A century ago, money from Andrew Carnegie created Teachers Insurance & Annuity Association to pay pensions to schoolteachers, professors and other people who work at nonprofit organizations. In the early days, these pensions were backed by bond portfolios and paid fixed monthly sums. Then, in 1952, TIAA invented the variable annuity.
Payouts from this novel product were tied to the return on a collection of stocks called the College Retirement Equities Fund. Don’t put all your money in this risky thing, a retiring prof would be told, but put in some in order to keep up with the rising cost of living. Your payouts from Cref will be unpredictable but still very likely, over time, to greatly outpace payouts from a fixed annuity. That’s because stocks, over time, outpace bonds.
With the variable annuity, TIAA married the high returns on equities with the classic annuity benefit of longevity pooling. Longevity pooling means that people who die young collect less over their lifetimes than their colleagues who live long. Pooling is a bet worth making because it allows you do live well off a pot of savings without taking a risk that you will exhaust those savings. Pooling is how all monthly pensions work. It’s how Social Security works.
Cref was a hit. It now has $279 billion under management.
Is it a good buy? It looks that way to me. The graph displays the monthly payouts for a 67-year-old female who invested $100,000 25 years ago in the main stock account, which is akin to a global index fund with a 30% foreign allocation. She rode a roller-coaster, with payments cut in half during the crash of 2007-2009, but if she’s still breathing at 92 she’s now getting $2,146 a month, better than triple her $610 starting pension.
For the index fund, the combined fee (for salesmen, annuity administrators and portfolio managers) comes to 0.24% a year. In the world of annuities that counts as a bargain. Variable annuities sold by stockbrokers can cost eight times as much.
It helps that TIAA is a nonprofit and its annuity pools are run on a mutual basis—meaning, pensioners share in the gains and losses that arise from unexpected mortality. Thus, if too few emeritus professors take up skydiving, there will be more than the expected number of mouths to feed and the growth in payouts will be less than hoped for. Conversely, a pandemic boosts payouts.
Now, a mutual form of organization is no guarantee of either efficiency or wisdom, but in this context it means that the insurance company does not have to pad its prices in order to cover the risk that retirees will live too long.
Nor does the nonprofit status mean an advisor won’t be tempted to steer a pensioner into products considerably more costly than an index fund (read this New York Times story). But if you stick to the cheap portfolio options you’ve got a good deal. Proviso: You should be in excellent health if you’re buying any kind of annuity.
Alas, not everyone can get in the door at Cref. You can acquire a TIAA annuity only if you or a fairly close relative works or worked in the nonprofit world—such as for a government agency, hospital, school or college.
What variable annuity is there for retirees in the corporate sector? Nothing that I would recommend. The insurance industry has responded to TIAA’s invention with a slew of convoluted and costly products that make price comparisons next to impossible.
You will probably see some kind of “mortality” charge in the prospectus (that padding I was talking about); you will probably not be able to discern what kind of worse damage is built into the formula that connects your payout to the return on the stock market; your salesman will probably be buying a new sports car right after you sign.
If you are not eligible for TIAA, and if an advisor mentions variable annuities, flee. Find a better solution at Do-It-Yourself Income For Life.