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Deferred annuities - rates increasing
Old 07-24-2013, 02:37 AM   #1
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Deferred annuities - rates increasing

A few people in the past have contacted me regarding deferred annuities, so I thought some of you may be interested to know that payout rates for these types of annuities have been increasing recently.

My contact at New York Life called me last week. His new quotes reflect about a 1% increase in monthly payouts in 14 years' time (about 12% instead of 11%). For example, a $100,000 deferred annuity bought today will pay out about $12,000 per year instead of $11,000.
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Old 07-24-2013, 05:42 AM   #2
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I'm guessing that he has you on his speed dial.

Given today's immediate annuity rates it looks like a deferral period return of between 4-5% a year.

On question for you though - are any of the annuities that you are buying COLA'd? If not, how does your plan provide for inflation?
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Old 07-24-2013, 08:14 AM   #3
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With the assumption you will be 65 by the end of the 14 year wait and you live another 20 years hence, the breakeven rate is about 3.90%, which is still pretty crappy since you are giving up the money for this long period.

Wife and I are also hoping to retire within 15 years but would rather invest the money ourselves since the rate of return should be higher than 4% over the period.
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Old 07-24-2013, 08:39 AM   #4
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On question for you though - are any of the annuities that you are buying COLA'd? If not, how does your plan provide for inflation?
We've asked obgyn this before and I seem to remember that his answer was that he's willing to experience a reduction in spending power over time due to the fact that he has such a large stash, and can also work on the side to supplement his income.

Please correct me if I'm wrong obgyn.
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Old 07-24-2013, 12:19 PM   #5
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payout rates for these types of annuities have been increasing recently
I own a small deferred annuity (MetLife's Longevity Income Guarantee), so this is intereting news to me.

I own it as a diversifier of retirement income and as an "insurance policy" in case I live to 110 and/or there is a long period of miserable returns for securities, where 90% of my investments are.

Not to hijack the thread, but does anyone here know exactly how to value a deferred, lifetime annuity? In other words, how to compare it (as an investment) with other types of investments like a portfolio of stocks and bonds? I've searched but haven't found a good answer to this.
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Old 07-24-2013, 01:21 PM   #6
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Not to hijack the thread, but does anyone here know exactly how to value a deferred, lifetime annuity? In other words, how to compare it (as an investment) with other types of investments like a portfolio of stocks and bonds? I've searched but haven't found a good answer to this.
Plug it into firecalc as a non-inflation adjusted income stream. Use the investigate tab, or iterate until you get an comparable success to a stock/bond portfolio.

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Old 07-24-2013, 01:33 PM   #7
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....Not to hijack the thread, but does anyone here know exactly how to value a deferred, lifetime annuity? In other words, how to compare it (as an investment) with other types of investments like a portfolio of stocks and bonds? I've searched but haven't found a good answer to this.
I would look at the value as being the amount that you would end up with if you cashed out today (just like a stock). I would not put any value on the annuitization option unless it was particularly favorable compared to today's SPIA payouts because you can always use the cash to buy a SPIA.

In terms of return, I would compute an IRR based on the cash flows for the measurement period. In comparing the return to other investments, you need to consider that a deferred annuity is more like a CD or other fixed income instrument than a stock.
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Old 07-24-2013, 02:04 PM   #8
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A few people in the past have contacted me regarding deferred annuities, so I thought some of you may be interested to know that payout rates for these types of annuities have been increasing recently.

My contact at New York Life called me last week. His new quotes reflect about a 1% increase in monthly payouts in 14 years' time (about 12% instead of 11%). For example, a $100,000 deferred annuity bought today will pay out about $12,000 per year instead of $11,000.
Obgyn, did you calculate, or ask your advisor to calculate, the FV (future value) of $100,000 in 14 years? Because that number is the denominator you need to use to calculate the rate of return. For example, using a 5% interest rate, the FV of $100,000 in 14 years is $197,993.16. Subsequently, an annual annuity payment of $12,000 fourteen years from now, on that sum represents a return on investment of 6.06% for the first year. After that, assuming the payments are constant, inflation will take its toll.

The Time Value of Money is the issue here. The calculations for an immediate annuity are easy; the calculations for a deferred annuity must be done in two stages. It is also possible to calculate the future value at some later point in time, using the FV at 14 years as the PV, and using the stream of cash payments. I haven't done that, because there are too many "ifs". What will the interest rate be at any given point in time? What will inflation do? You could use Excel to model various scenarios. I will certainly do so if I am ever seriously considering an annuity.

You might find these YouTube channels interesting:

http://www.youtube.com/user/MBAbullshitDotCom and

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Old 07-24-2013, 03:05 PM   #9
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Use the investigate tab, or iterate until you get an comparable success to a stock/bond portfolio.
For each $10,000 invested, the annuity will pay $133.33/mo, or $1600/yr, starting at age 70, which is twenty years from now. There is no COLA.

To replicate the payout of the annuity, I asked FIRECalc to find the necessary starting value of a 60/40 portfolio that will generate $1600/yr for 30 yrs with a 100% success rate. No inflation adjustment.

FIRECalc calcs the starting portfolio value as $34,598. So, twenty years from now, the annuity will generate the same annual income, for the same length of time, with the same success rate, as a securities portfolio worth $34,598.

I then calculated the compounded growth required to turn $10,000 into $34,598 in 20 years. It's roughly 6.4%.

So it looks to me as though I'm getting 6.4% annual "growth" from the annuity, assuming I live to 70 and start taking annuity payments then.

The comparison breaks down if I don't live to 100, since the annuity will stop paying, whereas a 60/40 portfolio wouldn't. But I'm far less concerned about leaving $$ on the table than I am about outliving my $$.

Two other things my calculation leaves out are 1) likely growth in the value of a 60/40 portfolio while income is being taken, and 2) counter-party risk with MetLife.

Does this look reasonable?
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Old 07-24-2013, 03:18 PM   #10
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Onward, it's interesting that the 6.4% rate of return you calculated is in the same ballpark as the 6.06% initial rate of return I calculated on obgyn's deferred annuity. They are in the same ballpark, suggesting face validity. However, the risks and benefits are another matter entirely.
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Old 07-24-2013, 03:18 PM   #11
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Does this look reasonable?
No, I don't think so. For the first reason you mention:

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Two other things my calculation leaves out are 1) likely growth in the value of a 60/40 portfolio while income is being taken, and 2) counter-party risk with MetLife.
You can't ignore the portfolio growth, and if I'm following you, you are ignoring 20 years of inflation?

Based on the 12% in 14 year numbers in the OP, I've done some runs a few minutes ago, I want to 2x check them, but the results (if correct) are eye-opening. I'm taking a quick break from some other things, and then I gotta run, so it may take a while to get back to it.

But basically, I looked at firecalc defaults but with 40K/1M for easy math. 95% success, right. That's my baseline.

Now, give up $500K of that portfolio (you purchase $500K of deferred annuities), and add in a non-inflation adjusted 'pension' that starts paying $60K (12%) starting 14 years later.

Is that the correct way to model it? If it is, the results look awful. Even more interesting, the optimal AA for this scenarios was..... hold on to your hats.... 100% equities! And no 'hump', a constantly rising line as you move towards 100% equities. Inference is, going out on margin would be even better!

So pls check my numbers, maybe I made a big ooooops somewhere?

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Old 07-24-2013, 05:51 PM   #12
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This is correct, except the 'large stash" part. Please remember I worked many years in Europe, where salaries were much lower than in the US.

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We've asked obgyn this before and I seem to remember that his answer was that he's willing to experience a reduction in spending power over time due to the fact that he has such a large stash, and can also work on the side to supplement his income.

Please correct me if I'm wrong obgyn.
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Old 07-24-2013, 05:55 PM   #13
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No. However, please note that I will not pay any taxes on this 'investment' for the next 14 years. Unlike CDs.

A portion of the payout is tax exempt also.


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Obgyn, did you calculate, or ask your advisor to calculate, the FV (future value) of $100,000 in 14 years?
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Old 07-24-2013, 06:36 PM   #14
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I think many people land here through searches and may blindly assume they reach good advice.
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Old 07-24-2013, 07:12 PM   #15
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For each $10,000 invested, the annuity will pay $133.33/mo, or $1600/yr, starting at age 70, which is twenty years from now. There is no COLA.

To replicate the payout of the annuity, I asked FIRECalc to find the necessary starting value of a 60/40 portfolio that will generate $1600/yr for 30 yrs with a 100% success rate. No inflation adjustment.

FIRECalc calcs the starting portfolio value as $34,598. So, twenty years from now, the annuity will generate the same annual income, for the same length of time, with the same success rate, as a securities portfolio worth $34,598.

I then calculated the compounded growth required to turn $10,000 into $34,598 in 20 years. It's roughly 6.4%.

So it looks to me as though I'm getting 6.4% annual "growth" from the annuity, assuming I live to 70 and start taking annuity payments then.

The comparison breaks down if I don't live to 100, since the annuity will stop paying, whereas a 60/40 portfolio wouldn't. But I'm far less concerned about leaving $$ on the table than I am about outliving my $$.

Two other things my calculation leaves out are 1) likely growth in the value of a 60/40 portfolio while income is being taken, and 2) counter-party risk with MetLife.

Does this look reasonable?
Not to me.

I get a 4.96% IRR if the annuitant lives to be 100. $10,000 today will grow to $26,317 in 20 years at 4.96%. If you then withdraw $1,600 a year from the end of year 20 to the end of year 50 then the $26,317 will decline to zero.

The IRR is negative until the annuitant turns 76 and then increases gradually to 4.96% at age 100 and more if the annuitant lives to be older than 100. If annuitant lives to 80, 85, 90 or 95 the IRRs are 2.30%, 3.53%, 4.23% and 4.67%, respectively.
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Old 07-24-2013, 09:23 PM   #16
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No. However, please note that I will not pay any taxes on this 'investment' for the next 14 years. Unlike CDs.

A portion of the payout is tax exempt also.
True, but if you had an equivalent amount invested in equities, you would be deferring capital gains, assuming a low turnover, and your returns might be higher than with CDs.
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Old 07-24-2013, 09:27 PM   #17
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I do not know how to evaluate this, but by using the US average annual inflation rate of 3.35%, I see that after 20 years the annual payout of $12K will be worth only $6K in today's dollar. It then decreases further down the years as one starts drawing. Another twenty years, then it's worth only $3K.

It does not seem like a good deal to me. What am I missing?

Source: United States Inflation Rate.

PS. The deferred period stated in the OP is 14 years, not 20. Then, the $12K will be worth $7565, not $6K as shown above.
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Old 07-24-2013, 09:37 PM   #18
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.....It does not seem like a good deal to me. What am I missing?....
Nothing. Inflation eats the heck out of your benefits over a long period of time, just like a non-COLAd pension.
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Old 07-24-2013, 09:49 PM   #19
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I get a 4.96% IRR if the annuitant lives to be 100. $10,000 today will grow to $26,317 in 20 years at 4.96%. If you then withdraw $1,600 a year from the end of year 20 to the end of year 50 then the $26,317 will decline to zero.

The IRR is negative until the annuitant turns 76 and then increases gradually to 4.96% at age 100 and more if the annuitant lives to be older than 100. If annuitant lives to 80, 85, 90 or 95 the IRRs are 2.30%, 3.53%, 4.23% and 4.67%, respectively.
This does look like a better way to value the annuity. Thanks. What tool(s) did you use to do this?

Gotta love life annuities. What other type of investment allows you to increase your returns by doing jumping jacks?
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Old 07-24-2013, 10:08 PM   #20
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Nothing. Inflation eats the heck out of your benefits over a long period of time, just like a non-COLAd pension.
OK. So, let's continue on.

The first year after the deferred period, you draw $12K which will be worth only $7565. Then, the next year, the $12K will be worth $7320, and so on.

So, what will you get after 5, 10, 15 years etc...? It is easiest to compute this as a geometric series, whose result is shown below.

5 years: $35.4k (in today's dollar)
10 years: $65.5K
15 years: $91.0K
20 years: $112.7K
25 years: $131.0K

So, you would recover your principal after drawing for 17 years, or 31 years after you hand over the $100K. And that is just to get back the principal without any interest whatsoever.

Darn! I am sure I will not live that long, no matter how many jumping jacks I do each day. And being as greedy as I am, I may do so many jumping jacks it will kill me by heart attack before the 14-year period is over.
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