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Q. My mom is 64 years old and attended a seminar about annuities for her retirement. She was about to transfer her $300,000 in retirement savings to the sales people but I stopped her from doing that after getting a better understanding of the financial product. The bottom line is that the actions of these sales people appear predatory, and buying annuities can impair growth and limit flexibility with my mother’s account. My mom’s entire retirement savings is this $300,000 but her condo is almost paid off and she will have a company pension that pays about $14,000 annually starting next year. I have two questions. Did I do the right thing by dissuading my mom from buying an annuity? Also, if she chooses to keep the $300,000 invested in a balanced portfolio of low-cost exchange-traded funds (ETFs) as I have set up for her, is this type of investment good for the long-term for her? —Many thanks, Andrew

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FP Answers: I feel your concern Andrew, but what if I told you that purchasing an annuity would automatically double your mother’s money from $300,000 to $600,000, not mathematically but psychologically? In Retirees Spend Lifetime Income, Not Savings, by David Blanchett and Michael Finke, the two research fellows suggest that every $1 transferred from an investment portfolio to a guaranteed income resulted in $2 worth of spending.

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They found that the person who buys an annuity paying $10,000 a year, with $140,000 will spend more on non-essential things than the person who doesn’t buy an annuity and spends from $140,000 kept in savings. Why? Because for one thing, the spending is on nonessentials, such as vacations, dining out more, and so on. And second, with an unknown future regarding inflation, interest rates and longevity, there is a reluctance to draw from investments.

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I see this in my own practice: even many retired clients with lots of money live a lifestyle well below their means. They say they are content, which may be, or they may feel more content about their prudence in dealing with the risk of future unknowns. It is as if they need two amounts of money saved for retirement: the mathematical amount that says they can retire, and an additional psychological amount providing them comfort to spend what the mathematical amount says they can spend. Having a larger guaranteed income may allow them to live a little larger.

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Andrew, think about your career progression. I am guessing you started out with a smaller income, which gradually grew along with your spending on nonessential things and you enhanced your lifestyle along the way. You do that because you have an income. At some point your paycheque may transition to a pension, which is another form of guaranteed income. It is not uncommon for pensioners to spend up to the maximum of their pension income because they know the income will keep coming for the rest of their lives. The fact is, people spend income, not investment portfolios.

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Does this resonate with you Andrew? If it does, then you will see that buying an annuity is not limiting, but freeing. It may ease limits around what you do with your remaining money, and give you freedom to spend more with less worry.

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If you disagree with the research findings and discount the psychological benefits of an annuity, then you will end up evaluating annuities only on their mathematical basis. Viewed mathematically, they will, as you say, come across as limiting and impair financial growth.