A Physician’s Retirement Income: Expert Tools to Avoid Poverty

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Retirement income implies cash flow for life.  You never want to run out of money in your old age.  Know your Wealth Zone and reduce taxes on retirement income. Learn all you can about guaranteed retirement income options like Social Security. This post looks at more advanced ways of providing retirement income for life.

[This is a guest post by David Graham, MD.  He and I commiserated by email about starting our blog’s last year.  His site is FIPhysician.  As the name implies he reached FI and enjoys helping other physicians get there too.  He coaxed me into taking a CFP course online at BU. I’m embarrassed to say I neglected to include him on my list of physician bloggers. If you like this, read his other guest posts at White Coat Investor, DrBreatheEasyFinance, DebtFreeDr, and Physician on FIRE.-WD]

Picture retirement spending as a “smile”— you spend more in the early years of retirement on things you enjoy. Later, spending slows down only to increase again on medical and geriatric needs. Fixed income forms a floor through all of retirement, while the higher early and late expenses are mostly variable.

Some retirees desire to cover their fixed income needs with guaranteed income such as social security, pensions or annuities. As a result, this creates flexibility in the early retirement years and safety from those fears of cat food and refrigerator boxes in the later retirement years.

Retirement Income with Annuities

Let’s look at the role annuities play in retirement income planning.

Negative feelings circle annuities like proverbial vultures, though Wealthy Doc says you can safely increase your retirement income with a SPIA (Single Premium Immediate Annuity). In addition, the White Coat Investor calls SPIAs “The Good Annuity.”

You don’t invest in annuities, you buy them. They are insurance products that transfer risk. The purpose of a SPIA is to guarantee a life-long income in exchange for a lump sum of money.

Single Premium Immediate Annuity

A SPIA is an immediate income annuity meant to provide income and some longevity insurance (the risk of running out of income if you live a long life). The income you get every month doesn’t stop until you (or you and your spouse if you purchase a Joint and Survivor annuity) die.

Deferred Income Annuity

Another annuity specifically for longevity planning is a DIA (Deferred Income Annuity). With a DIA, you make initial lump sum payments but defer turning on the income for a number of years in exchange for a higher percentage of income when it eventually is annuitized.

You can buy SPIAs in both non-Qualified (AKA taxable or brokerage) accounts and in Qualified (IRAs and other pre-tax) accounts. The tax treatments for these differ. The former is partially taxable and the latter is fully taxable.

Until recently DIAs could only be purchased in your brokerage account. Enter QLACs.

Retirement Income with QLACs

There is a new kid on the block, though, gaining some interest: the QLAC (Qualified Longevity Annuity Contract), a DIA for your IRA.

Some investors are excited to use QLACs to decrease Required Minimum Distributions (RMDs). They actually just delay RMDs, though, and you will pay eventually. QLACs do allow you to defer until as late as 85 years of age. As a result, they can be an interesting option for longevity insurance and for spouse protection/planning if used as a Joint and Survivor annuity. More on QLACs below.

SmackDown Comparison

I thought it would be fun for high-income folks to see a smackdown comparison of The Good Annuity vs. The New Kid on the Block in a fictional couple planning for their retirement.  This is truly an “apples and grapes to oranges and raisins” comparison (an immediate income brokerage annuity vs. a deferred longevity IRA annuity). However, it should be interesting to see how the match goes.

I will also briefly compare a brokerage DIA and a Qualified SPIA as well.

Meet Our Couple

Our couple is 74 and 69 years old in 2019. They made a good living and spent freely in early retirement. Since longevity runs in both families they worry about outliving their money. A 30-year plan (until 95 and 100 years of age respectively) wouldn’t be excessive. 

Their remaining nest egg is $2,000,000. Now that their spending has slowed down a bit, they plan to spend about $7,500 a month—a 4.5% withdrawal rate.  This couple is conservative and believes the stock market won’t keep making the great returns of the last decade. As a result, they keep $250,000 in cash and have a 50/50 stock-to-bond ratio (which they assume will pay 6% and 3%).

They have $250,000 in a Roth IRA, $750,000 in a roll-over IRA, and a brokerage account worth $750,000. Inflation is 2.5% except for healthcare which is 5%. Finally, they receive $3,000 a month in social security.

Current Plan Without an Annuity

Monte Carlo simulation of this scenario demonstrates a 53% chance that their plan will succeed. In addition, stress testing shows a particular sensitivity to interest rate and longevity risks.

Figure 1 above shows the confidence levels that money will last to specified ages of the 74-year-old partner. The plan ends at 105 which is when the 69-year old partner expects to die at 100 years of age, a full 10 years after the older spouse passes.

Figure 2 shows the income sources with 28.6% of the income “stable,” as it comes from social security. Note that the expected need for income and the social security income drops when the older partner dies at age 95. Also note there is a spike in “income” to pay the taxes at age 102 when the brokerage account runs dry and taxes are paid on the IRA, which is used briefly to fund income needs until it too runs out.

From a cash flow standpoint, the brokerage account is accessed for needs above RMDs. Initial RMDs start at about $28,000 a year and increase to $50,000 a year at age 95. The brokerage account runs out of money at age 101 and the IRA is exhausted at age 103. Finally, taxes in this scenario start at about $12,000 a year and max out at about $18,000 a year at age 87.

This plan upsets the younger spouse who is determined to live to 100, and they wonder if a SPIA would help.

SPIA Plan for Retirement Income

They decide that $260,000 from the brokerage account would be an acceptable amount to buy a SPIA, and are offered a 7.2% yearly rate of return on a single life annuity on the younger spouse.

A few words about the assumptions above: the QLAC maxes out at $130,000 this year, so I decided to see what a $260,000 SPIA would look like. On the planning software, Monte Carlo projections improve the more money spent, but our couple didn’t want to exhaust their brokerage account. Also, they could have opted for a Joint and Survivor policy, but the younger partner felt sure of a longer life than the older spouse. Of course, a single life policy offers better returns than a joint policy. Finally, the percentage return will, of course, vary depending on specific circumstances and current interest rates.

With a $260,000 SPIA, the couple now has a 60% chance for success on Monte Carlo Simulation. The asset simulation (similar to figure 1 above) for the SPIA plan looks just slightly better, so it is not reproduced here.

Figure 3 above shows a drawdown comparison between the two plans. Initially, a $260,000 investment can be seen in dark blue, but the income from the SPIA slows the downward slope of the drawdown. The “crossover point” where the couple has more money with the SPIA is after 23 years–when the oldest partner is 97. It should be noted, however, that at no point is there a huge difference in the total amount in either plan. At the end of the plan, the SPIA saves about $103,000.

Stable Retirement Income?

In the SPIA plan, 39.6% of the income is stable from social security and the annuity. We can see the spike in income again at age 102, so let’s look at the cash flows to see if the brokerage account runs out of money about that time.

With expected cash flows, the brokerage account starts out $260,000 less than in the previous simulation. RMDs are the same, and the brokerage account runs out of money at age 100. The IRA runs dry at age 102. However, the Roth has $103,000 more at the end of the plan than without an SPIA.

In summary, we slightly increased this plan’s Monte Carlo odds and offered a bit more income stability, but the younger spouse asked to see a QLAC.

QLAC Plan

In 2019, you can invest 25% of your IRA up to a maximum of $130,000 into a QLAC. The couple decided to see what $130,000 from their IRA would buy and were offered a 14.4% rate of return for a 10-year deferral of income. Again, don’t get hung up on the interest rate.

Monte Carlo simulation for the QLAC is 60%, and an asset simulation is seen below in figure 5.

The drawdown comparison is pretty similar to figure 3 above, so not repeated here. The crossover point in this example is 99 years of age when the QLAC plan has more assets than the initial plan.

In the QLAC plan, 36.3% of the income is stable from social security and the annuity. In addition, we again see the familiar bump—now at age 103.

Looking at cash flows, the IRA starts $130,000 less than in the other two plans. RMDs start at about $23,000 (down from $28,000 before) and peak at $41,000 at age 94 (down from $50,000 at age 95). Finally, the brokerage account runs dry at age 102 and the IRA at age 103.

Like the SPIA, the QLAC provides a slight increase in Monte Carlo odds, and both plans lower the risk of inflation and longevity on stress testing.

So—who is the winner of the smack-down competition? That is for our couple to decide.

Meanwhile, let’s briefly consider the two other possible combinations for immediate vs deferred and non-Qualified vs Qualified.

Brokerage DIA

Running some simulations of a 10-year DIA in the taxable account, the Monte Carlo success rate increases the more spent. We can spend all of the brokerage accounts on a DIA and achieve a 94% success rate.

As a result, about 71% of the income is stable and the ending balance is over $1,000,000. However, again, the 99 is the crossover point, meaning that longevity insurance comes at a price.

The younger spouse has to live at least 25 years to see the large initial drop in their brokerage account return to the baseline amount without the DIA.

Qualified SPIA

Like the other plans above, for the SPIA in a Qualified account, Monte Carlo success rates increase with higher initial sums of money from the IRA. We can use the entire $750,000 to purchase a SPIA and get up to a 79% success rate. Again, the large difference in account balances until the age of 99 demonstrates the cost of longevity insurance (see figure 7).

In a nutshell, either of these annuity options (SPIA or DIA) in either account type (Qualified and non-Qualified) increases the odds of success, especially if the couple is willing to use a large sum to purchase the annuity.

Of course, you can mix and match. Each spouse could get their own (or Joint and Survivor) QLAC from their IRA, with or without a SPIA or DIA from the brokerage account. Planning for income and longevity with multiple annuities is common.

Simply a Tool

There is a saying in retirement circles that annuities are simply a tool. And, as in all investing, decisions are tradeoffs. Asset allocation, partial Roth conversions, and delaying social security are examples of tradeoffs between risk and reward. Annuities, when used appropriately, lower both potential risk and possible reward.

If you have significant fixed income needs, then a SPIA is a good tool.

If you have significant longevity risk and may run out of money, a DIA can come in handy.

For folks with health and expectations to live a longer than average life, a DIA can help you sleep at night. Annuities have no under-writing or medical exams. Insurance company and other folks in your insurance pool “want” you to die early.

You just have to live longer than the actuaries think you will get your money back. But the point is insurance—not getting your money back.

Do any of us complain when we don’t get our death benefits from term life insurance?

Retirement Income Opportunity Cost

Of course, there is opportunity cost—the lost opportunity to otherwise invest the money used to buy an annuity. No one, however, is going to guarantee that the stock market will give you stable, life-long income.

In addition, it is often said that annuities are sold rather than bought. While it is clear annuities do have strengths, each investor must weigh the guarantees against the money spent. Once you sign up for an annuity, that money is gone and cannot be used for emergencies or given to heirs.

Retirement Income Inflation Risk

Inflation is perhaps the biggest risk to retirees. For that reason, Variable Annuities and Fixed Indexed Annuities are often sold as a hedge against inflation, as you can participate in the gains of the stock market (with all the risks theretofore and extra fees to boot). Perhaps a better way to deal with inflation is to set aside some of your nest egg for a future SPIA as part of your overall plan. Cost of Living Adjustment riders in annuities have lower initial payments and are likely not the best option.

Final Thoughts on Retirement Income

If you are married and have a large IRA, you can hedge against the widow/widower tax penalty (where tax brackets decrease at the death of the first spouse) with a Joint and Survivor QLAC. This will lower RMDs while providing future fully taxable income for the surviving spouse.

Otherwise, a Joint and Survivor annuity can offer some piece of mind at the cost of significantly lower income payment.

Consider a single life annuity if one partner is significantly younger or healthier than the other. Income payments for males are higher (as we die earlier), so a couple can explore both dual single life and Joint and Survivor options.

Finally, annuities often come with riders. There can be a term certain (it will pay for a certain number of years even if you die) or other refund type options in case you die early. Riders like this can be expensive and are something to think about forgoing. When buying insurance in case you live a long life, do you really want a refund if you don’t?

[Thank you for persisting to the end of a challenging post.  Retirement income that comes as guaranteed cash flow for life is worth studying.  I convinced my mother to sell some of her mutual funds and buy a SPIA.  She has been enjoying that guaranteed monthly cash flow.  If you don’t like volatility or you haven’t saved enough over the years to provide adequate cash flow, consider these more advanced tools. -WD]

About the Author

David Graham, MD is a practicing Infectious Disease physician and blogs at FiPhysician.com. After discovering his passion for personal finance, he started a Registered Investment Advisory to promote his mission “Financial Literacy for Physicians.” For personal enjoyment, he recently sat for and passed the CFP exam.

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