Smackdown: Dividends vs Annuities, The Main Event

Includes: BMY, CSCO, CSX, JNJ, KO, XOM
by: Regarded Solutions

Two weeks ago, I wrote this article about my opinion towards annuity purchases versus dividend stock investing. The response was overwhelming. It currently has 377 comments, and counting. There has been plenty of give and take from both sides of the fence, and for the most part, the commentary has been candid as well as respectful.

At times, I did become my cranky self, with some biting retorts, as did some of the other commenters. It was to be expected I suppose, with as touchy a subject as it is. I realize that I hit a nerve with insurance folks, and even a few professional financial planners (I even received some rather "interesting" direct messages). That being said, I still believe there are very few advantages in purchasing an annuity of any kind.

Let me be very clear about one important issue: If anyone is fearful of investing in the stock market, and is afraid that they will run out of money during retirement, investigating annuities could be prudent for you. As I stated in the original article, this is the number one reason an individual should consider purchasing an annuity insurance product.

On the other hand, if you are a prudent investor with a sound dividend investment strategy, I believe you will be much more financially secure than the annuity purchaser.

By simply looking at the Team Alpha Retirement Portfolio, an investor can see many of the basic elements of investing in a dividend income portfolio.

Our Team Alpha portfolio now consists of Chevron (NYSE:CVX) Apple (NASDAQ:AAPL), McDonald's (NYSE:MCD), Exxon Mobil (NYSE:XOM), Johnson & Johnson (NYSE:JNJ), AT&T (NYSE:T), General Electric (NYSE:GE), BlackRock Kelso Capital (NASDAQ:BKCC), KKR Financial (KFN), Procter & Gamble (NYSE:PG), CSX Corp. (NYSE:CSX), Realty Income (NYSE:O), Coca-Cola (NYSE:KO), Annaly Capital (NYSE:NLY), Cisco (NASDAQ:CSCO), Bristol-Myers Squibb (NYSE:BMY), Healthcare Select Sector SPDR (NYSEARCA:XLV), and iShares S&P U.S. Preferred Stock Index Fund (NYSEARCA:PFF).

The yield on cost of this portfolio is currently 4.72%, and the growth has been roughly 35% over the last 15 months.

If you were to invest in these very stocks right now, with an equal dollar allocation, your yield on cost would be roughly 4.29%. I suggest taking this into consideration as you contemplate your own dividend investing strategy.

The Smackdown

For this follow up article, let the facts and figures do all of the talking. I have prepared a spreadsheet on a plain vanilla dividend stock investment plan, versus an individual fixed annuity without any other features and benefits, other than the annual payout. It contains the following assumptions:

  • The investor is a 65 year old male with $100,000 in cash.
  • The portfolio consists of mega-cap, blue chip, dividend winning stocks only.
  • The average growth rate is 5%, which is lower than the historical growth rate of the S&P 500 (which is about 7-8%).
  • The dividend rate is 3.00%, which is right in line (actually a little less) with the historical dividend yields of the dividend champion stocks of the USA.
  • I did not calculate any growth for the dividends. (An unlikely scenario)
  • Both the dividends and the growth rate have been calculated back into the investment each year.
  • A steady withdrawal rate of 6% each year has been calculated.
  • I did not figure any tax implications on the withdrawals, nor have I added anything for inflation.
  • The annuity is for an individual male, aged 65.
  • The initial purchase is $100,000.
  • The annual payout rate is 7%, which is somewhat higher than average.
  • There are no joint survivor payments, since I wanted the highest payout possible for this annuity.
  • Since this is a fixed immediate annuity there is no growth rate, nor dividend accrual, to the $100,000 purchase.
  • The 65 year old male dies at age 80 in each scenario.

Let's Take A Look At The Results

Dividend Stock Portfolio
Total Growth Dividend Withdraw
Invested 5% 3% 6%
Year 1 100000 105000 108000 6480
Year 2 101520 106596 109341 6560
Year 3 102781 107920 111003 6660
Year 4 104343 109560 112690 6761
Year 5 105929 111225 114402 6864
Year 6 107538 112914 116140 6968
Year 7 109172 114630 117905 7074
Year 8 110831 116372 119696 7181
Year 9 112515 118140 121515 7290
Year 10 114225 119936 123362 7401
Year 11 115961 121759 125237 7514
Year 12 117723 123609 127140 7628
Year 13 119512 125487 129072 7744
Year 14 121328 127394 131033 7861
Year 15 123172 129330 133025 7981
At Death 125044 107967

At age 80, the value of the portfolio is $125,044. The amount withdrawn over the 15 year period is $107,967.

Individual Fixed Annuity
Initial Growth Dividend Ann.Pay
Purchase 0% 0% 7%
Year 1 100000 7000
Year 2 100000 7000
Year 3 100000 7000
Year 4 100000 7000
Year 5 100000 7000
Year 6 100000 7000
Year 7 100000 7000
Year 8 100000 7000
Year 9 100000 7000
Year 10 100000 7000
Year 11 100000 7000
Year 12 100000 7000
Year 13 100000 7000
Year 14 100000 7000
Year 15 100000 7000
At Death 0 105000

There is no value left at the time of death and $105,000 has been paid back to the policy holder.

I realize that this is a very simple calculation, and there are variables not accounted for in each scenario. I offer this link for anyone who cares to plug in their own numbers for virtually any sort of immediate annuity scenario.

I believe all of the numbers speak for themselves.

The Bottom Line

Pay $100,000 for an immediate annuity policy, and as I have noted in the above scenario, not only will you receive less than THIS dividend investor over 15 years, but there will be none of the $100,000 left either. This dividend investor will still have over $125,000 in his estate at the time of death.

The decision is yours, and all scenarios are unique. If the market crashes by 20% one year, the numbers will look different. If the market rises by 20% one year, the numbers will look different.

By using a rather conservative return and dividend yield, I attempted to even the field, but any investment in the stock market carries risks.

The choice is yours, let the comments begin!

Disclosure: I am long AAPL, BKCC, BMY, CSCO, CSX, CVX, GE, JNJ, KO, MCD, NLY, O, PFF, T, XLV, XOM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.