Annuities - Thoughts?

[mathjak107]

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Originally Posted by pb4uski Also, when that person dies be it at age 66 or age 96 or 106 then the money is gone. OTOH, if I run firecalc with $1,000,000 of assets, $33,000 initial spending and 3% COLA and a 60/40 portfolio I get the following: So the choice becomes a guaranteed benefit with a 3% COLA and a guaranteed nothing at the end (be the end is a year or 35 years or 45 years) OR a 99.1% success rate but a potential generous legacy and access to more money during my life if investment performance is favorable. I would take the second option but some people may prefer the first.

you can't look only at the annuity by itself anymore than you can look at bonds and cash by themselves .

if you are spending down from your portfolio that bond and cash money is also likely gone and depleted over the years before being refilled .

you pull 4% inflation adjusted from the bonds and cash portion and zero is what you have left eventually.

the spia starts out 40-50% higher in cash flow , does not take a yearly drop in income like spending your own cash and bonds down would either .

the magic is in letting equity's grow longer in the beginning before they need to replace that cash and bond money spent down .


in either case the cash and bond money or annuity money will not pass to heirs . it will either be spent in the case of bonds and cash or forfeited in the case of the annuity ..

as far as balance goes the spia gives you a wider variance of outcomes because there is no sequence risk in the annuity . your own investing requires more dry powder kept unspent to allow for poor sequencing up front .

but i think the main argument that folks have is heirs get nothing from an spia but they fail to realize spending your own cash and bonds to zero can leave you with less at the end as well . in either case you are pulling that money from yourself . .

[nun]

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Originally Posted by mathjak107 the spia starts out 40-50% higher in cash flow , does not take a yearly drop in income like spending your own cash and bonds down would either .

The SPIA only starts out with 50% higher income than a classic percentage SWR from a portfolio because the income from the annuity doesn't increase each year.

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the magic is in letting equity's grow longer in the beginning before they need to replace that cash and bond money spent down .

It's good to let the equities compound, so why not have equites instead of an annuity with a ridiculously low interest rate.

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in either case the cash and bond money or annuity money will not pass to heirs . it will either be spent in the case of bonds and cash or forfeited in the case of the annuity ..

With an equity and bond portfolio there is a chance of leaving money to heirs, and also a chance of running out of money. With the annuity there's no chance of running out of money, but also no chance of leaving any to heirs. It's a balancing act between risk and income.

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as far as balance goes the spia gives you a wider variance of outcomes because there is no sequence risk in the annuity . your own investing requires more dry powder kept unspent to allow for poor sequencing up front .

I think you mean that the portfolio gives the wider range of outcomes. I'm generally a fan of locking in some guaranteed lifetime income, but with rates so low it's hard to lock in such low income amounts from annuities. I recently bought into a defined benefit pension with $282k that pays $20k a year with a 3% COLA starting at age 55, those are good numbers. If I'd gone on the commercial market my $282k would have bought $14.5k annual income with no COLA. If you plug the commercial SPIA amounts into FireCalc you see that a 60/40 portfolio as a 98% chance of beating the annuity out to 30 years. The portfolio does use historical data and I assume the SPIA is fixed by today's low interest rates, but still I like the odds of the portfolio. If the annuity paid more it might be a different story.


If I only had access to commercial annuities I'd probably hold off and put my cash in a 5 year CD ladder to mitigate sequence of risk return rather than buying the SPIA.

[mathjak107]

annuity's are not a proxy for equity's . the best combo is likely the annuity instead of bonds and you still use equity's . don't forget cash and bonds have a declining balance as they are spent even though they may be getting a small amount of interest that level is dropping . each year generates less and less ..

don't forget as you spend down cash and bonds towards zero before refilling the spia still has the same base income so less equtiy's will be needed to refill .

a lot of an spia comes from the dead and your age not rates so much . an almost 6% draw rate for a 65 year old is pretty good cash flow today .

i would ladder them if i did any as a proxy for some bond and cash money . .

[nun]

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Originally Posted by mathjak107 annuity's are not a proxy for equity's . the best combo is likely the annuity instead of bonds and you still use equity's . don't forget cash and bonds have a declining balance as they are spent even though they may be getting a small amount of interest that level is dropping . each year generates less and less .. don't forget as you spend down cash and bonds towards zero before refilling the spia still has the same base income so less equtiy's will be needed to refill . a lot of an spia comes from the dead and your age not rates so much . an almost 6% draw rate for a 65 year old is pretty good cash flow today . i would ladder them if i did any as a proxy for some bond and cash money . .

Sure an annuity has zero risk so can't be compared to an equity. The thing is that given the low levels of income from annuities the risk associated with an equity and bond portfolio being able to produce that level is pretty low.

I think you need to adjust that 6% cash flow to 5% for a 65 year old male today. That level of income can be sustained for 25 years from a portfolio getting 2% interest. You can get 2% from a CD ladder with no risk and it will be a better bet than the annuity for 80% of 65 year old males, 68% of females and 72% of 65 year old male and female couples. It's hard to recommend an annuity when a CD ladder is better for most people.

[Danmar]

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Originally Posted by nun I'm not sure it's ignored by people who are dubious about annuities as they realize that the annuity with a 6% payout rate pays a constant amount and their SWR is supposed to increase with inflation. You need to compare the SWR with the initial payout rate of an index linked or escalating annuity.

Point taken.

[mathjak107]

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Originally Posted by nun Sure an annuity has zero risk so can't be compared to an equity. The thing is that given the low levels of income from annuities the risk associated with an equity and bond portfolio being able to produce that level is pretty low. I think you need to adjust that 6% cash flow to 5% for a 65 year old male today. That level of income can be sustained for 25 years from a portfolio getting 2% interest. You can get 2% from a CD ladder with no risk and it will be a better bet than the annuity for 80% of 65 year old males, 68% of females and 72% of 65 year old male and female couples. It's hard to recommend an annuity when a CD ladder is better for most people.

as of this morning a 65 year old male is 6.19% draw . immediate annuity's.com

income sustained not for 25 years but forever unlike the cd ladder .

[pb4uski]

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Originally Posted by mathjak107 ... a lot of an spia comes from the dead and your age not rates so much . an almost 6% draw rate for a 65 year old is pretty good cash flow today .

So much of what you have said in your last few posts is so wrong I'm not going to bother refuting you and nun has made many of the points that I would have made.

The main point is that if one can live with a high probability of success instead of guaranteed success then comparing the economics of today's pricing of COLAed annuities (and the 3.3% payout rate for a 65 yo) to a total return approach for a reasonably balanced portfolio then the portfolio is pretty attractive trade-off of risk and benefits in that there is a high probability of success and more financial flexibility.

What we are comparing here is a 3% COLAed annuity which has a 3.3% payout rate with a 60/40 portfolio with a 3.3% WR.

If someone wants to accept the inflation risk of a SPIA then a 6% fixed payout would be better than almost any portfolio because the high payout rate results in high sequence of withdrawals risk.

[mathjak107]

it may be your opinion it is wrong but there is nothing i said that has not been shown in academic study's to be true

[pb4uski]

That's the beauty of the first amendment...

[nun]

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Originally Posted by mathjak107 as of this morning a 65 year old male is 6.19% draw . immediate annuity's.com income sustained not for 25 years but forever unlike the cd ladder .

Ops, sorry, you are correct......so using 6% for the 65 year old male the money in a 2% CD ladder will last for 19 years so 52% of males will be better using the CD ladder. Not such a slam dunk for the CD, but still better for most people. Of course you are buying the insurance and the mortality credits with an annuity. Still, a commercial annuity would be one of the last things I'd choose in retirement. I'd rather defer SS and set up a 5 year CD ladder if I was nervous about my equity and bond portfolio. Still a 60/40 portfolio has a 95% chance of generating that initial flat 6% for 30 years and that is going to be better than the annuity for 94% of 65 year old males.

[mathjak107]

kitces looked at comparing cd ladders to spia's

https://www.kitces.com/blog/understa...rement-income/

[pb4uski]

Interesting... but if you take Kictes example of a 3% inflation adjusted benefit and compare it to a 35/65 portfolio (like for example, plunking $1,000 into Wellesley) and taking out $41 the first year and increasing withdrawals 3% annually FIREcalc indicates the following results:

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FIRECalc looked at the 121 possible 25 year periods in the available data, starting with a portfolio of $1,000 and spending your specified amounts each year thereafter. Here is how your portfolio would have fared in each of the 121 cycles. The lowest and highest portfolio balance at the end of your retirement was $-112 to $3,438, with an average at the end of $707. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.) For our purposes, failure means the portfolio was depleted before the end of the 25 years. FIRECalc found that 2 cycles failed, for a success rate of 98.3%.

The result is similar to what was outlined for the 3.3% payout annuity for a 65 yo :

• a high (98.3%) probability of success vs 100% guaranteed success
• modest equity risk vs no equity risk
• no ability to increase spending if needed/desired vs the potential to spend more if investment results are good
• no legacy vs likelihood of a reasonable legacy (70% of the initial premium on average and as much as 3.5 times the initial premium)

If someone prefers 100% guaranteed success but with no future flexibility or legacy, then fine.... I happen to think that last 1.7% of success isn't worth the financial inflexibility of the SPIA.

[mathjak107]

like delaying ss the real question is do you want more market and interest rate risk in your life or more longevity risk .

that is the real determining factor , not dollars and cents so much .

i am more comfortable with longevity risk since we are a healthy couple . i rather diversify a bit bet on us .

first line of defense is delaying ss reducing our market dependency down the road for decades and 2nd line may be adding some spia's to the portfolio too .

my wife experienced being a widow already once in her life .

she had a pile of investments dropped in her lap and 2000 hit us .she lost a bundle and des not want almost her total income left to the whims of markets and rates and i respect that fact .

[nun]

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Originally Posted by mathjak107 kitces looked at comparing cd ladders to spia's https://www.kitces.com/blog/understa...rement-income/

Yes, the article outlines the principles of annuitizing. However, where will you get a 9.8% payout rate from a commercial annuity as used in the article. The maths of pooled contributions might be able to sustain that amount, but you won't get that when you get a quote from an insurance company. Today a 65 year old male will get 6%, as you correctly say. You need 3.5% return from a portfolio to sustain that withdrawal rate for 25 years and only 2% to sustain it for the 65 year old male of average lifespan (ie 84). Annuities certainly provide longevity insurance, but the rates they are paying today make it quite expensive insurance.

[nun]

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Originally Posted by pb4uski If someone prefers 100% guaranteed success but with no future flexibility or legacy, then fine.... I happen to think that last 1.7% of success isn't worth the financial inflexibility of the SPIA.

That's how I feel too. The low payout rates of today's SPIA's makes the chances of a 60/40 portfolio not beating them almost vanishingly small.

[nun]

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Originally Posted by mathjak107 like delaying ss the real question is do you want more market and interest rate risk in your life or more longevity risk . that is the real determining factor , not dollars and cents so much . i am more comfortable with longevity risk since we are a healthy couple . i rather diversify a bit bet on us .

As a couple the numbers for annuities start to look a bit better. I'm not against annuities, just the poor value ones on offer today. As I've said I just bought into a defined benefit pension plan because the numbers were very good (7% payout, 3% COLA at age 55) and I also have a TIAA-Traditional Annuity that has an interest rate of 4.8% (NB that's not the payout,it's the annual growth). If SPIAs had that level of IRR I would be far more positive about them.

[mathjak107]

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Originally Posted by nun Yes, the article outlines the principles of annuitizing. However, where will you get a 9.8% payout rate from a commercial annuity as used in the article. The maths of pooled contributions might be able to sustain that amount, but you won't get that when you get a quote from an insurance company. Today a 65 year old male will get 6%, as you correctly say. You need 3.5% return from a portfolio to sustain that withdrawal rate for 25 years and only 2% to sustain it for the 65 year old male of average lifespan (ie 84). Annuities certainly provide longevity insurance, but the rates they are paying today make it quite expensive insurance.

it is not a 9.80% payout on a continual basis . he was illustrating the effect of how mortality credits work and the longer you live the bigger your percentage is .

the pool is reduced every year by x-amount of people dying and each year the remainder of the pooled money gets redistributed . each living person gets more and more from the pool and all that is figured day 1 in to the rate that is paid since they know how many will die . they just can't tell us who . the 9.80 % represents your share of what you would get if you lived long enough as your share .

that is calculated though already in to the draw day 1 .

[nun]

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Originally Posted by mathjak107 it is not a 9.80% payout on a continual basis . he was illustrating the effect of how mortality credits work and the longer you live the bigger your percentage is . the pool is reduced every year by x-amount of people dying and each year the remainder of the pooled money gets redistributed . each living person gets more and more from the pool and all that is figured day 1 in to the rate that is paid since they know how many will die . they just can't tell us who . the 9.80 % represents your share of what you would get if you lived long enough as your share . that is calculated though already in to the draw day 1 .

The principles of pooled risk and mortality credits are great as long as you actually get them. Kitches comes up with a 9.8% level payout from the pooled contributions of 25 people over 25 years assuming 3% interest rate. If an insurance company could offer that I'd take it. However, as a 65 year old male I'd only get a 6% level payout. If payout rates were to get back up to around 7% then annuities would be come more sensible and if I could get 9.8% I wouldn't bother with equities at all. But at 6% payout rate SPIAs are poor value for money.

[Huston55]

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Originally Posted by sengsational A tontine would cut-out the middle-man, but I think they're illegal.

Yep...one 'middle man' at a time.

[mathjak107]

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Originally Posted by nun The principles of pooled risk and mortality credits are great as long as you actually get them. Kitches comes up with a 9.8% level payout from the pooled contributions of 25 people over 25 years assuming 3% interest rate. If an insurance company could offer that I'd take it. However, as a 65 year old male I'd only get a 6% level payout. If payout rates were to get back up to around 7% then annuities would be come more sensible and if I could get 9.8% I wouldn't bother with equities at all. But at 6% payout rate SPIAs are poor value for money.

but he isn't using 9.80%as an annuity amount .

he is illustrating the mortality credit effect and why you can never duplicate that on your own . . what he is saying is if you took 25 people and they all bought bonds , that at the time were paying 3% no one would do better than 3% .

but if you pooled the money and bought the 3% bonds and gave 1 to each of 25 people who each died one year apart , the pooling effect would have the last person getting a 9.86% return on their 1k investment which started life as the same 3% bond

25 people were used because drawing that amount of money from the bonds the money would be depleted in 25 years and hit zero including interest and principal . .

it was only an example of how risk pooling money and mortality credits give you more than the subsequent value of each investment on its own .

in this case the 3% bonds multiplied themselves to the survivor so the survivor got much much more than a 3% bond would allow .

it only demonstrates a process not a policy , it is only a hypothetical example of what mortality credits bring to the party and why buying bonds or cd's can not equal that effect no matter what the rates are . . . .