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Old 09-17-2013, 10:13 AM   #41
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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.
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Old 09-17-2013, 10:15 AM   #42
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"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.
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Old 09-17-2013, 10:44 AM   #43
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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.
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Old 09-17-2013, 10:47 AM   #44
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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.
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Old 09-17-2013, 11:03 AM   #45
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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.
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Old 09-17-2013, 11:08 AM   #46
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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.
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Old 09-17-2013, 11:31 AM   #47
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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.
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Old 09-17-2013, 11:49 AM   #48
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Originally Posted by FIRE'd@51 View Post
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.
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Old 09-17-2013, 02:34 PM   #49
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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.
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Old 09-17-2013, 02:47 PM   #50
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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.
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Old 09-17-2013, 02:55 PM   #51
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Originally Posted by Rich_by_the_Bay View Post
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.
I think you are mixing up an EIA/FIA (what the article is talking about) with a SPIA.
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Old 09-17-2013, 03:33 PM   #52
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I think you are mixing up an EIA/FIA (what the article is talking about) with a SPIA.
+1 totally different animals.
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Old 09-17-2013, 03:42 PM   #53
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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.
Its always interesting how much people invest for themselves and how much for their heirs. Many financial advisers say to invest for yourself first, get the retirement saving sorted before you save for your children's college etc. It seems that the choice of an SPIA over a DIY annuity is similar; either spend your principal to guarantee income or keep the principal available and hope you generate some income.
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Old 09-17-2013, 05:31 PM   #54
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This sounds like too much work. I would prefer to give some money to an insurance company after I reach the age of 70, buy an SPIA, and forget about it. The insurance company carries the risk, not me. I know some here will disagree.
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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.
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Old 09-17-2013, 06:23 PM   #55
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There may be a sweet spot for this idea. As the risk-less rate rises so does the stock allocation but at what point do you forego stocks altogether and just stick with risk-less assets.
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Old 09-17-2013, 06:38 PM   #56
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There may be a sweet spot for this idea. As the risk-less rate rises so does the stock allocation but at what point do you forego stocks altogether and just stick with risk-less assets.
Ahh the good old days of living off CD interest. That number is going to depend on how much you need to generate from your portfolio.
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Old 09-17-2013, 08:39 PM   #57
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Ahh the good old days of living off CD interest. That number is going to depend on how much you need to generate from your portfolio.
I think the important thing to watch will be real interest rates rather than nominal. A 5% CD rate may sound juicy unless inflation is bouncing between 4 and 6%. This was the original idea as to the attractiveness of TIPS: lock in a real rate. If I saw 10 to 20 year TIPS at 3% or better real I would be buying quite a lot of them. CDs at some nominal rate would require some careful estimation of what future inflation rates might be before I were willing to lock in. Since the feddle gubmint has not locked in much of its debt at low rates for long term, the temptation to allow inflation to take care of that pesky debt problem is high enough that I am extremely loathe to lock in for the long term. My 2021 Pen Fed CD is at 5% and I can surrender early any time I like, Every other piece of fixed income I have is considerably shorter maturity.
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Old 09-18-2013, 07:06 AM   #58
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I think the important thing to watch will be real interest rates rather than nominal. A 5% CD rate may sound juicy unless inflation is bouncing between 4 and 6%. This was the original idea as to the attractiveness of TIPS: lock in a real rate. If I saw 10 to 20 year TIPS at 3% or better real I would be buying quite a lot of them. CDs at some nominal rate would require some careful estimation of what future inflation rates might be before I were willing to lock in. Since the feddle gubmint has not locked in much of its debt at low rates for long term, the temptation to allow inflation to take care of that pesky debt problem is high enough that I am extremely loathe to lock in for the long term. My 2021 Pen Fed CD is at 5% and I can surrender early any time I like, Every other piece of fixed income I have is considerably shorter maturity.
I've been doing a lot or research on TIPS and you are right. A 3% real return would be hard to pass up. The conclusion I have made about TIPS are they are good if there is unexpected inflation. Otherwise, expected inflation is priced into regular Treasuries and CDs. For long terms with more uncertainty, TIPS are great especially if you can get a decent coupon.
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Old 09-18-2013, 08:42 AM   #59
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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.
arrrgh!

I wrote an earlier response to this, and made a rather serious error. Now I find that I can't edit it this morning, so I'll re-write, and hopefully correct it, here:

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.

Because my CD has grown back to the original $100,000, I can spend my entire stock portfolio.

Suppose my original split was $27,000 in stocks and $73,000 to the CD. If my stocks doubled, I can spend the whole $54,000. If they don't go anywhere, I can still spend $27,000. And they may do great and triple and I'll be able to spend $81,000.

But ... 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. I could do something like 1/10 the balance after one year, 1/9 the balance after two, etc. This would provide income, but I wouldn't call it "rock solid".

OTOH, if we can get $458/mo in an SPIA, that would be a stable predictable income. 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 (assuming I spend the stocks along the way).
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Old 09-18-2013, 12:38 PM   #60
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arrrgh!

I wrote an earlier response to this, and made a rather serious error. Now I find that I can't edit it this morning, so I'll re-write, and hopefully correct it, here:

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.

Because my CD has grown back to the original $100,000, I can spend my entire stock portfolio.

Suppose my original split was $27,000 in stocks and $73,000 to the CD. If my stocks doubled, I can spend the whole $54,000. If they don't go anywhere, I can still spend $27,000. And they may do great and triple and I'll be able to spend $81,000.

But ... 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. I could do something like 1/10 the balance after one year, 1/9 the balance after two, etc. This would provide income, but I wouldn't call it "rock solid".

OTOH, if we can get $458/mo in an SPIA, that would be a stable predictable income. 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 (assuming I spend the stocks along the way).
It is the CD interest distributions that I would consider rock-solid. The stock fund may not be rock-solid but it has a very high likelihood of beating the CD over a 10 year incubation. At maturity, I might use it to by another larger round of DYI SPIA. Unless I needed a new car. Dealer's choice.
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