CFI Blog

Annuity Dollar Cost Averaging

“My NFL pension can barely pay my son’s tuition. You know, it’s very little money.”
–O. J. Simpson

Many years ago, people worked for a company for their entire lifetimes, got a gold watch and a pension upon retirement, and were able to live on that pension for the rest of their lives. The retirement age was pretty close to the life expectancy, so not that many people enjoyed a long life with a pension. However, as life expectancies rose and employers changed, the use of pension benefits decreased. As of 2008, only approximately 20% of workers were covered by a defined benefit pension plan. Resultantly, a minority of people can count on steady retirement payments outside of Social Security upon retirement; the rest have to use their own savings to make up the shortfall, if necessary, between Social Security and their expenses.

One possible solution to make up the shortfall and to reduce risk is to purchase an annuity. Annuities give some level of security that payments will continue no matter how long you live. Just as with nearly anything else, though, there are some risks to annuities. The annuity provider could go bankrupt, and if your annuity amount was greater than the amount covered by guaranty providers, then you will lose that money – usually this amount is $100,000, but varies by state.

Dollar Cost Averaging

Another risk is that interest rates could change. This has two repercussions. The first is that the amount of payments the same purchase price would buy could change: if interest rates rise, then payments will rise, and if interest rates drop, so, too, will payments. You could find yourself thinking “woulda, coulda, shoulda.” The second repercussion is that inflation will generally rise or drop with interest rates. Inflation tends to be low in low-interest-rate environments and high in high-interest-rate environments, though interest rates aren’t usually the cause of inflation. Higher inflation means that you lose purchasing power with the same amount of money. Many annuities offer inflation riders, for a cost, but the rider may not adjust your payments as much as inflation rises.

One approach is to dollar cost average annuity purchases over several years. Similar in concept to dollar cost averaging, where you buy stocks/mutual funds/bonds periodically to buy more when the market is low and to prevent you from attempting to time the market, the idea behind annuity dollar cost averaging is to buy streams of payments in increments rather than in one big lump sum. There are many reasons to consider dollar cost averaging into annuities:

  • Dollar cost averaging can allow you to have annuities that are under the guarantee thresholds of your state.
  • It allows you to buy streams of income in years when payments are higher.
  • As you age, the amount of money required to fund you through your life expectancy decreases, allowing you to buy more income for the same purchase price.

When you have annuitized enough to cover your expenses, then you are free to take more risks with your remaining assets to try to grow them, as you do not need the assets to ensure an adequate standard of living.

This is an approach that, over time, trades growth for security. Once you’ve bought an annuity, you’ve, for the most part, locked in an income stream at a guaranteed rate and forsaken the upside of significant market growth. However, you’ve also reduced the chances of running out of money and reduced the impact of a decrease in the market.

Dollar cost averaging annuities are not for everyone, but if you are considering buying annuities, it is a viable alternative to purchasing all of your annuities in one lump sum.

Author Profile

John Davis
John Davis is a nationally recognized expert on credit reporting, credit scoring, and identity theft. He has written four books about his expertise in the field and has been featured extensively in numerous media outlets such as The Wall Street Journal, The Washington Post, CNN, CBS News, CNBC, Fox Business, and many more. With over 20 years of experience helping consumers understand their credit and identity protection rights, John is passionate about empowering people to take control of their finances. He works with financial institutions to develop consumer-friendly policies that promote financial literacy and responsible borrowing habits.

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