Annuities as an Investment

[FreeAtLast]

Anunities seem like a pension that you pay for. Hopefully it will be there when you need it. While you will be ahead if you live a long life, there is also more time for something to go wrong.

[RockOn]

IRR Calculations:

Ok I think I have this ready, quick and dirty, it may have a few errors. I used Vanguard (AIG) payouts my age of 53 with and without a spouse age 53. I think Vanguards payouts are somewhat higher than most, so beware. I used no inflation protection and 3% inflation protection. I could have used the CPI-U, it's about same as the 3% option but the payouts are not known for the calculation. For the married person I assumed keeping the same payout after the death of the first spouse. The four numbers under the age are the IRR's.


Here it goes:
...............................................Age at death 70...78...86...94
Single Person, No infl prot, Payouts till death, 2.60 5.36 6.40 6.87
Single Person, 3% Infl Prot, Payouts till death, 1.37 4.99 6.49 7.23

Married Person, No infl Prot, Payout till last death 1.12 4.14 5.32 5.87
Married Person, 3% Inf Prot, Payout till last death 0.00 3.63 5.32 6.17

Single person, 30 years guaranteed, 3% infl 4.71 in all cases, the term was set at 30

Taken out at age 43
Single Person, No infl prot, Payouts till death, 1.32 4.30 5.47 6.00
Single Person, 3% Infl Prot, Payouts till death, 0.00 3.52 5.22 6.08

Taken out at age 63
Single Person, No infl prot, Payouts till death, 4.70 7.12 7.99 8.35
Single Person, 3% Infl Prot, Payouts till death, 4.08 7.20 8.42 8.99

Note these returns are IRR'sof the investment. I know it has been said IRR isn't valid. I disagree with that. It is valid in a simple investment like this.

IRR is the internal yield of the annuity. I've been talking about 6% which requires me to live to ~86. I think the clearest way to state this is that if I put $100,000 in an annuity and live to 86 I will end up with 33 years of payments and have $0.00 left at the end. If I put the same amount of money in a mutual fund that returns 6% and take out the same payments fom the mutual fund as I was getting from the annuity, I will also end up with 33 years of payments and have $0.00 left at the end. A 6% IRR investment has the same investment characteristics as investing in a mutual fund that returns 6% per year. Maybe there is a better way to say this.

A few things jump out. (If anyone wants to know a specific situation, I have the calcs on a spreadsheet and could fire up yours in minute or two, let me know. )

With that, I'm done. I'm sorry for some of stuff losing alignment.


Just for info, the following were the payment amounts on the above 9 examples based upon investing $1 Million.....$73514, $52342, $64936, $44578, $43843, $66078, $43937, $86741, and $66455 respectively. The following were the initial withdrawal percentages.....7.3%, 5.2%, 6.5%, 4.5%, 4.4%, 6.6%, 4.3%, 8.7%, and 6.6%.

[Finance Dave]

Originally Posted by 2B

If you go into a Medicaid facility they will take any asset you have including the monthly social security and annuity checks since it is for your care. They aren't a "creditor" that you are protected from.

If you have a portfolio, you will get to spend it to avoid going into a Medicaid facility. I have seen a number of nursing facilities while dealing with my in-laws. They all are not places I want to go but I really don't want to go to a Medicaid facility. Personally, I'll be spending down my portfolio.

I know that...you missed my point. What I'm saying is that after you leave the nursing home, if you had an annuity you would still have income...whereas with a portfolio they may have already taken all of it.

[Finance Dave]

Originally Posted by 2B

Your money is as good as the credit rating of the company and the state insurance pool where you bought it.

You could say the same for your portfolio...it's only as good as the credit rating of where it's held/invested. If it's in stocks, it's only as good as the company. If it's in bonds, again only as good as the company's creditworthiness. If it's in a municipality, well...they go bankrupt too sometimes. If it's in a savings account at and FDIC bank, then you're at least safe up to $100,000.

[samclem]

Originally Posted by Finance Dave

You could say the same for your portfolio...it's only as good as the credit rating of where it's held/invested. If it's in stocks, it's only as good as the company. If it's in bonds, again only as good as the company's creditworthiness. If it's in a municipality, well...they go bankrupt too sometimes. If it's in a savings account at and FDIC bank, then you're at least safe up to $100,000.

All those who have all their money in one stock, raise your hand. One bond?
Wouldn't it be more correct to say that investing in an annuity is like deliberately putting all your money in a bank with no FDIC insurance? In both cases all the money rests with the fate of a single company, and you stand in line ahead of the stockholders if things go south.

[2B]

I declare this thread beyond the point of a discussion.

[rs0460a]

Originally Posted by samclem

All those who have all their money in one stock, raise your hand. One bond?
Wouldn't it be more correct to say that investing in an annuity is like deliberately putting all your money in a bank with no FDIC insurance? In both cases all the money rests with the fate of a single company, and you stand in line ahead of the stockholders if things go south.

As part of my SPIA application process, I had to "attest" that the annuity (along with any currently existing annuities) did not represent more than 50% of my retirement assets (e.g. portfolio) at the time of application.

Conversion of more than 50% of assets is strongly dissuaded.

BTW, I only "converted" 10% of our then current retirement portfolio for the purchase of the SPIA. If/when we purchase more in the future, we will be purchasing through another company, in order to manage the "company risk". No different then investing in different funds, different companies (as stated by your indivudial AA).

- Ron

[ladypatriot]

This is my first post on the forums, so I hope I'm doing this correctly!

I've been reading the friendly discussion about annuities, and many cogent arguments have been made on each side. My husband and I have a variable annuity with the Hartford Group. We make purchases into the annuity each month, in varying amounts, through the mutual funds available in the plan. There are over 20 funds to choose from, thus we can determine our asset allocation pursuant to our investment goals. By investing monthly, we have the advantage of dollar-cost-averaging. We also have the option of moving invested money from one fund to another within the plan.

The annuity is only a portion of our portfolio, and we plan to stop investing in the plan when it reaches a certain amount. Why an annuity? It's insurance. Everyone knows that, and we purchase the annuity acknowledging that it's insurance. The particular plan we selected has a feature that guarantees the amount we invested, but will pay out at the highest value the plan reached (the water mark).

Well, that's our experience with a variable annuity. As I said, it's only a portion of our portfolio so we're comfortable with it.

I can't wait to learn how to use the emoticons!

Ladypatriot

[samclem]

Ladypatriot,
Welcome to the board, and thanks for the input. You've picked quite a thread to jump into.
I'm sure you did a lot of research before starting down the annuity path. Variable annuities have a particularly bad reputation, and I'll leave it at that. Still, the fact that you realize that this is insurance and that you are paying a premium for it, and that it only constitutes a portion of your portfolio, are all good things.

[donheff]

Oh no, LadyPatriot brought up variable annuities - now this thread is guaranteed to crash and burn or go to 15 pages.

[2B]

I reserve my comments for those asking about purchasing SPIA or VAs. There's no point in telling someone the reasons they would be better off not doing what they've already done. ladypatriot is a newbie and gets even more courtesy than those falling into the "demonstrated troll" category.

When she realizes the amount of lost return due to annualized fees and other charges, she will experience the buyers remorse my father did. What's done is done and she really can't get her money back now without paying a significant penalty. Now, in a weak market, the VA will probably look pretty good. As time goes on and the market moves up, she may notice that the great returns that she thought she'd get somehow don't show up due to the fine print in their contract. My father noticed all that but my FIL never did. He has Alzheimer's.

Welcome to the forum ladypatriot. I'm the resident anti-annuity troll but I freely disclose the reasons for my positions. Some people feel more secure with their future (to a certain extent) left to an insurance company even though simple math demonstrates the odds are greatly in the insurance company's favor. If you don't do math well, guesss where all the money came to pay for the friendly agents and build those fancy office buildings.

Please use the forum to educate yourself on taking charge of your own investing. There are many resources here and many helpful people. Just don't ask me to recommend an annuity for you.

[rs0460a]

Originally Posted by 2B

I reserve my comments for those asking about purchasing SPIA or VAs. Just don't ask me to recommend an annuity for you.

However, if you're interested in SPIA's, I'll give you factual information (based on actual use of the product) ...

- Ron

[RockOn]

2B, I wonder if this would be more correct?

Some people feel more secure with their future (to a certain extent) left to an insurance company even though simple math demonstrates the odds are greatly in favor of those who invest on their own in a portfolio of well chosen diversified low cost investments and have the risk tolerance to accept the volatility while making those higher returns.

Isn't that what you really mean? After all brokers, mutual fund companies, hedge funds, commodity brokers, clearing houses, money managers, financial planners, M&A experts, and many, many, others also build those fancy office buildings.



And I said I was done.

[gryffindor]

Having read a number of these debates, would love to figure out the key assumptions on where people really disagree on this issue (seriously).

Not sure I see the difference between an annuity and a defined benefit pension (even adjusted for inflation). It seems the major difference is whether someone made an active decision. With pensions, people get them from their employer and don't make an active decision in many cases. If people had an option to take an actuarially equivalent lump sum payment it would be the same decision as investing in an annuity. It would be interesting for people who had a pension to defend their decision on not taking the lump sum payment and investing in it rather than keeping the cash flow.

I think a big issue is people's attitudes towards insurance. If you die early with an annuity the money goes to the insurance company. In the other situation, the money goes to your heirs. That's a very personal decision on legacy that doesn't have an mathematically correct answer.

I think another big issue is people's attitudes towards risk. Of course, mathematically the annuity will be a worse decision -- the insurance company is making money off these products. But the benefits of reducing risk and volatility may be worth it, if its not too expensive. Again another area on where people can legitimately disagree.

I am interesting in figuring out the right answer for myself, as I'll need to make the decision about either keeping a defined benefit plan or taking the lump sum in a few years when leaving my employer.

Cheers,

[rs0460a]

Originally Posted by gryffindor

Not sure I see the difference between an annuity and a defined benefit pension (even adjusted for inflation). It seems the major difference is whether someone made an active decision. With pensions, people get them from their employer and don't make an active decision in many cases. If people had an option to take an actuarially equivalent lump sum payment it would be the same decision as investing in an annuity. It would be interesting for people who had a pension to defend their decision on not taking the lump sum payment and investing in it rather than keeping the cash flow.

Exactly. In my case, I was required to take a lump sum (pension program "converted" to a cash balance plan years ago) and "split the proceeds". Part to an SPIA (which "mimics" a pension) and the remainder kept in investments (funds).

I could have taken the same money and "invested" it 100% in either an SPIA or 100% in funds. Like the game of roulette (or a well defined AA), I "split my bet".

- Ron

[Alan]

Originally Posted by gryffindor

Having read a number of these debates, would love to figure out the key assumptions on where people really disagree on this issue (seriously).

Not sure I see the difference between an annuity and a defined benefit pension (even adjusted for inflation). It seems the major difference is whether someone made an active decision. With pensions, people get them from their employer and don't make an active decision in many cases. If people had an option to take an actuarially equivalent lump sum payment it would be the same decision as investing in an annuity. It would be interesting for people who had a pension to defend their decision on not taking the lump sum payment and investing in it rather than keeping the cash flow.

I think a big issue is people's attitudes towards insurance. If you die early with an annuity the money goes to the insurance company. In the other situation, the money goes to your heirs. That's a very personal decision on legacy that doesn't have an mathematically correct answer.

I think another big issue is people's attitudes towards risk. Of course, mathematically the annuity will be a worse decision -- the insurance company is making money off these products. But the benefits of reducing risk and volatility may be worth it, if its not too expensive. Again another area on where people can legitimately disagree.

I am interesting in figuring out the right answer for myself, as I'll need to make the decision about either keeping a defined benefit plan or taking the lump sum in a few years when leaving my employer.

Cheers,

Tough choice and 90% choose the lump sum apparently, although I expect I will be choosing the pension for my main employee pension in 2010. A couple of years ago I started receiving a pension from a former employer. I had the choice of a lump sum or pension, and decided on the pension.

The best way to take a pension - Jul. 1, 2008


One thing these days is that a pension is insured up to a certain value following some big name pension catastrophies in recent years, and the pension funding is more tightly regulated than it used it be to also.

[RockOn]

Originally Posted by gryffindor

Having read a number of these debates, would love to figure out the key assumptions on where people really disagree on this issue (seriously).

I think the key assumptions on where people really disagree are:

1) What actual return does the investor get by buying an annuity?

2) Are insurance companies ripping me off more than other financial products or simply offering a fair return for taking on the risk of offering the non-volatile lifetime payout?

3) Maybe also this, is buying a single company product from an insurance company too risky and an accident waiting to happen?

4) Obviously this, but I don't think we disagree on it. Is a volatile diversified portfolio likely to give a better return than a non-volatile SPIA?

I might be wrong.

[RockOn]

OK, this is it! If we haven't conviced you that annuities are a reasonable investment option this is finally it:

In Bernanke's portfolio: annuities, and a bit of Canada | Money & Company | Los Angeles Times

All the FED and BLS supporters cannot argue with the facts now. Where is the FED chairmans money invested?

And at age 54.