Annuities ?

[renferme]

Will soon retire (next year sometime) at about age 57.5.
Can buy a Vanguard immediate annuity. An example:
for about a 57000 dollar premium, I can get $300/month
fixed joint and 50% survivor. Or, to get $300/mo. with a 1% yearly payout increase, the cost would be $63000.
This, of course, represents a modest investment on my part in relation to my total assets. The premium would be paid out of my 401k (pre-tax). What does everyone think of this idea ? Vanguard's opinion is to wait until I'm about 68 yrs old. I was thinking that this is a way to further diversify and gain 'guaranteed' income. The rate of return on the $57000 is 6.3% and the initial first year rate on $63000 is 5.7%.

[earlyout]

It depends on what your plan is and what other income you have.

Diversification is very important. The following can be considered annuities: defined benefit pension, social security, plus insurance company annuities. Non-annuity items are: your stocks, bonds, 401k, your house, etc.

Insurance annuities by there nature (profit to insurance company) are not, over the long run, going to beat a diversifed portfolio. That said, to have some portion of your assets in annuities can make perfect sense.

I would check around on the annuity, you should be able to get $ 300+ month for you and your wife (100% survivorship) for the $ 57,000 you mentioned.

I have also considered getting a small annnuity, but am not yet convinced that it is the thing for me to do right now.

earlyout

[wzd]

This is the website I use for quick quotes to answer annuity questions:
http://personal.fidelity.com/product...ame_quote.html
<can't even edit the link to be right....arghh, but it seems to work even though it displays funny>

I am not recommending them, but it is the only website I found to get quick quotes without someone contacting me.

It shows 51k for what you want, without the survivership option, and 57k for a joint lifetime annuity, assuming your wife is the same age as you.

My pension is an annuity, and that is all I personally am planning to have set up that way. The lump sum offer made by my employer was lowballed, which they could do only because of quirks in their early retirement offer, so I didn't have to make a choice myself.

The key worry with an annuity for a long period of time is inflation. At only 3% inflation, I think the value of the monthly payment is cut in half in about 24 years.

Wayne

[sgeeeee]

I read an article about annuities and nest egg longevity a few weeks ago and posted the link over on the MSN Retire Early Boards. Folks over there were almost universally anti-annuity. Here's the link to the MSN board and my first post. The TIAA-CREF research paper link is mentioned in the post:



http://groups.msn.com/REHPDiscussion...50589180931947

I've never been a fan of annuities as a retirement investment, but I ran across this interesting article from TIAA-CREF. The conclusion, based on some detailed simulations, is that use of an immediate annuity along with an aggressive investment portfolio reduces the risk to your portfolio that is implied by your unkown longevity. If you have interest, go to

www.tiaa-crefinstitute.org
click on "Pensions and Retirement"
click on "Published Articles"
click on "2001"

The article is titled:
Making Retirement Income Last a Lifetime
John Ameriks, TIAA-CREF Institute, Robert Veres, Inside Information and Mark J. Warshawsky
December 2001

The authors use a Monte Carlo simulator which I am also not much of a fan of, but they are only looking at qualitative results and they do compare their Monte Carlo simulations to historical based simulations as a base line. The article is interesting, but raises some suspicions when the authors close with comments on how professional retirement planners might better represent the annuity option to clients.

[Ted]

*The rate of return on the $57000 is 6.3% and the initial first year rate on $63000 is 5.7%.

I think that immediate annuities are particularly worth considering by retirees with fairly modest assets. Without having specifically compared the annuities offered by different companies, I would trust those from Vanguard and TIAA-CREF to provide the best benefits, consistent with the low-expense approach of these companies.

In considering the "rate of return" on annuities, however, it is somewhat misleading to evaluate it the way that bennevis did. The annual payment actually consists of two parts: (1) a return of capital on the premium and (2) an interest component. Part 1 is not taxable (unless the premium was paid with pre-tax dollars from a retirement plan). Part 2 is taxable. The actual "rate of return" determines the amount of Part 2. As best I can estimate, the interest being paid now by TIAA-CREF's immediate annuity is a little over 4%, and Vanguard's is probably close to that.

[renferme]

Ted, yes, I'm aware of that.

[renferme]

Salaryguru,
I read the article that you mentioned "Can investors make Retirement Income last a Lifetime".
The article makes a case for having an annuity plus the rest of your savings invested for growth or aggressive growth. I'm assuming that my pension should be included as an annuity. Right?

[sgeeeee]

Salaryguru,
I read the article that you mentioned "Can investors make Retirement Income last a Lifetime".
The article makes a case for having an annuity plus the rest of your savings invested for growth or aggressive growth. * *I'm assuming that my pension should be included as an annuity. * Right?

Yes. Absolutely. It was important to their results that the part of the portfolio that was not tied up in an annuity was invested in growth and aggressive growth. That situation might make some of us pretty nervous. Because FIRECalc allows you to put in pension and annuity benefits directly, you can see the affect on porfolio longevity in your simulations. The downside, of course, is that you miss out on opportunity to increase your portfolio during times of good stock market runs. Also, if you die early, the annuity company is the one that makes out -- not your heirs or favorite charities.

In my case my wife and I each take 2 pensions into retirement. None of them are large, but combined they will make up enough of our retirement income that I'm not too interested in adding another annuity to my portfolio.

[sgeeeee]

Bennevis,

There are several articles on annuities in the TIAA-CREF publications link. The more technical article that I was referring to can be reached directly at:

http://www.tiaa-crefinstitute.org/Pu...fs/pa12-01.pdf

Regards,
SG

[wzd]

Ok, I am not a fan of annuities, but after reading these articles I decided to take a look at evaluating them using firecalc. What I did is run my current plan for 95%, then I reduced my assets by 1/3 and put in a non-inflation adjusted annuity cash flow as a 'reduction in need'. This is the recommended way to deal with pensions as Dory had indicated that the inflation applies to the full amount and the reduction is subtracted yearly. (hope I am remembering this right Cap'n). For my case the annual cash flow at 95% dropped by about 5%.

Whats up? Has anyone else run this? Perhaps a 50 year run is too long because in the later years inflation has eroded the annuity substantially? But the results are quite different than the above referenced articles!! And I used annuity rates for age 55 instead of 50 since that is all I had available, which should have been on the optimistic side.

No time right now, but I'll play around some more later with the numbers, and post any results. Any other inputs?

Wayne

[sgeeeee]

Ok, I am not a fan of annuities, but after reading these articles I decided to take a look at evaluating them using firecalc. *What I did is . . .

Whats up? *Has anyone else run this? *. . .

Any other inputs?

Wayne

I'm not sure what's happening, because it was never something I actually considered for myself for other reasons. But after reading your post I ran a couple of simulations myself and saw similar results.

There are several issues that might be affecting our simulations: 1) The papers used a Monte Carlo simulation instead of historical data. Monte Carlo techniques have a number of problems that might cause the researchers to see different results. 2) I'm not sure how the authors actually defined portfolio longevity. If they used any definition other than that FIRECalc tests against, you might see different results. 3) The authors reccommended a mix of an annuity with agressive growth investments. If "aggressive growth" means something other than S&P 500, then they would see different results.

These are just some thoughts I had initially. I may be all wet.

[Ted]

I appreciate links to legitimate studies like TIAA-Cref's, and they are worth discussing as to their potential limitations.

Monte Carlo simulation is based on historical data, in the sense that it uses the historical average returns and standard deviations of those returns. It would have to be very sophisticated to account for the various ways in which the returns on different asset classes are correlated, and the serial correlation of the annual returns on individual asset classes (and inflation). FIRECalc implicitly accounts for these factors. Its potential weakness is that there may be too many "outlier" events in its historical data.

An inherent problem with any simulation is that there is no way of knowing whether future asset returns and standard deviations will be the same as in the past. In particular, I think that it is realistic -- for fundamental economic reasons -- to assume that inflation will be higher than the historical average and that the real rate of return on assets will be lower. The practical implication is that neither annuities, stocks, nor long term bonds should be counted on to do as well. The good news, however, is that TIPs are now available as an alternative (especially to annuities and other bonds). The analysis by TIAA-CREF did not consider this alternative.

As I mentioned above, the "internal return" on annuities (which the annuity providers don't reveal, but which can be inferred) is around 4%. TIPs paying 2.5% plus inflation are pretty likely to beat this. This is a reason why annuities tend to be more suitable investments for older retirees -- that with a lesser life expectancy, the risk of loss of value from an increase in the inflation rate is less.

[wzd]

The age may be a key factor in the differences. For my sample run, an annuity for 33% of portfolio at age 67 beats the no annuity case. Reducing portfolio life also helps as the inflation component needed from the non-annuitized funds is less.

Wayne

[sgeeeee]

The age may be a key factor in the differences. *For my sample run, an annuity for 33% of portfolio at age 67 beats the no annuity case. *Reducing portfolio life also helps as the inflation component needed from the non-annuitized funds is less.

Wayne

Exactly. I was looking at ruins and pot sherds and thinking about settlement patterns of prehistoric Hohokam in the Tucson-Phoenix area when I thought about the issue of your age when you buy the annuity. (The mind works in strange ways).

So for this strategy to work to extend your portfolio longevity, you need to wait till you are about 67 to buy the annuity? What did you assume about the rest of the portfolio at that point?

[wzd]

sg - my comparison was with current portfolio as a starting point, not with a hypothetical future portfolio. I just increased the annuity payout in firecalc till it got close to the non-annuity case. Then I checked to see at what age 1/3 of my portfolio would buy that much per year.

Age should have been as obvious as you indicate, but I didn't even note the age the first time I read thru the article. Still I don't get close to the advantage that the article indicates; just breakeven at 67, and an advantage above 67.

Ted's comment above on firecalc vs. monte carlo could explain some of it. Also the article may have been written when annuities paid slightly better than today.

In any case, they are not for me to worry about for a decade or two.

Wayne

[Ted]

I think that it is realistic -- for fundamental economic reasons -- to assume that inflation will be higher than the historical average and that the real rate of return on assets will be lower. *The practical implication is that neither annuities, stocks, nor long term bonds should be counted on to do as well. *The good news, however, is that TIPs are now available as an alternative (especially to annuities and other bonds). .

So as not to appear unduly pessimistic, I'll add another hopeful sign -- there won't be another sustained economic crash of the type that occurred in the 1930s. The FIRECalc data is "conservative" in the sense that it includes that period, which would have been a horrible time for anyone who had a large part of their assets in stocks.

Looking at it from a statistical standpoint, I think that the future standard deviation of returns will be less than historically, which will tend to help retirees liquidating their portfolios even as lower average returns hurt them. Of course, there is always the possibility of a major catastrophe (worse than 9/11) that will destroy the value of financial assets, but in that respect we are in the same "boat" with everyone else in the U.S. and civilized world.

[sgeeeee]

So as not to appear unduly pessimistic, I'll add another hopeful sign -- there won't be another sustained economic crash of the type that occurred in the 1930s. *The FIRECalc data is "conservative" in the sense that it includes that period, which would have been a horrible time for anyone who had a large part of their assets in stocks. *

I tend to agree with that assessment. And when I look at the historical retirement simulations I see that the next greatest problem that has faced retirees was the inflation of the 70's. That coupled with some of the talk from the Fed these days, makes me fear future rampant inflation more than I am worried about another major stock market decline.

Of course, I don't take my own crystal ball too seriously. But I do view all my strategic decisions with a healthy respect for how devestating inflation can be.

[wabmester]

there won't be another sustained economic crash of the type that occurred in the 1930s

That's a pretty bold prediction. Two of my biggest worries are the increasing trade deficit and the foreign outsourcing of formerly high-wage jobs. If those trends continue long-term, that would have a nasty impact on GDP and employment, and even has the potential to shift power on a global scale.

[Ted]

Salaryguru,

What you and I expect could come about by the nominal return on assets being similar to the past, but the inflation rate being higher, causing the rel rate of return on assets to be lower.

Wabmester,

I'm not particularly concerned about the trade deficit and alleged "foreign outsourcing of high paying jobs." The depreciation of the dollar relative to foreign currencies (which is occurring in a substantial way right now) will tend to correct the trade imbalance. The flip side of the trade imbalance is the investment imbalance, i.e., the fact that foreigners have been using the "excess" dollars that Americans send abroad to purchase U.S. financial assets, thereby helping to sustain the price of those assets. The reversal of the trade imbalance will tend to reduce foreign investment.

From a strictly economic perspective, I realize that there are a practically unlimited number of high paying jobs for highly skilled people that can't be outsourced abroad. People who participate in these forums tend to be a lot more closely connected to the type of jobs that involve sitting on one's dead butt in front of a computer screen, and those are the type that can be sent abroad. While I'm not such a macho traditionalist as to believe that all Americans should be like the mountain men and pioneer farmers who settled this country (or the more civilized native Americans who preceded them), I also don't favor the idea of America turning into a nation of office-bound computer nerds. If some of those jobs can be exported, it's fine with me.

Well Ted, as you know I am kind of a macho
traditionalist, and exporting the jobs you refer to is fine with me also, but for a slightly different reason.
I've run/owned several businesses. The point is to make money. If you can make more by moving
labor and/or sources of materials offshore, then the
smart managers will do it. It's called free enterprise.

John Galt