Posted by Tim Stobbs on September 12, 2012
I personally don’t have a defined benefit pension, but in some regards I do understand the pension envy around defined benefit pension plans. You make you contributions, work your required period of time and as long as your employer doesn’t go bankrupt you get to collect a set amount of money per month for life. Talk about easy for the employee: no stress about investment decisions, no worry about running out of money in retirement, you just sit back and collect the checks after your done work.
So what is a person to do if they don’t have a defined benefit pension, but they would like some of those features in their own retirement plan? Simple, you buy your own mini defined benefit pension by purchasing an annuity. But aren’t annuities for old people? Typically yes, older people do have them, but in function they are very similar to a defined benefit pension plan as you pay the insurance company to accept all the investment risk for you in exchange for a set amount of payments.
Now obviously doing this sort of investment does have its price. You have to know that insurance companies don’t do this out of the goodness of their heart at a cost neutral basis, they expect to make a profit on it. So keep in mind you likely won’t get the same level of return if you had invested the money yourself. You also have consider what features you want in your contract with the insurance company. Do you want to have your spouse get a benefit when you die? If not, did you want a set amount of payments to go to your estate in the event you get hit by a bus the day after your annuity? Do you want to the payments to increase with inflation? The more features you add the lower your payment will become.
Overall I personally don’t have a problem with annuities if you have a very low risk tolerance and you only invest some of your nest egg to cover some of your basic expenses, the idea does make some sense. I have issue with people that go overkill and put all of their retirement savings into an annuity. If you choose this option you really need to shop around at different companies to get an idea of what they can do for you and get some quotes, for example check out Aviva which has some decent reference material (and then check our insurance companies in your home country). I personally won’t use an annuity for my early retirement period, but when I start getting older the idea does have some merit. After all, I’m not sure I want to be worrying about my investment portfolio so much when I turn 70.
So would you ever consider buying an annuity?