Do It Yourself Fixed Annuity alternative

[Gatordoc50]

I like the concept. It shows the value of CDs or AAA bonds over bond funds in guaranteeing a floor over a specific time period. I also believe asset price declines are a much bigger risk than inflation. Most investors disagree with my philosophy and I like that too.

 

[Rich_by_the_Bay]

Just like many of us were skeptical of the 'buckets' approach - you can't just wipe away risk by giving your money 'names' - it's all AA when you get down to it. And it appears the buckets approach blew up. This is just asset allocation, wrapped up with a bow. Now take a look over a longer time frame, and see how it performs. I wonder if Rich may be 'chasing buckets'?

-ERD50

Mea culpa re:chasing buckets but I'm not sure that's a bad thing, in proportion. You just need to avoid becoming a slave to the bucket name.

BTW I looked at ImmediateAnnuities.com and vanguard.com but both seemed to have altered their SPIA calculators to make a direct comparison difficult to achieve (for me). I'd like to see a comparison using a 6% up front commission, Vgd expense ratios v. typical expense ratios, 100% survivor benefit on original principle, etc.

Anyhow, food for thought.

 

[nun]

With a SPIA one gets a managed payout of sorts. I am not endorsing annuities, in fact the opposite is my opinion but, they do give a monthly stipend. I do see a lot of value in this DIY approach, but for some folk (Not anyone on this Forum I am sure) an Annuity provides discipline that perhaps they do not have on their own, for that they pay the cost.

Quite a few people on this forum use SPIAs to provide a foundation of income to cover the essentials and to insure against living a long time or a big down turn in the stock market.

 

[Independent]

Though I am almost never a fan of commercial annuity products, Lynn and I are on the verge of re-allocating some of our cash reserves to a Do-It-Yourself immediate annuity strategy. No insurance companies are involved.

This "instrument" has been discussed here and elsewhere. Our goals are a) an rock-solid income generator for basic expenses beyond what SS and a small pension will produce, b) smooth the jump from several years of almost no taxes to the tax created by consulting pocket-change and SS kicking in in 2015 and c) simplification for the surviving spouse when that time occurs.

I'm missing the income.

It looks to me like you put $X in a CD and ($100,000-X) in stocks. You don't withdraw anything. When the CD matures, you have $100,000 from the CD and whatever the stocks grow to.

Maybe you've already covered where you get the income in a later post, I didn't see it.

 

[Meadbh]

I'm missing the income.

It looks to me like you put $X in a CD and ($100,000-X) in stocks. You don't withdraw anything. When the CD matures, you have $100,000 from the CD and whatever the stocks grow to.

Maybe you've already covered where you get the income in a later post, I didn't see it.

+1. The only way I can see getting a regular income from this strategy is to have a ladder of 10 year CDs, and/or to take dividends and capital gains from the equity portfolio.

 

[Independent]

BTW I looked at ImmediateAnnuities.com and vanguard.com but both seemed to have altered their SPIA calculators to make a direct comparison difficult to achieve (for me). I'd like to see a comparison using a 6% up front commission, Vgd expense ratios v. typical expense ratios, 100% survivor benefit on original principle, etc.

The items you're talking about are typically disclosed on a Variable Annuity, but not on a Single Premium Immediate Annuity.

With an SPIA, you pay your $100,000 to the insurance company, they send you a check a month later and every month thereafter as long as you live.
If the check is $458/mo, that's the end of the story.
Yes, the insurance company pays the agent a commission, incurs other expenses, and hopes to make a profit. But all those things come out of your $100,000 before they start paying the $458. The only thing you expect to find on a quote site is the monthly payment.


I got the $458 by logging into vanguard.com, clicking until I got to a place where I could click on "get quote" for an SPIA. That kicked me over to incomesolutions.com where I logged in again. I answered the questions on their quote form, said "no" to have someone contact me. I said I wanted a joint life annuity for a couple who are both 60, and I have $100,000 for the premium. They gave me five numbers, varying between $452.30 and $460.99

 

[nun]

I got the $458 by logging into vanguard.com, clicking until I got to a place where I could click on "get quote" for an SPIA. That kicked me over to incomesolutions.com where I logged in again. I answered the questions on their quote form, said "no" to have someone contact me. I said I wanted a joint life annuity for a couple who are both 60, and I have $100,000 for the premium. They gave me five numbers, varying between $452.30 and $460.99

The number you want to get at is the interest rate. Right now it looks like a single life SPIA for a 60 year old male has a interest rate of 3%. Is that worth the guarantee of income for life? Is a 10 year CD significantly better? At least the CD offers the opportunity to buy at another rate....hopefully it would be larger. A CD ladder would allow advantage to be taken of increasing rates, but the rates will be less the shorter the duration. There's no free lunch.

 

[pb4uski]

Where are you getting the 3%?

I'm not sure how one could compute an interest rate for a life annuity unless you knew the insurer's pricing assumptions, mortality table, etc. What you could do is compute the IRR for a long period certain annuity and assume that an insurer would likely use similar interest rates for a life annuity.

 

[nun]

Where are you getting the 3%?

Just taking the life expectancy from the SSA tables, the monthly payout amount from one of the online quote sites and backing out the interest rate, it's probably an over estimate and there are a lot of assumptions, but it's something to hang a hat on.

The great thing about TIAA-CREF is they actually give you the accumulation interest rate and the payout interest rates used to calculate your annuity. For 2013 vintages the payout interest rate is 3%, but many of my contributions get a payout interest rate of 7.75%. Applying the same logic as I used to get the 3% rate above to the annuity quote I got from TIAA-CREF for a SPIA starting at age 55 the combined payout interest rate is 5.5% and the payout rate is 7.1%. These numbers are the reason I'll take the TIAA-Traditional annuity

 

[Rich_by_the_Bay]

I'm missing the income.

It looks to me like you put $X in a CD and ($100,000-X) in stocks. You don't withdraw anything. When the CD matures, you have $100,000 from the CD and whatever the stocks grow to.

Maybe you've already covered where you get the income in a later post, I didn't see it.

The CD keeps cranking out its interest payments (say every 6 mos) and this is your "annuity payment." The stock gains are a variable bonus but neither stable nor predictable; just gravy you should enjoy but not count on. Or leave it around til the next ladder comes up down the road.

 

[pb4uski]

....Take a read of the brief article above and tell me if it makes good sense.

If you're in accumulation phase and considering this alternative compared to a equity-indexed annuity, then I think the idea has some merit.

Let's say you have $100k to invest and you can buy a 10 year CD paying 3.5%. You would invest ~$71k of the $100k in the CD and it would grow to $100k in 10 years. The remaining $29k would be invested in a a low cost equity index ETF.

Worst case 10 years later your ETF has gone bust (never happen) but you still have your $100k in the CD. Likely case if stocks appreciate 8% annually your $29k grows to ~$63k over ten years so you have ~$163k in total and a aggregate 5% annual return. Even if stocks are flat over the 10 years you end up with $129k and a 2.58% annual return.

The thing is, it isn't a payout phase solution. Repeat--- it isn't a substitute for an immediate annuity - it is a substitute for an equity-indexed annuity.

In the example I outlined I "think" it would be like buying an EIA with a 29% participation rate and no cap. In reality, I think most commercial EIAs have higher participation rates but caps so it is arguably a wash.

 

[scrinch]

The thing is, it isn't a payout phase solution. Repeat--- it isn't a substitute for an immediate annuity - it is a substitute for an equity-indexed annuity.

Agreed, as described in the article referenced, it is not structured for payouts at all, so it is not a substitute for an immediate annuity. However, there is no reason why you could not create a CD ladder with associated equity investments, and then you could use it for periodic payouts as the CDs expire.

I'm a little amused by all the little mental schemes that people dream up to slice, dice, name, and categorize pieces of their investments ....in buckets, baskets, boxes, or broomclosets. If you put $71k in a CD and $29k in a stock ETF, then you have a 71/0/29 asset allocation. It has a certain risk/return profile that gives it a very high probability of being worth between $120k and $190k in 10 years...call it whatever nickname you want. A 0/0/100 allocation has a risk profile that gives it a high likelihood of being worth between $60k and $300k in 10 years. As an earlier poster mentioned, it is just a different asset allocation with its particular risk/return profile.

 

[Independent]

The number you want to get at is the interest rate. Right now it looks like a single life SPIA for a 60 year old male has a interest rate of 3%. Is that worth the guarantee of income for life? Is a 10 year CD significantly better? At least the CD offers the opportunity to buy at another rate....hopefully it would be larger. A CD ladder would allow advantage to be taken of increasing rates, but the rates will be less the shorter the duration. There's no free lunch.

Why do I "want to get at the interest rate"?

An SPIA has many "interest rates", or "internal rates of return".

In the case of $100,000 => $458 monthly joint life payment, the IRR is

-10.3% if our second death is at exactly 10 years
1.0% if our second death is at exactly 20 years
3.7% if our second death is at exactly 30 years
4.7% if our second death is at exactly 40 years

 

[Independent]

The CD keeps cranking out its interest payments (say every 6 mos) and this is your "annuity payment." The stock gains are a variable bonus but neither stable nor predictable; just gravy you should enjoy but not count on. Or leave it around til the next ladder comes up down the road.

That's not what I understand.

... the client needs $72,629 of the $100,000 to go into this CD to grow to $100,000 in 10 years.

Were you thinking the $72,629 would both grow to $100,000 and "crank out interest payments"?

 

[Rich_by_the_Bay]

I'm a little amused by all the little mental schemes that people dream up to slice, dice, name, and categorize pieces of their investments ....in buckets, baskets, boxes, or broomclosets. If you put $71k in a CD and $29k in a stock ETF, then you have a 71/0/29 asset allocation. It has a certain risk/return profile that gives it a very high probability of being worth between $120k and $190k in 10 years...call it whatever nickname you want. A 0/0/100 allocation has a risk profile that gives it a high likelihood of being worth between $60k and $300k in 10 years. As an earlier poster mentioned, it is just a different asset allocation with its particular risk/return profile.

I think it is a desire to avoid very low sustained returns on my cash or ST bond holdings that leads me to seek alternatives. The type of categorizing and labeling really doesn't matter as long as it accurately reflects what you're trying to do with the money -- "DIY Annuity" works for me as do many others. "Low Risk CDs blended not stirred with a dollop of Total Stock ETF Balanced to Retain its original equity value" just didn't flow off the tongue .

 

[nun]

Why do I "want to get at the interest rate"?

An SPIA has many "interest rates", or "internal rates of return".

In the case of $100,000 => $458 monthly joint life payment, the IRR is

-10.3% if our second death is at exactly 10 years
1.0% if our second death is at exactly 20 years
3.7% if our second death is at exactly 30 years
4.7% if our second death is at exactly 40 years

Sure it all depends on when you die. But when considering an SPIA I think it's important to understand the effective interest rate if you die when the mortality table says you will so that you can compare SPIA quotes and also so you can compare the guarantee and return of the annuity against other investment options. I wonder how many people would buy annuities if they actually worked out the interest rate on their money so that it would go to zero given the annuity payout rate and expected life span.

 

[scrinch]

"DIY Annuity" works for me as do many others. "Low Risk CDs blended not stirred with a dollop of Total Stock ETF Balanced to Retain its original equity value" just didn't flow off the tongue .

Ok, you're right. It is a lot catchier. Just don't forget that it is a part of the overall portfolio and doesn't really exist on its own. The CDs are for low risk and the stock is for growth whether they are in the same or separate broomclosets.

 

[brewer12345]

The linked article in the original post is about replicating an equity indexed annuity (EIA) also known as a fixed index annuity (FIA). I think it is much, much cleaner and a lot more flexible to replicate an EIA with options and your choice of CD product as detailed here: Life, Investments & Everything: Rolling Your Own

In fact, I think this is a goofy product idea to begin with that is totally and completely about selling the sizzle rather than the steak. But since it is obviously an irresistable idea to many people who should know better, at least make your own for 15 minutes worth of effort rather than getting hosed by an insurer or bank. I would note that if you replicate an EIA with options it is likely to be pretty tax efficient and it is also very flexible: if you want to switch from the S&P 500 as the underlying index to the small cap index when the first set of options expire, you just use options on your new index. You could even create a short EIA using puts, or an exotic EIA with call options on something like CORN or VXX. Or you could clear the crap out of your [-]brain[/-] eyes and stop this strategy after the first year or two and invest like a grown-up.

 

[FIRE'd@51]

The CD keeps cranking out its interest payments (say every 6 mos) and this is your "annuity payment." The stock gains are a variable bonus but neither stable nor predictable; just gravy you should enjoy but not count on. Or leave it around til the next ladder comes up down the road.

If you spend the interest payments from the CD you lose the guarantee of the 100K floor. You've invested 72K in the CD. If you spend the interest payments, you will have 72K when the CD matures, plus the value of the stock portfolio. If the total return on the stocks is negative over the 10-year period, the CD/stock combination will have a value less than 100K.

 

[Independent]

Sure it all depends on when you die. But when considering an SPIA I think it's important to understand the effective interest rate if you die when the mortality table says you will
1) so that you can compare SPIA quotes and
2) also so you can compare the guarantee and return of the annuity against other investment options. I wonder how many people would buy annuities if they actually worked out the interest rate on their money so that it would go to zero given the annuity payout rate and expected life span.

1. You don't need to work out the IRR on an annuity to compare SPIA quotes. You simply look at the monthly payouts.
2. Calculating a series of IRRs like I did may give some insight into SPIA vs. investments. Calculating only one gives less insight.

But, I agree that a lot of people look at the $458/mo and think that's 5.5% annual "interest". For these people, an IRR calculation is one way of explaining the loss of principal. Though, I think simply pointing out that a 5.5% bond has a maturity value and a $458/mo SPIA has none should get their attention.

 

[brewer12345]

If you spend the interest payments from the CD you lose the guarantee of the 100K floor. You've invested 72K in the CD. If you spend the interest payments, you will have 72K when the CD matures, plus the value of the stock portfolio. If the total return on the stocks is negative over the 10-year period, the CD/stock combination will have a value less than 100K.

6 to 10 years ago one of the dumber investment houses came out with a mutual fund that did the same thing. I don't imagine the whole idea took off, since this is being touted in Op's article as a novel idea, but it is nothing new.

 

[nun]

1. You don't need to work out the IRR on an annuity to compare SPIA quotes. You simply look at the monthly payouts.
2. Calculating a series of IRRs like I did may give some insight into SPIA vs. investments. Calculating only one gives less insight.

But, I agree that a lot of people look at the $458/mo and think that's 5.5% annual "interest". For these people, an IRR calculation is one way of explaining the loss of principal. Though, I think simply pointing out that a 5.5% bond has a maturity value and a $458/mo SPIA has none should get their attention.

Yes you can just look at the payouts, that's me being a bit of a Homer. The the various rates of return given different lifespans is interesting, but you'll only have one lifespan and in comparing options I'd just go for your predicted lifespan as who knows when the grim reaper will arrive. If I knew I'd live to 120 an annuity looks pretty good, if I'm going to die tomorrow it's a waste of money.

When I did the simple "predicted life span interest rate" calculation for current SPIAs I got an interest rate of 3%. I have a stable value fund currently returning 2.6% in my 457 so that looks like a reasonable alternative to me and the 5.5% interest rate over my predicted lifespan of my TIAA annuity quote looks positively rich.

My plan is to use the stable value fund to fund my ER up to 59.5. Then I'll probably annuitize the 5% of my AA that's in TIAA-Traditional, spend down the IRAs and delay SS until I'm 70.

 

[Rich_by_the_Bay]

If you spend the interest payments from the CD you lose the guarantee of the 100K floor. You've invested 72K in the CD. If you spend the interest payments, you will have 72K when the CD matures, plus the value of the stock portfolio. If the total return on the stocks is negative over the 10-year period, the CD/stock combination will have a value less than 100K.

The article says you can take CD distributions from the account as long as it keeps the CD balance no lower than the original value of the CD.

 

[Onward]

The article says you can take CD distributions from the account as long as it keeps the CD balance no lower than the original value of the CD.

But then stocks could fall the next day, and you've potentially lost your $100k floor.

 

[Independent]

The article says you can take CD distributions from the account as long as it keeps the CD balance no lower than the original value of the CD.

At the end of the ten year period, after I know what the stock market did during the first 10 years, I can take out some money.

For example, if my CD/stock split is $73,000/$27,000, and the stock market doubles in 10 years, then I can pull out $27,000 and start the second cycle with $100,000.

If the market triples, I can get $54,000.
If the market goes up by a third, I will only be able to pull out $9,000.
etc.

Since I don't know what the market is going to do, I can't really anticipate any amount that I can withdraw at the beginning.

Meanwhile, if we can get $458/mo in an SPIA, we would get almost $55,000 in the first 10 years.

Of course, if we both die in the tenth year, the SPIA has no residual value, while the CD/stock AA will have $100,000 plus the stocks.