 with today's yields, one must remember that interest rates then were about 45% higher than currently (e.g. Vanguard Long Term Corporate Bond Fund yield was about 4.74% then compared to 3.26% in May 2021). So I'm guessing yields on simple fixed income annuities were also 45% higher than currently.

If an annuity has an equity component (e.g. an indexed annuity or variable annuity tied to the performance of the S&P 500), then its yield and performance should be compared to a balanced fund (combination equities + bonds) rather than a pure bond fund.

I realize there are a virtually infinite number of kinds of annuities, e.g. ones that continue paying after death for a set number of years "period certain", to a beneficiary. Or that promise a "refund" if one dies before a certain number of years -- ensuring that at the worst, you and your beneficiaries get back in total what was put in -- the "get back in total" includes payments previously received. Such provisions result in getting quoted a lower yield, but still beating yields of bonds.

Annuities also have a risk factor -- if one dies early (and particularly if it’s a life-only annuity), the return can suck (at least consider getting that period certain or "refund" option so that it isn't a negative return). If gotten when interest rates and annuity yields are low, such an annuity locks in low yields for life. On the other hand, they certainly beat bonds if one way outlives their life expectancy. And annuities function as a kind of longevity insurance -- a considerable benefit.

I have an annuity, so I'm not ideologically opposed. I appreciate the nearly $21,000 annual checks. (It's a charitable gift annuity that I got in return for donating my farm in December 2016. It's yield is 4.7%. (The equivalent on an annuity purchased on the marketplace at that time would have been 6.5%).

I'm also in the "market" to consider an annuity given the catastrophically low yield of one of my bond funds (which is too heavily weighted in low-yielding Treasuries).

These CD-like annuities, "Fixed Annuities" also known as a multi-year guaranteed annuity or MYGA, look pretty good to me:
3 year: 2.40%, 4 year: 2.80%, 5 year: 3.00%, 7 year: 3.10%, 10 year: 3.20% (as of 6/11/21 at https://www.blueprintincome.com/ ). For someone who doesn't want to get locked into today's low rates for decades or life. (But is this going to result in yet more accounts heirs will have to deal with? Or a declining cognitive skills me?)

I'm just cautioning anyone comparing an annuity to a bond or CD that it's an apples and oranges comparison as they are two very different products, and reaching conclusions from just comparing yields (the sizes of the monthly or annual payments) is simply wrong.

The below compares the total return of an immediate annuity yielding 5.63%, and for a deferred annuity (8 year deferral) yielding 9.54%, as a function of "N", the number of years since the purchase until death..

These are quotes for a 65 year old female in Minnesota, per the Fidelity annuity estimator obtained on June 6.

I've checked quotes at USAA and BluePrintIncome.com and IncomeSolutions.com and they are practically the same (except USAA doesn't seem to offer deferred annuities).

All my examples below assume a $100,000 annuity is purchased in year zero.

IMMEDIATE ANNUITY: An income stream of $5,630/year for N years is received. There is no residual amount received in year N at death.

DEFERRED ANNUITY, deferred for 8 years: No income is received for 8 years, and then for the next N - 8 (N minus 8) years, $9,540/years is received. There is no residual amount received in year N at death. So for example, if N=20, then for 8 years, no income is received, and then for the next 12 years, $9,540 is received.

The yields I quoted above for the annuities: 5.63% for the immediate annuity and 9.54% for the deferred annuity were based on simple life-only with no refund guarantee and no fixed period N guarantee (aka "period certain" ).

If I had gotten quotes with either one of these provisions, the quoted yields would have been lower. But since my table starts at N=20, neither of these provisions would have helped: The longest guarantee period I've seen is 20 years, which we've already reached at the beginning of my table.

And as for the "refund guarantee", both of these annuities have paid back the full $100,000 investment in yearly payments by year 20, so the refund guarantee has already been met and exceeded (for the immediate annuity: 20 years * $5,630 = $112,600. For the deferred annuity: 12 years * $9,540 = $114,480).

Total Rates of Returns (Annualized) for An Immediate and
a Deferred Annity (deferred by 8 years)
Quoted yields obtained 6/6/21 for a 65 year old woman
N is the number of years since purchase until death.



Methodology: The Excel IRR function was applied to the stream of cash flows. Results were also checked using the Excel NPV and PV and FV functions (net present value, present value, and future value).

The average life expectancy of a 65 year old woman is about 21 years. I realize that an annuity is not an investment, but rather insurance. The yields are quite decent for someone who lives well past their life expectancy, but not eye-popping. Still they are reasonably guaranteed by the strength of the insurance company and the backing of state guaranty funds (check for details for limitations and maximums).