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Another Wade Pfau SPIA article
Old 08-10-2013, 12:26 PM   #1
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Another Wade Pfau SPIA article

Unlocking the Two Mysteries behind SPIAs

Using the household balance sheet approach (see separate thread), Wade has some "new" ideas on SPIA's.

Quote:
Two mysteries confound planners who purchase single-premium immediate annuities (SPIAs) for their clients: Why does the present value of a SPIA often exceed its cost, and why do equity allocations appear to increase when a SPIA is purchased? Unlocking those mysteries requires advisors to use a different framework – based on the household balance sheet – for the withdrawal phase of retirement...

[Mystery #1]:
Calculating the survival-weighted present value with these alternative assumptions gives us a present value for the SPIA of $228,444. This is 54.5% larger than the cost of the SPIA...

[Mystery #2]:
... it turns out that from a balance-sheet perspective, partial annuitization ends up behaving as though it were a so-called bucket strategy, in which the retiree disproportionately spends down their fixed-income assets first, leaving their stocks to grow. The present value of remaining SPIA payments declines as retirement progresses and continued survival probabilities worsen. These factors cause stock allocations to increase as a percentage of the client’s assets....

[Summary]:
Strategies for the withdrawal phase of retirement require a different thought process than for when one is accumulating assets. The objective in this phase is not to maximize a risk-adjusted return, but to provide a sustainable income over an unknown length of time. Planning for this income requires a holistic process where issues are framed from the perspective of the client’s household balance sheet. This requires advisors to quantify the present values of different cash flow streams, whether they represent income or expenditures. I have solved two important mysteries facing advisors when incorporating the present value of a SPIA in their client’s balance sheet.
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Old 10-05-2013, 07:54 AM   #2
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I've read this Wade Pfau article and like the concept of viewing these annuity decisions from a 'family balance sheet' perspective. It seems to be a good way to personalize an otherwise theoretical choice.

This approach also seems similar to the asset allocation approach that includes the equivalent "allocation" for one's guaranteed income streams (SS, pension, etc) into the AA decisions; which, of course, leads to higher equity allocations with the remaining portfolio.

Here's another article by Pfau that is a follow-up to his article on using an equity/SPIA mix for improved portfolio/income longevity. This article says that using deferred annuities, versus immediate annuities, is advantageous. My read of this is that there is not really any substantial advantage from a DIA in terms of income or ending portfolio value. The only DIA versus SPIA advantage is less loss of principal and liquidity.

Why Retirees Should Choose DIAs over SPIAs

However, from a strategic perspective, I still prefer the "annuity hurdle" approach described by Fullmer and Otar (in his "zone" approach). It seems much better to make the annuitization decision when one HAS TO versus at some arbitrary age like 65.
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Old 10-05-2013, 10:08 AM   #3
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Originally Posted by Huston55 View Post
However, from a strategic perspective, I still prefer the "annuity hurdle" approach described by Fullmer and Otar (in his "zone" approach). It seems much better to make the annuitization decision when one HAS TO versus at some arbitrary age like 65.
+1. Especially at the current low yield/interest rates which make annuities more costly historically for income provided than ever. I check my hurdle quarterly, though I hope I never hit it...
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Old 10-05-2013, 11:52 AM   #4
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Quote:
Originally Posted by Huston55 View Post
However, from a strategic perspective, I still prefer the "annuity hurdle" approach described by Fullmer and Otar (in his "zone" approach). It seems much better to make the annuitization decision when one HAS TO versus at some arbitrary age like 65.
I've never quite understood how this would work, since I have never figured out how to buy or sell stocks or bonds at yesterday's prices. I have never purchased an annuity, but I thought that annuity prices were volatile like mortgage rates.

What am I missing?
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Old 10-05-2013, 12:50 PM   #5
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Originally Posted by bamsphd View Post
I've never quite understood how this would work, since I have never figured out how to buy or sell stocks or bonds at yesterday's prices. I have never purchased an annuity, but I thought that annuity prices were volatile like mortgage rates.

What am I missing?
Here's the Fullmer article; see Figure 9. The idea is that you monitor your hurdle (or zone for Otar) and, if you're getting close, you annuitize. In Otar's zone concept, if you're in the "Green" zone you don't need annuitization but, if you pass into the "Gray" zone, you do annuitize before passing into the "Red" zone, where it's too late (ie: you're below the annuitization hurdle of having enough assets to 'purchase' the guaranteed income stream you need.).

Hope this helps.


http://www.schulmerichandassoc.com/M...cumulation.pdf
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Old 10-05-2013, 08:36 PM   #6
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Originally Posted by Huston55
However, from a strategic perspective, I still prefer the "annuity hurdle" approach described by Fullmer and Otar (in his "zone" approach). It seems much better to make the annuitization decision when one HAS TO versus at some arbitrary age like 65.
The main problem with this approach for me is that the chances of the annuity hurdle coinciding with the depths of a bear market are probably high. Thus I would be selling at a low in order to buy the annuity. How do you handle that?
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Old 10-05-2013, 10:46 PM   #7
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The main problem with this approach for me is that the chances of the annuity hurdle coinciding with the depths of a bear market are probably high. Thus I would be selling at a low in order to buy the annuity. How do you handle that?
And/or, just when you need to jump into the annuity lifeboat because a bear market has crashed your portfolio, the gummint starts pumping in money and lowering interest rates. That can really hurt the size of those monthly annuity checks your tattered portfolio can buy.
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Old 10-06-2013, 06:11 AM   #8
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The main problem with this approach for me is that the chances of the annuity hurdle coinciding with the depths of a bear market are probably high. Thus I would be selling at a low in order to buy the annuity. How do you handle that?
Good question. Let's look at a hypothetical.

Using Otar's zone concept, assume I'm a single 55 yr old male in the green zone, meaning I have assets (net worth) >=33 x annual income. The bottom of the gray zone (gray zone is where I have sufficient assets to export longevity risk, IOW but an annuity) is 26 x annual income. That means I'd have to see a >(33-26)/33=21% drop in NW for this approach to not work. Further assume my AA is 60/40. The worst S&P drops since 1950 are: Day=20%, Month=22%, and Year=38%. The decision to annuitize couldn't be made in a day but, could be made in a month and certainly a year. Take the worst case of 38% (.60)=23%. Therefore, the zone concept essentially works even if you ride the bear down for a year, and certainly if you ride it down for a few months. Of course, gender, age, AA, etc. will affect your case.
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Old 10-06-2013, 08:28 PM   #9
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Quote:
Originally Posted by Huston55 View Post
I've read this Wade Pfau article and like the concept of viewing these annuity decisions from a 'family balance sheet' perspective. It seems to be a good way to personalize an otherwise theoretical choice.


Here's another article by Pfau that is a follow-up to his article on using an equity/SPIA mix for improved portfolio/income longevity. This article says that using deferred annuities, versus immediate annuities, is advantageous. My read of this is that there is not really any substantial advantage from a DIA in terms of income or ending portfolio value. The only DIA versus SPIA advantage is less loss of principal and liquidity.

Why Retirees Should Choose DIAs over SPIAs
Wow, makes my choice of TIAA-Traditional 27 years ago look positively brilliant.
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