Will Annuities Make You Happier?

“Happiness has many roots, but none more important than security.”
–E.R. Stettnius

Happiness is a warm puppy. If you think about that saying, then you will soon realize that there is a lot more to the saying that simply cuddling up to a cute ball of fur. You get companionship from the dog. The dog represents security. There are visions of fun and play and long walks and an old friend who stands by your side.

So, can happiness be a warm annuity?

Read on and find out.

When we retire, we want to be able to kick back (or in some cases, actually do something…you know who you are!) and relax and not have a worry in the world. In the mythical good old days, you worked for a company for fifty years, and when you retired, they gave you a gold watch and a pension to ensure that you never ran out of money. The reward for a life of hard work was a few years where you didn’t have to worry about putting food on the table before you peeled the garlic and went on to the afterlife.

For a majority of us, the pension is a relic of the past. Our parents or grandparents may have or have had a pension, but most of us are not expecting one. Thus, to accomplish the same results, since Social Security isn’t likely to do the job for us, we have one of three choices:

1. Save and invest enough money so that we have a sufficient pile of it to live off of the interest, capital gains, and principal without running out (for a related article, see “Is 4% the Correct Safe Withdrawal Rate at Retirement?”), or
2. Purchase an annuity that provides us with enough income to live on, or
3. Some combination of 1 and 2

Choice #1 is the full-bore do it yourself model. You get to manage the money, adjust for asset allocation, and hope for the best. Choice #2 is the full-bore hands-off model. The insurance company who sells you the annuity gives you money every month until you peel the garlic. They get to keep the rest (note: to see why Monkey Brain doesn’t like annuities, read the article “Maybe You Don’t Need Bonds in Retirement: An Interview With Dr. Wade Pfau, CFA”…hint: you’ll see him down below). Choice #3? Self-explanatory, I hope!

Recent research by Dr. Wade Pfau, CFA (see, I told you so!) and Michael Kitces demonstrated that it was possible to replicate most of the benefits of a single premium immediate annuity (SPIA) by lowering the amount of money you have in equities (stocks) compared to fixed income (bonds) and then raising the allocation to equities over time. It’s counterintuitive, since every financial planner on the planet recommends using a formula like 110 – age to determine the percentage of your portfolio that should be in stocks versus bonds. According to the old wisdom, the older you get, the more money you should put in bonds.

The reason that the shift works is because most retirees who face money problems will do so because their portfolios get hit in the first 10 years of retirement. Endure a few bad years in the market while you’re withdrawing money and cat food beckons. This is because, even though you’re no longer contributing to your retirement portfolio, it’s still supposed to grow, at least for a while, to reduce the chances that you’ll run out of money before you run out of heartbeats. Kneecap it while it’s still young (relatively speaking), and it has no chance to recapture the lost value. You will take out more and more of a percentage of your portfolio every year because your expenses will exceed the growth, and that’s a formula for learning the fine art of dumpster diving.

Thus, according to their research, you want to be most conservative in those vulnerable years – the 10 years after you retire – so that you can preserve capital first and foremost and then give it a chance to grow. Once you’ve survived the initial period of vulnerability, you can get more aggressive with your portfolio because you’ve, most importantly, noticeably reduced the amount of time you’ll have left on the planet to need it.

It’s the same reasoning that Dr. Pfau used to suggest not needing bonds in retirement if you purchase annuities (see the comments in the research article for his confirmation).

Being able to effectively replicate the financial outcomes of buying an annuity is very important. There is one thing, though, that it does not buy for you.

Buying annuities means buying happiness.

Yes, according to research by the RAND Corporation’s Constantijn Panis, buying an annuity can buy you a degree of happiness in retirement that you don’t get without one. Panis’s research looked at the Social Security Administration’s Health and Retirement Study (HRS) to compare the reported happiness of retirees who had guaranteed streams of income (pensions and/or annuities, not counting Social Security) with those who did not have the guaranteed streams of income.

Even those retirees who had a small amount of guaranteed income – between 1% and 25% of their total income – were, on average, 24.1% happier than those who did not have guaranteed income. They were also less prone to depression and they maintained a higher level of happiness throughout retirement, compared to their guaranteed income-less peers, whose retirement satisfaction decreased over time.

Panis even isolated retirees who had the same amounts of income, since, naturally, people with more income would be happier than people with less income. Even in the same income brackets, regardless of income, retirees with guaranteed sources of income were happier than those without. They were slightly less inclined to be depressed, too.

A study of British citizens confirmed the RAND findings; the only factor that increased satisfaction and happiness and decreased anxiety among retirees was having a steady source of income.

If we can achieve the same financial results by doing it ourselves that we can by purchasing annuities, why, then, are we happier when we buy annuities?

It’s because personal finance isn’t just about numbers.

Psychology and our friend Monkey Brain play a large role in the actual implementation of money strategies in our lives. Let’s look at a few of the reasons why we might be happier.

• Loss aversion. Whenever we lose a dollar, we feel a lot more pain than we feel happiness when we win a dollar. This is known as prospect theory, and it can affect our overall happiness. So, while, in constructing a DIY equivalent of an annuity, we may wind up at the same destination, we have to suffer from ups and downs along the way, causing us stress and unhappiness. Your portfolio will go up and down every year; an inflation-adjusted annuity provides you the same, steady purchasing power each and every year.
• Fear of risk. No annuity is 100% safe and guaranteed, but a SPIA purchased from a solid provider will be as close to certain as you can get without being the U.S. government. However, even though the market generally goes up over time, there’s no guarantee that it won’t completely tank. The chances of falling off the tightrope are fairly slim, but you have no safety net when you roll your own retirement.
• Cognitive decline over time. We’ve previously discussed in the article “Are Your Parents Losing the Ability to Deal With Money?” how, after age 60, people start to suffer from cognitive decline, and the first skill that shows a noteworthy reduction is the ability to do math. Trying to figure out how much of your money should be in bonds versus stocks is not a calculation a lot of centenarians want to be making.
• Knowing an income number makes you happy. As we discussed previously in the article “Why You Shouldn’t Obsess Over Your Net Worth,” people who know how much income they’re going to have in retirement are happier than those who focus on the amount of money they have in the portfolio. Since Monkey Brain is bad at math, he’s happier when he has a simpler mental calculation to make.
• Retirees have better things to do with their time than to mess with their money. Face it, those who reach retirement by choice (rather than by being forced to retire due to ailments) scrimped and saved and invested wisely to get to a point of security, and they just don’t want to have to fool with the **** thing anymore!
• The older you get, the happier you become by focusing on the present, and not the future. Having a guaranteed stream of income for life takes away the need to think about how safe and secure the future is, allowing retirees to think more about the present, which leads to more happiness.

In my interview with Dr. Pfau, we covered the annuity puzzle and why Monkey Brain doesn’t like the idea of purchasing annuities, even if they could make him happier. He will take some convincing if you decide that they are, after you account for all of the factors involved in a decision to buy annuities, right for you.

Maybe annuity advertisements should come with pictures of soft puppies. They both can bring happiness.

What do you think? Do the findings about annuities and their link to happiness surprise you? Let’s talk about it in the comments below!

Around a year ago, I wrote about how Monkey Brain can get involved in your home purchasing decisions. If you haven’t read it, go check it out!