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Old 11-10-2014, 11:04 AM   #41
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....just to finish off. If you have a COLAed pension your effective interest rate can be greater than your initial payout rate. For my state pension the initial payout rate is about 6.9%, but the payout obviously increases over time and assuming a 2% COLA the interest rate is 7.04%
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Old 11-10-2014, 11:29 AM   #42
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For the life of me I don't see the benefit of annuities at today's interest rates when you can buy dividend paying stocks or funds and withdraw as if it were an annuity. Yes, there is risk of principal but historically dividend paying corporations increase their dividends over time.
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Old 11-10-2014, 11:35 AM   #43
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For the life of me I don't see the benefit of annuities at today's interest rates when you can buy dividend paying stocks or funds and withdraw as if it were an annuity. Yes, there is risk of principal but historically dividend paying corporations increase their dividends over time.
Well, income generation is about how you assess risk vs return......some people might see dividend stocks as riskier than an annuity, particularly if you are eating into your capital. Anyway the annuity, dividend stock comparison is like comparing apples and oranges. But for me the decision isn't that hard....would you buy an annuity with a 7% interest rate?
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Old 11-10-2014, 12:20 PM   #44
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I would consider it if that were really a 7% interest rate not 2% with a 5% return of principal. The other matter is the age of the annuitant(s).. if I were in my 60s and the interest rate was really 7%, absolutely I would jump on it. But if I were closer to 80 (as I am) I wouldn't be quite so eager.
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Old 11-10-2014, 02:04 PM   #45
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I would consider it if that were really a 7% interest rate not 2% with a 5% return of principal. The other matter is the age of the annuitant(s).. if I were in my 60s and the interest rate was really 7%, absolutely I would jump on it. But if I were closer to 80 (as I am) I wouldn't be quite so eager.
Yes age is a big factor.....I probably wouldn't be thinking about an annuity if I was 80 either. But the OP is looking at an annuity with a 4.4% discount rate starting at 46 and I'm looking at. COLAed annuity starting at age 55 with an discount rate of 7% if I assume a 2% annual COLA.
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Old 11-10-2014, 02:44 PM   #46
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Very good explanation Nun. Interesting how the industry chooses to explain annuities when they market this SPIA product.


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Old 11-10-2014, 02:47 PM   #47
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Very good explanation Nun. Interesting how the industry chooses to explain annuities when they market this SPIA product. Sent from my iPhone using Early Retirement Forum
Yes, when selling mortgages the interest rate is emphasized, because you're borrowing the money and it's lower than the initial payout rate.. With annuities the emphasis is reverses to make you think you're getting more for your money.
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Old 11-10-2014, 02:54 PM   #48
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So ... An interesting question. What are the terms used when selling annuities .. Return of capital at x percent and return on capital of y percent.

Are there industry standard terms like we see in mortgage lending such as APY that have to be described and disclosed by law ?

How does the annuity salesman at fidelity get paid ? Through an insurance company ? A certain percent of my annuitized capital ?




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Old 11-10-2014, 04:10 PM   #49
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Odds. Gambling. Stuff like that. The insurer hopes you die before your money runs out and they have to start using their own. Your return is negative for a long time and might someday be slightly positive. You can't put normal investment terms like ROI because an annuity is not an investment.


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Old 11-10-2014, 04:18 PM   #50
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So ... An interesting question. What are the terms used when selling annuities .. Return of capital at x percent and return on capital of y percent.

Are there industry standard terms like we see in mortgage lending such as APY that have to be described and disclosed by law ?

How does the annuity salesman at fidelity get paid ? Through an insurance company ? A certain percent of my annuitized capital ?




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I'm not sure how the sales person gets paid or how the fees are structured...it's pretty opaque for variable annuities, but for an SPIA the things you need to look at are the lump sum you are paying, the annual payment you get, any growth (COLA) and the discount rate...that's the interest rate on your lump sum and the number you really need to look at. The final piece of the puzzle is your life expectancy.

The number that the sales person will push is the payout rate which is just the ratio of the income to the lump sum. You can compare annuities by simply comparing the payout rates...go for the biggest....but to know how they compare to investments you need to make some assumptions about how long you'll live (to sort of remove the insurance aspect) and work out the internal interest rate. The SPIA is a great example of the hardest thing about retirement income planning, the unknowable factor of when you will die. It's an insurance product, not an investment.
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Old 11-10-2014, 04:29 PM   #51
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It is 100% return of capital for a long time (20 years). By then your money has doubled a couple times (for the insurance company) so they start giving you some return on capital. I'm pretty sure even if you live to 120 the insurance company still wins so it is better to stay out of the casino. At least for the bulk of your money.


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Old 11-10-2014, 04:37 PM   #52
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.....I'm pretty sure even if you live to 120 the insurance company still wins....
No way. If you live to 120 then the insurer would take a hosing unless your "cohort" as other buyers who die earlier than assumed in pricing the annuity.
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Old 11-10-2014, 04:43 PM   #53
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It is 100% return of capital for a long time (20 years). By then your money has doubled a couple times (for the insurance company) so they start giving you some return on capital. I'm pretty sure even if you live to 120 the insurance company still wins so it is better to stay out of the casino. At least for the bulk of your money.


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With an annuity you are buying insurance, but not all annuities are created equal. If your megacorp or state employer offers a defined benefit plan with a COLA, which is increasingly rare, they can be excellent foundations for a retirement. Personally I'm jumping at the chance of trading my DC account balance for a DB plan with a payout rate of 6.9% and an interest rate of 7% using actuarial mortality numbers.
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Old 11-10-2014, 04:47 PM   #54
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+1 to Nun's comments.

I would also recommend William Bernstein's book the Ages of the Investor which goes over the methods of achieving safe cash flows for your basic needs in some detail.
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Old 11-10-2014, 04:52 PM   #55
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Agree not all are equal as I am also trading money for a guaranteed cola pension.

As far as the insurance company not winning, seems to me if the market averages 10% and the annuity pays out 5.6% then the insurance company gets richer regardless of how long you live.


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Old 11-10-2014, 04:53 PM   #56
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No way. If you live to 120 then the insurer would take a hosing unless your "cohort" as other buyers who die earlier than assumed in pricing the annuity.
Well the annuity company isn't really bothered if one person lives to 120 because its such a small fraction of their annuitants. And even if someone lived forever the annuity company would probably still be ok because all they have to do is make more than the initial payout rate (plus fees) on your money to keep paying you. For the OP that payout rate is 5.6%.
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Old 11-10-2014, 04:56 PM   #57
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Agree not all are equal as I am also trading money for a guaranteed cola pension.

As far as the insurance company not winning, seems to me if the market averages 10% and the annuity pays out 5.6% then the insurance company gets richer regardless of how long you live....
The flaw in your thinking is that the insurer invests principally in bonds to back the annuities, not equities.
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Old 11-10-2014, 04:58 PM   #58
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Well the annuity company isn't really bothered if one person lives to 120 because its such a small fraction of their annuitants. And even if someone lived forever the annuity company would probably still be ok because all they have to do is make more than the initial payout rate on your money to keep paying you. For the OP that payout rate is 5.6%.
On the first part, that is what I said, but on the second part there is no way they would earn 5.6% in today's interest rate environment.
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Old 11-10-2014, 05:03 PM   #59
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But there is no way they would earn 5.6% in today's interest rate environment.
Not today, but what about tomorrow....anyway the insurance companies don't think in terms of individuals so they will do just fine in aggregate, they know that their numbers work. It's wrong to think of the insurer getting hosed if someone lives to 120.....it's better to think of the individual making out big time.
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Old 11-10-2014, 05:08 PM   #60
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Not today, but what about tomorrow....anyway the insurance companies don't think in terms of individuals so they will do just fine in aggregate, they know that their numbers work.
Tomorrow doesn't matter because they would receive your SPIA premium today and have to invest it today so the pricing of today's SPIAs reflect today's interest rate environment.

I agree they don't think in terms of individuals, they think in terms of cohorts or PYA (plan, year of issue, age) blocks of business. My earlier point was that if one person lives to 120 then that is no big deal, as long as the cohort mortality is consistent with mortality pricing assumptions which means that over lives in the cohort would need to die earlier than expected.
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