Tags: annuity

Ken Nuss: Schwab Intelligent Income vs. Immediate Annuity

retirement income
For successful people, money seems to fall from the sky. The Schwab Intelligent Income and a traditional immediate annuity attempt to make retirement income easy for retirees. (Dreamstime)

Friday, 05 November 2021 11:53 AM EDT

Most people worry about running out of money in retirement. In response, Charles Schwab launched the Schwab Intelligent Income™ in 2020. The program promises monthly income from a regularly rebalanced portfolio of diversified exchange-traded funds (ETFs) plus a cash account. Participants pay no commissions or advisory fees. This is one of the newest strategies to generate retirement income.

In contrast, the traditional income annuity is a strategy that has been around a long time.  It provides a guaranteed income for either a lifetime or a fixed term. It can also provide deferred or immediate payments.

A single-premium immediate annuity, or SPIA, is a popular choice that starts paying income right away. How does it stack up against Schwab Intelligent Income?  Each has its pros and cons, but I believe that the annuity comes out ahead overall. Since I make my living selling annuities via a long-established website, it’s not surprising I’d believe that, but I have good reasons.

Pros and Cons

The number-one advantage of an immediate annuity is that it will provide more income and is guaranteed to continue unchanged for your lifetime no matter how long you live. The Schwab plan provides less income, and you have a significant risk of running out of money if you live to a very old age.

The Schwab program does have some advantages, though. With the Schwab program, you retain control over your money and portfolio, unless you eventually exhaust your funds. With an immediate annuity, you turn over your money to an insurance company in exchange for a stream of guaranteed income. This type of annuity typically has no cash withdrawal value.

Schwab also provides more flexibility. You can choose your asset allocation anywhere from conservative, with very little in equities, to aggressive, with a larger percentage in equities. You may also start, stop or change the withdrawal amount.

Additionally, if markets do better than expected, you have the potential for long-term portfolio gains. There also might be some tax benefits via tax-loss harvesting and long-term capital gains. These potential benefits are difficult to quantify, however.

The Schwab program has significant cons. Along with the potential for long-term gains, there’s the risk of short- and long-term downturns in the stock and bonds markets. Related to this is market-timing risk: i.e. investing your money just before a market downturn and then exacerbating the problem by continuing to take monthly withdrawals from a depleted portfolio. That could make it difficult to recoup losses and result in eventually depleting your funds.

All this said, there are some cons to an immediate annuity. You’re relying on the long-term financial solvency of the issuing insurance company, so it’s wise to choose that insurance carrier very carefully. State guaranty associations insure consumers up to certain limits in the unlikely event that the insurance company fails. 

Also, an immediate annuity is less flexible than the Schwab program. You can’t start, stop or change the payment amount or term.

Why an Annuity Comes Out Ahead

In the end, however, after stacking up all of the pros and the cons, there is compelling evidence the immediate annuity is still the better choice. For all of an immediate annuity's cons, I believe that they are more than offset by the fact that an annuity pays more income than the Schwab plan -- and that income is guaranteed to last a lifetime.

The insurance aspect of the annuity provides this unique advantage. Even after the insurer has repaid your entire principal, your income will continue at the same level, even if you live to 95 or 105. Yes, you give up the opportunity for potential market gains, but you are completely protected from market declines.

Additionally, an annuity is simple. You set it and forget it. Furthermore, it’s also tax-advantaged because each payment includes both non-taxable return of principal and taxable interest until the principal has been repaid. This assumes you’re using nonqualified funds -- not an annuity in an individual retirement account (IRA) or other tax-deferred retirement plan.

An immediate annuity also offers options as to who it covers. It can cover a single person or a married couple. With the latter, if it’s a lifetime annuity (which most people choose), the payments will continue as long as either spouse is living.

Three Examples of Annuity Income

Each of the following scenarios is a joint annuity for a married couple, both age 65, purchased with $500,000 of nonqualified funds (as of October 2021).

Joint lifetime only income option annuity guarantees $2,058.59 of monthly income, of which just $391.13 is taxable for the first 25 years of the contract. After 25 years, the entire amount is taxable. With this option, there’s no payment to heirs should both spouses die before the principal is repaid.

Joint lifetime annuity with installment refund annuity guarantees $2,020.82 monthly payments, with $462.77 taxable for the first 26.75 years.  With an installment refund annuity, the insurance company guarantees that the total payout will not be less than the amount paid to purchase the annuity. If both spouses die before receiving payments that equal the purchase price, the difference is paid to their named beneficiaries in continued income installments.

Joint lifetime annuity with 30 years certain guarantees $1,886.54 monthly payments with $552.76 taxable for the first 31.25 years. The 30-years certain means that if both spouses die before 30 years are up, their beneficiaries will continue to receive the monthly income payments until a total of 360 payments have been made.

Three Schwab Scenarios

Let’s compare these choices with Schwab Intelligent Income, using figures generated by the calculator on its web page.

More Conservative Portfolio (15% equity) produces a $1,390.00 monthly withdrawal amount with a 20% chance that money will not last for 30 years

Moderate Portfolio (40% equity) offers a $1,500.00 monthly withdrawal amount; 20% chance that money will not last for 30 years

More Aggressive Portfolio (55% equity) offers a $1,580.00 monthly withdrawal amount; 20% chance that money will not last for 30 years

What are the chances that at least one spouse—a married couple, male and female, each age 65—will live to age 95 or older?  The Actuaries Longevity Illustrator gives us answers.

When both spouses are nonsmokers in average health, there is a 33% probability that at least one will live beyond the 30-year mark. When both are nonsmokers in excellent health, there’s a 45% probability that at least one spouse will. So, there’s a real possibility the Schwab plan will fail and run out of money eventually.

This article compared the Schwab program with an immediate annuity. But if you don’t need immediate cash flow, a deferred income annuity that starts payments in the future may be a better choice because it takes advantage of tax deferral longer.

Of course, it’s not an all-or-nothing choice. You can split up your funds among an immediate and/or a deferred income annuity and the Schwab plan or something like it. 

If you’d like to see what type of guaranteed lifetime income is available for your specific needs, AnnuityAdvantage offers a free immediate income annuity and deferred income annuity quote comparison services showing the highest payouts available.
Annuity expert Ken Nuss is the founder and CEO of AnnuityAdvantage, a leading online provider of fixed-rate, fixed-indexed, and income annuities. He launched the AnnuityAdvantage website in 1999 to help people looking for their best options in principal-protected annuities. He writes on retirement income and annuities regularly for several leading financial websites. A free quote comparison service with interest rates from dozens of insurers is available at https://www.annuityadvantage.com  or by calling (800) 239-0356.

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Most people worry about running out of money in retirement. In response, Charles Schwab launched the Schwab Intelligent Income annuity in 2020. This article examines that choice versus a traditional immediate annuity.
Friday, 05 November 2021 11:53 AM
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