With the US Congress poised to pass a bill allowing annuities to be offered in mainstream 401(k) plans, Americans soon will be asking a lot of questions about these financial products that provide guaranteed lifetime income for an upfront investment.
Moshe Milevsky is one of the few annuity scholars who can provide the answers in language regular people can understand.
By day, he teaches personal finance at the Schulich School of Business at York University in Toronto. He is also the author of several personal finance books, the most recent of which is “Longevity Insurance for a Biological Age.”
Milevsky spoke with Reuters about what people need to know about annuities. Below are edited excerpts.
Q: Why are you such a proponent of annuities?
A: The short answer is that anything that pays you money for the rest of your life is a good thing.
Q: So why don’t more people own annuities?
A: For 50 years, economists have been puzzling on why don’t more people buy annuities if they make so much sense. A hundred billion dollars in annuities is nothing compared to the trillion dollars in the retirement system.
At least 15 to 20 reasons have been posed. One of them is the trust factor.
Annuities are by definition complicated, emotional instruments that require an intermediary to help. Buying an index fund, by contrast, is a very cold transaction that you can do very cheaply online in about 10 seconds.
Q: Can people be convinced by logical arguments to overcome those fears?
A: Absolutely not. It’s a gut instinct. The last thing you want to do to somebody reluctant to buy an annuity is send them to Econ 101.
Q: What is the biggest money conundrum for your personal finance students?
A: They are very concerned that our curriculum is about investing and asset allocation when most of them have no assets. They have debt. They want to know how to manage debt properly and how much is too much.
I also find that they are fascinated with taxes. Once they learn that Uncle Sam (or the Canadian Revenue Agency) has a piece of you for the rest of your life, they want to know how to minimise that.
Q: When do people need to get serious about retirement?
A: If I could pick a number, I’d say 40 is the magic age. Once you hit 40, you start to see this day when you will want to work less. I hate to use the word retirement; it doesn’t mean anything anymore. But people understand that they will want to slow down, and they will want to draw some of their money down.
Q: Your research delves into the centuries-old history of annuities. Why is this practice new again?
A: There’s a groundswell of support for annuity-like products not sold by insurance companies. This goes into the subject of tontines, and group self-annuitisation and with longevity risk-sharing schemes.
The Twitter summary of a tontine is that a group of people get together, buy a bond and share the coupons as long as they are alive. As we pass away, the coupons only get shared with the people who are alive. The longer you are alive, the more you get to enjoy the coupons, and the payments will continue to increase because people are passing away.
It’s a bit disappointing to me that we have to go back 300 years or 400 years to look for innovation in the retirement income space. There was a much more robust market for retirement income products in the 17th Century.
Q: Most people start retirement planning by trying to predict when they will die. What is your argument against that?
A: This is about saying: There’s a probability that you will live a very long time - much, much longer than you expect - and you need protection.
The wrong way is to say, “I’m going to only make it to 80, so I don’t need something that pays me if I get to 85.”
Stop guessing longevity. I wish I had a bumper sticker.