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Do It Yourself Fixed Annuity alternative
Old 09-15-2013, 04:05 PM   #1
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Do It Yourself Fixed Annuity alternative

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'd average in over 2 - 3 cycles to smooth carrier and interest risks. There should be plenty left over for traditional investments -- maybe even a bit more aggressively given the annuity-like reassurance of such a plan.

I realize some of this has been discussed but times change. Take a read of the brief article above and tell me if it makes good sense.
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Old 09-15-2013, 04:36 PM   #2
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Where is the article?
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Old 09-15-2013, 04:42 PM   #3
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Where is the article?
Click on the word "here" in the second paragraph of the post. I'll recheck it but seems to work OK for me.
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Old 09-15-2013, 04:43 PM   #4
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Hmm, this just looks like a conservative asset allocation.
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Old 09-15-2013, 05:07 PM   #5
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Hmm, this just looks like a conservative asset allocation.
Yes, it is. To me it's a specialized set of rules for investing in SPIA-like goals with little or no obscene commissions, low cost, withdrawal penalties, tax efficiency etc.

If you had SPIA type goals would you purchase a commercial policy or create a DYI alternative such as the above?
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Old 09-15-2013, 05:19 PM   #6
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But to get the benefit, one has to stay the course until the CD matures.

This appears to be a great strategy for our ob gyn friend though.
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Old 09-15-2013, 05:25 PM   #7
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But to get the benefit, one has to stay the course until the CD matures.
Right. You have to follow the rules .

But if you cash in early, you at least have your original investment less a small penalty. No 8% muggings.
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Old 09-15-2013, 05:39 PM   #8
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Wouldn't a conservative allocation fund such as Wellesley deliver a similar result?
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Old 09-15-2013, 05:47 PM   #9
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Right. You have to follow the rules .

But if you cash in early, you at least have your original investment less a small penalty. No 8% muggings.
Not necessarily because it will depend on what the stock portion did. That is, don't forget that if you cash in the CD early it has not made enough interest to get back to your original investment in the CD + equity. If equities have dropped, it could easily be more than an 8% mugging.

So this is not a strategy to use if you need to be spending any of this investment before the CD matures.
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Old 09-15-2013, 05:56 PM   #10
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Hmm, this just looks like a conservative asset allocation.
Yeah, looks like a 27% equity, 73% CD AA.

From the article.....

If long-term CD rates move back to 6%, where they were only four years ago, then only 56% of the funds would be required for the CD, leaving a 44% allocation to equity funds to provide much more of the market upside (see "Looking Up," at left). Should CD rates climb to 10% (we've seen it before), less than 39% of the portfolio would need to go to the CD.

That might be hard for some to do. Lot's of retirees will have the tendency to do the opposite and buy more CD's if rates are that attractive.
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Old 09-15-2013, 06:37 PM   #11
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Yeah, looks like a 27% equity, 73% CD AA.
That's exactly what it is. IMO, if you want to play this game, you would be better off to invest the discount (i.e the $27K) in long-term call options (LEAPS) on the index. At least you get some leverage on the equity returns. IIRC, Brewer wrote a nice explanation about how to create your own EIA using zero-coupon bonds and call options a while back.
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Old 09-15-2013, 06:57 PM   #12
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It looks like Apple's Credit Union's highest CD available now is 7 years paying 2.10%.

Looking at those numbers, the $72,629 would be $88,694 at the end of 10 years, and if the stock ETF of $27,629 at 7% without expenses would be worth $55,524. Best possible outcome $144,218.

Leaving the whole $100,000 in a safe bond fund yielding 2.10% reinvesting dividends would yield $123,345, assuming the bond fund had the same value per share at the end of the 10 years.

This is also assuming the stock market goes up 7% over the 10 years and not down, sideways or has only a small gain.

Also, where are you if stocks decline and bonds values increase?

In the CD scenerio you have $88,694 in "safe money" and $27,629 in an unsafe investment that can go either way. What is the likely hood that your $123,345 bond fund would drop over 27% or conversely go up by 5%. What is the likely hood that your stock ETF could only earn 3% instead of 7%

The other consideration even using the 10 yr. CD is that in five or six yrs., that 3.5% locked in rate might be really low (depending on the terms of redemption) Though admittedly probably not as bad as the loss of value to a bond fund that goes from 2% yield to a 3.5% (though that pain is mitigated over time.)

I guess my point is I don't think it's a bad plan, I just don't think it is a slam dunk either way, and there are still risks involved no matter which way you chose. No doubt about it, for retirees seeking safety and income during retirement years, this present day interest environment leaves much to be desired (put nicely )
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Old 09-15-2013, 07:47 PM   #13
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Wouldn't a conservative allocation fund such as Wellesley deliver a similar result?
Probably, though more susceptible to an admittedly low level of volatility versus the exact DYI approach. I think it would be impractical to achieve unwavering payments long-term.

I am not sure why exact annual payments are that necessary other than the monthly reminder that what goes up must go down. But at least for one segment of my portfolio it is good to know it has a floor that simply does not go down. A CD or individual bond at maturity answers that need but at lower returns. Just like a SPIA, less the fees, commissions, etc.
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Old 09-15-2013, 07:47 PM   #14
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If I understand what you are suggesting, this is essentially the combination of a CD-ladder to guarantee funding of retirement at a certain basic level, and an equity component to try to capture market upside, if any. The CD ladder is funded in a way, based on current CD rates, to give you the amount you will need each year (or two, or five), and the rest of your capital is placed at higher risk in the equity market. It is a smart, if conservative, way to invest, in my opinion, keeping the money to fund your most basic needs at the lowest possible risk, and then only taking market risk with the money you can do without in a pinch. Your "number" will be higher using this conservative approach, given its lower expected returns, especially in today's environment of low CD rates. If you go this way, you should build expected inflation into your CD-ladder investments so that the maturity values of your CDs increase through time with your estimate of your personal inflation rate.
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Old 09-15-2013, 08:06 PM   #15
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I am not sure why exact annual payments are that necessary other than the monthly reminder that what goes up must go down. But at least for one segment of my portfolio it is good to know it has a floor that simply does not go down. A CD or individual bond at maturity answers that need but at lower returns. Just like a SPIA, less the fees, commissions, etc.
This sounds similar to the "Buckets" way of thinking. Rather than thinking of a portfolio in terms of total return you divide it up chronologically. Of course the CD not going down in real terms depends on inflation, but I agree with the philosophy of setting up stable income to cover basic necessities.
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Old 09-15-2013, 08:18 PM   #16
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Yes, it is. To me it's a specialized set of rules for investing in SPIA-like goals with little or no obscene commissions, low cost, withdrawal penalties, tax efficiency etc.

If you had SPIA type goals would you purchase a commercial policy or create a DYI alternative such as the above?
I had SPIA type goals when I first started investing and I set those up 25 years ago by contributing to TIAA-Traditional and I will annuitize that at some time. It's nice to have something ticking along at 4.4% in such a low interest rate environment. I've also paid 25 years of voluntary UK National Insurance while also paying US FICA tax so that I'll get two SS checks when I retire. Those are still the best annuities.
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Old 09-15-2013, 08:25 PM   #17
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If I understand what you are suggesting, this is essentially the combination of a CD-ladder to guarantee funding of retirement at a certain basic level, and an equity component to try to capture market upside, if any. The CD ladder is funded in a way, based on current CD rates, to give you the amount you will need each year (or two, or five), and the rest of your capital is placed at higher risk in the equity market. It is a smart, if conservative, way to invest, in my opinion, keeping the money to fund your most basic needs at the lowest possible risk, and then only taking market risk with the money you can do without in a pinch. Your "number" will be higher using this conservative approach, given its lower expected returns, especially in today's environment of low CD rates. If you go this way, you should build expected inflation into your CD-ladder investments so that the maturity values of your CDs increase through time with your estimate of your personal inflation rate.
Yes, that is the fundamental logic. The article also makes the critical point that for a 10 year period the stock market has never failed to earn money nor to beat the bond market, IIRC.)

Nun, now that you mention it, it does remind me of buckets except that buckets are separated from one another to achieve specific goals, while Diy "buckets" are consolidated allow them to work as one entity.
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Old 09-15-2013, 09:09 PM   #18
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Clever. Very conservative. I see nothing wrong with it.
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Old 09-16-2013, 06:05 AM   #19
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You are really only looking at doing exactly what the insurance company does with your money when you buy a SPIA except pay a commission, all the salaries and the cost of that fancy office building.
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Old 09-16-2013, 06:55 AM   #20
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You are really only looking at doing exactly what the insurance company does with your money when you buy a SPIA except pay a commission, all the salaries and the cost of that fancy office building.
Except the SPIA return benefits from pooling longevity risks and thus theoretically returns a higher level of income for as long as you live as long as you are willing to give up the difference if you die early. Have you compared the actual cash flow you would receive from cashing out your CDs over time to the cash flow of the SPIA? If the SPIA return after expenses is higher, I think I would lean that way for a "rock solid" guarantee. Some risk of insurance company failure but you could mitigate that by buying a few SPIAs under the state guarantee threshold each with a different reputable company.
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