A Floor with an Upside: The Best Strategy for Lifetime Income?

[Midpack]

Not new, a topic that's been discussed here periodically. The article is not long or detailed, but it's a good overview. If you've already given guaranteed floor income due consideration you won't learn anything from this article. If you haven't and your guaranteed income sources (Soc Sec, pensions/annuities, other ongoing incomes sources) fall well short of meeting your essential living expenses, it's something every retiree should at least think about IMO. A Floor with an Upside: The Best Strategy for Lifetime*Income? - Home - Can I Retire Yet - Your Retirement Roadmap

Could you live off your investment portfolio indefinitely, if you had too? The answer to that question lies in the relationship among your total assets, your living expenses, your investing skill, the length of your retirement, market valuations when you retire, and market performance thereafter. That's a lot of variables, only some of which you can control…

This process starts by first understanding your essential living expenses.

Next you must add up all the guaranteed, inflation-adjusted sources of income that you can rely on receiving at retirement. Many of us can count on some Social Security and/or other pensions.

Finally you compare those two values. If your expenses exceed your income, as they will for many, you must "backfill" up to the amount of your essential expenses from a new guaranteed income source.

I noticed one of our Mods among the comments, so he's read it...

 

[Chuckanut]

I read the article and see his point.

I have to ask this question: Isn't one of the reasons we have a portfolio balanced between stocks and bonds for the times when the stock market is low? At those times we can sell our shorter term bond assets and give the stocks time to recover. Right? Or am I missing something?

Another question: It's not as simple as COLA'd versus non COLA'd pensions/annuities. Today, many DB pensions have a partial COLA. The cap is usually set at 2-3% annually from what I have observed. How does one adjust for the more common partially COLA'd pensions that many of us have?

 

[Koolau]

I see the lure of such a plan and I wouldn't suggest that it's a "bad" plan. However, even with inflation riders on an annuity plus COLA's on pensions/SS, there is NO guarantee that inflation won't burn down such a plan if it gets bad enough. Most COLA's don't really completely cover inflation in good times. If for no other reason than tax-bracket creep, COLA's usually only soften the blow. During bad times (high inflation) such a plan (any plan?) could fail rather quickly IMO. In short, I've yet to find a "plan" which gives any "guarantees" about inflation. All the typical plans (balanced portfolio, "buckets", Otar, etc. etc.) work - until they don't. Picking between the various options probably comes down to comfort level. I see why this one might be popular.

Show me a plan which guarantees to survive significant inflation and I'm all over it. Other than that, I see them as pretty much the same - just a different way to look at the issues of income/growth/inflation. I'm no expert, so YMMV.

 

[braumeister]

How does one adjust for the more common partially COLA'd pensions that many of us have?

Just for my own peace of mind, when I run projections of my future financial status, I make these two assumptions:

1. My spending will increase at the rate of inflation.
2. The future COLA on my pension/SocSec will be between 1/3 and 1/2 the inflation rate.

 

[Mulligan]

Just for my own peace of mind, when I run projections of my future financial status, I make these two assumptions:

1. My spending will increase at the rate of inflation.
2. The future COLA on my pension/SocSec will be between 1/3 and 1/2 the inflation rate.

That was kind of what I did, to ensure I had enough income safety down the road, as my COLA was reduced to 2% fixed instead of CPI. I got lucky this past fiscal year, as we got the 2%, but CPI was only 1.7%.

 

[mathjak107]

kind of like longevity insurance

 

[W2R]

The very FIRST sentence in the article, you know, the one that is supposed to suck us in and arouse our interest in the article is,

Could you live off your investment portfolio indefinitely, if you had too?

(groan)

I won't say a word... I won't say a word... I won't say a word...

 

[Dawg52]

Could you live off your investment portfolio indefinitely, if you had too?

My calculations say yes. But as discussed before, the main reason I 'might' buy an annuity is protection from poor financial decisions I might make due to mental instability as I age. Then again......some might think I have already entered a period of mental instability if I'm thinking about an annuity.

If I ever get one, it won't be anytime soon. Plenty if time to mull over the idea.

 

[Gumby]

The very FIRST sentence in the article, you know, the one that is supposed to suck us in and arouse our interest in the article is,

(groan)

I won't say a word... I won't say a word... I won't say a word...

I probably could, if I had two.

 

[Katsmeow]

The article seems to assume that relying upon withdrawals from your portfolio is too risky to meet your essential income floor (well, indicates that it might be OK with a 2% or 3% withdrawal rate) and pushes annuities as an alternative. Fair enough, but the author mentions none of the downsides of annuities particularly the risk of the insurer going broke. To me, that is the huge negative of annuities in that situation. You are turning over your money to someone who can always go broke keeping your money and leaving you broke (yes, I know about the guaranty funds but I also know their limitations).

 

[pb4uski]

There have been no significant insurer insolvencies since risk based capital solvency standards were put in place about 20 years ago. Between solvency standards and monitoring, the roles played by the rating agencies and the backstop of state guaranty funds the risk of loss is very low - IMO much lower than a corporate bond, but higher than a US government bond (though some days I wonder about that). That includes the economic downturn of 2008-2009 which tested the industry but they came through it ok (unlike the banks).

 

[mathjak107]

the real problem is having the deal you signed on for altered as insurance companies struggle with trying to keep the guarantees they made.

already we seen prudential stop allowing anymore money into 14 different annuity products.

transamerica and axa are offering lump sum cash to policy holders to let them off the hook for some of the promises.

im a big believer of having some pensionized income in a plan but im reserving my opinion on annuities until the smoke clears and we see just whats what.

 

[growing_older]

There have been no significant insurer insolvencies since risk based capital solvency standards were put in place about 20 years ago.

That's nice to know. But if I decide I want to use an annuity, I intend to hold it and receive payments for a lot longer than 20 years. Given that there have been (and likely will again be) significant changes in solvency standards as recently as 20 years ago I will be considering that as part of my assessment of how "safe" an annuity payout really is.

 

[foxfirev5]

While I would consider ananuuity it is way down the list of fall back positions just ahead of a reverse mortgage.

 

[haha]

I may have missed it, but all I saw was how to add up your inflation protected, secure income flows, and if inadequate, buy an annuity. But where are the inflation protected annuities?

Until there is a reasonable market in these things, it seems crazy to just imagine that the fixed annuity that you buy will in fact give you meaningful protection toward real income needs.

I think that a reasonably diversified set of well chosen dividend paying stocks should fill the bill. Not high payers, but companies that give some good indication that they should be able to pay and increase dividends for a long time, or a quality dividend focused ETF, should work pretty well. Is it certain? No, but it is likely that anyone who is not asleep at the wheel should be OK, within the limits of human life. A good set of high quality dividend payers probably is more likely to deliver some reasonable degree of stable real income than a given marriage is likely to last for 10 years.

On this board we are very fond of absolute security, but there really isn't much of that to be found in any realm. Instability is not limited to financial matters.

Ha

 

[W2R]

I may have missed it, but all I saw was how to add up your inflation protected, secure income flows, and if inadequate, buy an annuity. But where are the inflation protected annuities?

Are fully inflation protected immediate lifetime annuities no longer available? I have no idea. Vanguard used to have them listed on their website, IIRC, although they were costly. I don't know if they still have them.

 

[mathjak107]

i looked at the supposed low cost ones a while ago from fidelity and vanguard .

they really werent so low cost.

right off the bat fidelitys was cheaper because there was no death benefit compared to others.

the variable really werent a great deal as best as i could figure out.

it looks like depending on age you got a 4-6% withdrawal... the expenses ran almost 3% .

the deal is if at anytime your balance goes higher then you started with you lock in a new high water mark.

now im not great at math but it looks to me that bewtween pulling a 4-6% withdrawal and 3% expenses the markets would have to have a crazy gain to get you anything above the min payout.

 

[Independent]

I may have missed it, but all I saw was how to add up your inflation protected, secure income flows, and if inadequate, buy an annuity. But where are the inflation protected annuities?

Right. Back when I knew about this stuff, none of the VA's with "guaranteed lifetime withdrawal benefits" had inflation protection. Unless times have changed, that possibility shouldn't be on his list.

There used to be SPIA's that were indexed to the CPI. The rational investment for insurers to back those annuities is TIPS, and we all know about the yield on TIPS. I haven't checked rates recently, but I expect payouts in the 3% of premium range.

 

[longinvest]

There used to be SPIA's that were indexed to the CPI. The rational investment for insurers to back those annuities is TIPS, and we all know about the yield on TIPS. I haven't checked rates recently, but I expect payouts in the 3% of premium range.

If that's the case, why not buy dividend stock, instead, get as much payout and keep a growing principal? I know that dividends are not 100% guaranteed, but neither is the survival of insurers...

 

[pb4uski]

If that's the case, why not buy dividend stock, instead, get as much payout and keep a growing principal? I know that dividends are not 100% guaranteed, but neither is the survival of insurers...

nor government debt

 

[Sun456]

Interesting article. There are pros and cons to every strategy. Earlier this year I put 20% of my assets into 4 different annuities. Two have an income doublers (one for nursing home and one for loss of activities of daily life - so you can still live at home). It took me a long time to get comfortable with the idea as I want to know how the companies could make the guarantees they do and all the details about the programs. As I studied the rates took a drop so then I had to decide whether to buy anyways. I decided to go ahead and do it. Between then (a few months ago and now) most of the programs I bought have either been dropped or the rates reduced again.

Although I think it was a great decision for my situation I think it is a hard place to get to due to the complexity of the products and that they aren't suitable for most people. We have no kids so don't need to leave the money to anyone. We also have no pensions so wanted to set up something that would be there no matter what. Were 45 and chose products that could accumulate for 20 yrs at about 7% and then we can withdrawal either 5% for single or 4.5% for two lives covered.

The annuity sales people in general were not particularly useful due to either not knowing their stuff or being intentionally deceitful. Finding the best products took alot of leg work as you have to plow through alot of materials because the sales people could not be counted on to bring things to your attention that will benefit you or conversely the things that aren't suitable for you. They just pitch 'whatever'. I can see why they have such a bad reputation.

None of what I bought is COLAd so I did my own calculations and assumed 3.3% inflation every year to decide how much to put in now to get our baseline expenses covered. Three of the annuities I bought are equity indexed and one is variable.

Now that I made the leap I'm tempted to put a little bit more in. However I may be better served by revisiting it in 5 years. But in the mean time I struggle to get safe returns so who knows what will be best in the long run.

 

[haha]

If that's the case, why not buy dividend stock, instead, get as much payout and keep a growing principal? I know that dividends are not 100% guaranteed, but neither is the survival of insurers...

That is basically my point. Articles like this point out a real issue, then suggest a fictional solution. Would have worked fine from time to time in the past, but it is pure fantasy under current conditions. And of course when it would have worked, you would have had to figure it out for yourself, because there would not have been any articles about it. At least none that got published.

Ha

 

[traineeinvestor]

That is basically my point. Articles like this point out a real issue, then suggest a fictional solution. Would have worked fine from time to time in the past, but it is pure fantasy under current conditions. And of course when it would have worked, you would have had to figure it out for yourself, because there would not have been any articles about it. At least none that got published.

Ha

+1

It raises an important issue but the solution does not work for me.

I'm going with a mix of dividends and rental income to fund our retirement with a cash/near cash reserve to tide us over any rough patches.

Annuities are something of a non-starter at this time:

1. the pricing is currently awful due to low interest rates

2. they are low cost

3. I'll be 47 and my wife 40 when I retire. It will be a long wait before we are old enough to make an annuity a realistic option. If the portfolio gets through the intervening years in good shape, it's possible we wouldn't need to consider an annuity

4. since what passes for annuities out here in Hong Kong are seriously bad ways of destroying wealth I would have to look at a US product. As a non-resident of the US I might be subject to 30% non-recoverable withholding tax, which makes a questionable investment look even worse compared to many of the shares I can buy in HK or elsewhere which have either no taxes or much lower witholding tax rates depending on country of origin

5. even splitting the money and buying annuities from more than one provider still leaves me with more concentrated credit risk than other portfolio options

I'll revisit when the time comes, but if interest rates get high enough to make an annuity attractive, I'll have to wonder if very long term government bonds would be better.

 

[obgyn65]

Hello - have you looked at deferred annuities ? I bought my first one this year, as discussed in other threads. To me it looks like a very good deal.

+1

1. the pricing is currently awful due to low interest rates

2. they are low cost

 

[Midpack]

Are fully inflation protected immediate lifetime annuities no longer available? I have no idea. Vanguard used to have them listed on their website, IIRC, although they were costly. I don't know if they still have them.

I provided a link just a few months ago if someone wants to search for it. I have not found "inflation protected immediate lifetime annuities" based on CPI or a like metric. I can understand why no annuity provider would expose themselves to indexing based on CPI as it would be too hard to predict for a lifetime, and they'd have to hedge so much no customer would be willing to pay for that uncertainty.

But I have found immediate lifetime annuities with fixed/contractual annual increases. IIRC, an immediate annuity with an annual increase of 3% cost almost twice (initial purchase price) as much for the same starting income, as I'd expect. Or IOW an immediate annuity with a 3% annual increase would provide half the first year income of a fixed immediate annuity for the same initial purchase price.

And I think a fixed annual increase immediate annuity product is as close as we'll ever see to "inflation protected" - CPI doesn't make sense for the insurer or the recipient.