# One Way to Beat the Rate of Return Offered by Annuities

A recent Wall Street Journal article asked an interesting question: Could You Retire Without Social Security? Please note, you might require a WSJ subscription to view the article.

According to government data, a 65-year-old man can expect to live, on average, another 17 years. A woman can expect to live on average another 20 years. But these are only averages, and they are widely misunderstood. Some people will die at 66. Others will live to 100.

What are your odds? According to federal data, someone who is 65 has around a 25% chance of living to 90 and nearly a 10% chance of living to 95. For women the figures are even higher. Of women age 65, one in eight will live to 95. If you're making a pile of savings last, you need to plan for all contingencies. The only way to make sure of that is to buy an "immediate annuity," the kind that most closely mirrors Social Security's steady stream of regular payments.

Social Security also offers something most annuities don't: inflation protection. Very few insurance companies offer anything similar.

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According to ImmediateAnnuities.com, a 66-year-old man would have to pay \$128,000 for an annuity providing him with income of \$10,000 for life. A 66-year-old woman would have to pay even more, about \$138,000.

If we fire up Microsoft Excel and use the 66-year-old man as an example, then, if we assume 17 years of additional life, we get a return of 3.35%. If, however, we assume only 16 years of additional life because he is 66, not 65, then we get a return of only 2.75%. Either way you slice it, the results are meager. So, if we were to assume that this man wanted \$50,000 annually, he would require \$640,000. However, his \$50K retirement income is not indexed. As his life progresses, he will receive less and less in real money. Even worse, as he gets older his medical expenses are likely to increase in real terms. That is, he will require more medical assistance.

Let's assume inflation runs at 2% per year. After just ten years, his real income has decreased by about 22%, leaving him with about 78% of his initial purchasing power. But what happens if inflation skyrockets over the next few years. Commodity prices, particularly energy, continue to escalate quickly. Then what?

Then what, indeed. He's trapped. He might not be able to find additional work to supplement his income.

The current quantitative easing is depressing interest rates and raising the risk of higher inflation percolating though the economy. The low interest rates make annuities unattractive, and inflation destroys purchasing power. For those retiring, this combination is lethal.

Given the extremely low rates of returns for annuities, people should carefully examine their options. For example, Bank of Montreal (NYSE:BMO), which closed at \$57.26 on Friday, pays a dividend of approximately 4.5%. On 17 December 2010, BMO announced an acquisition (again, a WSJ subscription might be required) of Marshall & Isley. Remember, Canadian banks largely escaped the U.S. mortgage mess, and in BMO's takeover, it's buying a U.S. bank after the damage has been done. While I am not recommending BMO, or any security for that matter, I am pointing out that there are reasonable options that allow you to match or beat the rate of return offered by annuities. And even better, you can change your mind in a heartbeat.

The WSJ article was one of its most emailed articles last week. I am not surprised given that boomers are retiring or planning to retire in the not too distant future. If you are planning for your retirement, I encourage you to read the WSJ article.

Disclosure: I have no position in Bank of Montreal.