^“I like to go for broke cause I'm that kind of man” My Name is Young – Young MC.

Balancing Self-Insurance and Annuitizing for Longevity Risk

As the CEO of a wealth management firm, one of the most crucial discussions I have with clients involves balancing self-insuring for longevity risk and annuitizing retirement income. Both strategies have distinct advantages and potential downsides, and understanding these can help you make informed decisions for a secure retirement.

What am I talking about?

At its simplest, if you do not insure a particular risk, you are self-insuring that risk. According to Google, self-insuring can be defined as insurance of oneself or one's interests by maintaining a fund to cover possible losses rather than by purchasing an insurance policy. As a person with some sort of investment account or assets set aside to provide for retirement, you are essentially self-insuring against the risk of living so long that you run out of money. Our experience is that when we ask prospective clients or clients about risk, #1 or at least in the top 3, is the risk of running out of money.

And because of this risk, families typically do one of two things:

1. Spend the rest of their time on the planet worrying about running out of money, or
2. “Over Self Insuring” and leaving this planet with a large amount of funds they cannot take with them, not having necessarily lived life to the fullest that their money could have provided.

This is a topic worthy of debate and discussion in person but here is a list of some thought-provoking pros and cons of either alternative.

Self-Insurance: Pros and Cons

Self-insurance means relying on your savings and investments to provide income throughout retirement. This approach requires careful planning and disciplined saving during your working years.

Pros:

1. Control and Flexibility: You retain complete control over your assets, allowing for more personalized and adaptable financial strategies.
2. Legacy: Unspent assets can be passed on to heirs, making this option appealing for those who wish to leave an inheritance.
3. Potential for Higher Returns: If your investments perform well, you could potentially generate higher returns compared to the fixed income from an annuity.

Cons:

1. Market Risk: Your retirement income is subject to market fluctuations, which can impact the stability and predictability of your income.
2. Longevity Risk: There is the risk of outliving your savings, especially if you underestimate your life expectancy or face unexpected expenses.
3. Complexity: Managing a self-insured retirement plan requires ongoing attention and potentially complex investment strategies.
4. Over insuring and worry: The tendency to spend life worrying or not spending your hard-earned money on what life offers while you are here to enjoy it.

Annuitizing: Pros and Cons

Annuitizing involves converting a portion of your retirement savings into a guaranteed income stream through an annuity. This can help mitigate longevity risk by providing a steady income for life.

Pros:

1. Guaranteed Income: Annuities provide a reliable income stream, which can help cover basic living expenses and reduce financial stress.
2. Longevity Protection: You will not outlive your income, as annuities can be structured to pay out for the remainder of your life.
3. 3. Simplicity: Annuities can simplify financial planning by reducing the need to manage investments and withdrawals.

Cons:

1. Lack of Flexibility: Once you annuitize, the decision is typically irreversible, and you lose access to the principal amount.
2. Inflation Risk: Fixed annuities may not keep pace with inflation, potentially eroding your purchasing power over time.
3. Cost: Annuities can come with fees and lower returns compared to investments, particularly if they include features like inflation protection or death benefits.

Finding the Right Balance

Balancing self-insurance and annuitizing requires a personalized approach, considering your unique financial situation, risk tolerance, and retirement goals. Here are some things to consider:

1. Hybrid Approach:

   - Combination Strategy: Many retirees find a hybrid approach beneficial, using annuities to cover essential expenses while keeping some assets invested for growth and flexibility.

   - Risk Mitigation: This strategy can mitigate both longevity and market risks, providing a stable income while allowing for growth potential.

2. Considerations for Self-Insurance:

   - Adequate Savings: Ensure you have sufficient savings and a diversified portfolio to manage market fluctuations.

   - Withdrawal Strategy: Implement a disciplined withdrawal strategy, such as the 4% rule, adjusted for market conditions and personal needs for your foundation. But push the cash flow analysis and projections to make sure you are spending enough and enjoying that which you enjoy while you can enjoy it.

   - Emergency Fund: Maintain an emergency fund to cover unexpected expenses without depleting your investment portfolio.

3. Considerations for Annuitizing:

   - Essential Expenses: Calculate your basic living expenses and consider annuitizing enough to cover these costs, ensuring financial security.

   - Inflation Protection: Look for annuities with inflation protection to maintain your purchasing power over time.

   - Diversification: Don't annuitize all your assets; keep a portion invested for flexibility and potential growth.

Conclusion

Both self-insuring and annuitizing have their merits and challenges. The optimal approach may involve a combination of both or at least a more thoughtful approach than you may currently have. Either way your solution should be tailored to your specific circumstances and retirement goals.

Every family is different. Some want to leave a legacy for their families, some want to stiff the undertaker, die with zero and go for broke[i]. Regardless of the specific goal, I have yet to meet a family that has the goal of worrying about running out of money for the rest of their lives.

At Members’ Wealth, we are committed to helping you navigate these decisions, toward a balanced and secure retirement plan. By understanding and addressing the pros and cons of each strategy, you can confidently work towards a financially stable and fulfilling retirement.

[i]
"Go for broke" is an idiom that means to risk everything in an all-out effort to achieve a goal. It suggests putting everything on the line, whether it's money, effort, or resources, with the aim of achieving something significant or worthwhile. The phrase originated during World War II, used by the 442nd Regimental Combat Team, a unit composed mostly of Japanese American soldiers, which adopted it as their motto. It essentially means to give it your all, regardless of the potential risks.

About the Author – Dane Czaplicki, CFA®

Dane Czaplicki is CEO of Members’ Wealth, a boutique wealth management firm that offers a comprehensive approach to serving individuals, families, business owners, and institutions. The firm’s goal is to preserve and grow its clients’ wealth to endure over time, while thoughtfully evolving its strategy to suit an ever-changing world. With over 20 years of wealth management experience, Dane and the Members' Wealth team thrive on bringing clarity and confidence to clients' unique situations. He believes everyone needs sound financial advice from someone whose interests are aligned with theirs, and is determined to put service before all else.

Dane received his MBA from The Wharton School of Business at the University of Pennsylvania and his bachelor’s degree from Bloomsburg University. Outside work, he enjoys spending time with his wife and kids, hiking and camping, reading, running, and playing with his dog. To learn more about Dane, connect with him on LinkedIn.

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