Annuities - Thoughts?

[mathjak107]

kitces looked at comparing cd ladders to spia's

https://www.kitces.com/blog/underst...ties-beat-bond-ladders-for-retirement-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:

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]

kitces looked at comparing cd ladders to spia's

https://www.kitces.com/blog/underst...ties-beat-bond-ladders-for-retirement-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]

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]

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]

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]

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]

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

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

 

[mathjak107]

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 . . . .

 

[nun]

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 . . . .

We are in total agreement, the article outlines the principles of pooling risk and mortality credits. But let's assume we understand how an annuity works and deal with the products you can actually buy from an insurance company; those will pay 6% for a 65 year old male. They don't give you nearly the advantages of the example given in the article, but they will be for a lifetime. If the payout was 7% the annuity might make sense, but at 6% they are hard to justify.

 

[mathjak107]

6% is 30% more than i can safely draw . that cash would allow me to sustain from selling equity's for more years than cash and bonds would . you would likely be refilling sooner without the spia . .

it would take a decade or more for inflation to catch up while allowing equity's to grow longer up front .

 

[pb4uski]

Wow... in that case you should dump the whole load into a SPIA. Go big or go home.

 

[mathjak107]

the spia only replaces bonds and cash , it does not provide growth or eventual inflation protection . i need both equity's and an income source .

but if inflation wasn't an issue you are right . keep an emergency fund , get some life insurance for legacy money and the spia's for income and you would likely do very well and never worry about markets or sequencing but inflation is the wild card .

in fact that is what ed slott recommends , spia's with cola's and life insurance plus cash for emergency's . pfau took it a step further in his study and found the integrated combo of spia's /equity's/life insurance outperformed buy term and invest the rest 67% of the time in over 10,000 different scenario's run .

the tax freeness of the life insurance made a huge difference .

it gave you a bigger pay check 100% of the time because of little sequence risk and 67% of the time a bigger balance at the end .

i think more and more we are going to find that if we need our portfolio's to live off of , unconventional times are going to call for unconventional strategy's

 

[nun]

6% is 30% more than i can safely draw . that cash would allow me to sustain from selling equity's for more years than cash and bonds would . you would likely be refilling sooner without the spia . .

it would take a decade or more for inflation to catch up while allowing equity's to grow longer up front .

You can safely withdraw a flat 6% from a 60/40 portfolio. If you don't index for inflation the 60/40 portfolio has a 98% probability of producing at least 6% for 30 years. I'm not arguing with your reasoning...or the analysis of Pfau which I think is very useful....but today's rates are 0.5% to 1% less than used in the original papers and that pushes the SPIA into pretty dubious territory for the majority of people.

If you are really worried about sequence of returns issues I'd put 5 years worth of cash into a 5 year CD ladder keeping your flexibility and the chance to buy an annuity later on if the rates are better.

I'm lucky in that I use my defined benefit pension in my portfolio to do what your SPIA is doing. I just think SPIAs are expensive today for what they offer.

 

[mathjak107]

we are to young yet for starting spia's . but when we do i would ladder in to them . between age , mortality credits and hopefully higher rates they will work fine .

i am 64 and that is to young for the sweet spot .

 

[RobbieB]

I plan to convert half of my IRA to Roth over time and use the IRA half to buy an annuity.

Then I'll have equities, muni bonds, a Roth and SS & annuity income. Stability.

 

[nun]

we are to young yet for starting spia's . but when we do i would ladder in to them . between age , mortality credits and hopefully higher rates they will work fine .

i am 64 and that is to young for the sweet spot .

OK. that's important information.

I took 20% of my portfolio and transferred it from my employer's DC pension plan into the DB plan at age 54 when I had the one time chance. I'm now 55 and got my first pension payment this month. The payout is 7% and it has a 3% COLA so it was a no brainer.

 

[Floridatennisplayer]

Isn't part of the thought process behind an annuity the protection from the market taking a 30% drop etc?

 

[RobbieB]

Yeah, that's why I'm going to buy one.

 

[Floridatennisplayer]

One of my friends who is 66 put over half of his savings in one and is a happy guy. Said he knows the market is going to take a massive dump and he can't bear the thought of watching years of gains go down the drain. Said he would never out live the huge losses. And it would take years off of his withdrawals. Said he sleeps well at night.

I'm feeling the same way.

 

[COcheesehead]

The typical market recovery cycle is usually less than 3 years and more likely less than 2 years. You're going to forever "give" your money to an insurance company for 2-3 years of feeling good? Not this guy.

 

[Dawg52]

I plan to convert half of my IRA to Roth over time and use the IRA half to buy an annuity.

Then I'll have equities, muni bonds, a Roth and SS & annuity income. Stability.

Agree. I have no plans to dump a ton in an annuity, but enough to balance out my income(cash flow) needs. I'm 62 so no plans to buy one anytime soon.

 

[bmcgonig]

You can safely withdraw a flat 6% from a 60/40 portfolio. If you don't index for inflation the 60/40 portfolio has a 98% probability of producing at least 6% for 30 years.

That's a risky way of looking at it cos it's not true. In the past you could have taken a flat 6%. But who knows what the bond and market will be like for the next 30 yrs. Some folks here act as if Firecalc has a guarantee with it. It predicts nothing. And that uncertainty is why people use the SPIAs.


Sent from my iPad using Early Retirement Forum

 

[pb4uski]

One of my friends who is 66 put over half of his savings in one and is a happy guy. Said he knows the market is going to take a massive dump and he can't bear the thought of watching years of gains go down the drain. Said he would never out live the huge losses. And it would take years off of his withdrawals. Said he sleeps well at night.

I'm feeling the same way.

Well... since your friend KNOWS the market is going to take a massive dump then he would simply buy a load of at-the-money puts and become rich. No disrespect but he doesn't KNOW anything... the so-called experts don't either.

That is the beauty of a well diversified portfolio... it will weather all storms... and I sleep well at night too.

Although certain to happen again, crashes are rare. The 2008 type scenarios, are extremely rare. Only 3 times since 1825 did the market finish a calendar year down 30% or worse. That’s about once every 63 years. People tend to overestimate the probability of a market crash when one recently occurred. The storm clouds of 2008 are in the rear view mirror, but they are still visible, and the effects of the storm still evident.

You and your friend are suffering from recency bias.