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How should annuities be classified in a portfolio?
Old 12-13-2012, 08:54 AM   #1
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How should annuities be classified in a portfolio?

My wife has a 403b annuity we need to keep for another couple years. (She's retired, I will be shortly). In the overall allocation, how should I classify it - cash or 'bond'? I've been pretty much ignoring it for allocation purposes, but I'm curious as to the proper way of icluding it in an allocation.

It returns about 3% annually.

Thanks in advance.
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Old 12-13-2012, 09:00 AM   #2
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I assume that you are calculating a PV for the annuity for this question...

Me, I would put it in bonds... I think cash is something you can get your hands on today... an annuity you can not.... it just provides cash flow like a bond....

I am sure others will disagree....
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Old 12-13-2012, 09:08 AM   #3
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To my knowledge there are two schools of thought.

One is to ignore it for AA purposes. That is what I do with my small defined benefit pension and SS. It is a slippery slope because if you include the PV in your AA, why would you not also include other pensions and SS?

Others believe it should be included as a bond equivalent.

I can see both points of view, but then the question for me becomes should the AA target change if I include them vs exclude them?

No "right" answer that I've ever heard.
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Old 12-13-2012, 11:06 AM   #4
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It's fixed income that you can calculate a present value for - it's a bond for allocation purposes.
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Old 12-13-2012, 11:16 AM   #5
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Have you actually made the decision to annuitize the 403b? Or, might you still convert it to a rollover IRA? (Don't confuse the fact that a 403b is referred to as an annuity during the accumulation stage with "annuitizing" which is when you turn over the lump sum to the insurance company in exchange for a series of monthly payments over your life.)

If you have commited to annuitizing, count it as fixed.

If you are going to convert it to a rollover IRA (that's what we did), then the AA is however you have it invested.
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Old 12-13-2012, 12:26 PM   #6
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I think the answer is: it depends.

From the POV of net worth, the annuity payment is no longer yours, so once purchased, it should not be counted in NW.

From the POV of income, as others have said, it's fixed income. Does FI have a present value? Sure, just like a pension.

From the POV of asset allocation, the asset now belongs to the annuity provider, but it can be invested in a combination of financial instruments. And the research paper below suggests that the optimal asset allocation is identical to what it would be had the annuitant kept the money. So what's the difference? The annuitant has exported longevity risk.
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Old 12-13-2012, 12:30 PM   #7
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link doesn't work for me.
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Old 12-13-2012, 01:42 PM   #8
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link doesn't work for me.
Apologies, I guess I must have library access. I have uploaded a PDF instead. BTW, I didn't read all the equations either!
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Old 12-13-2012, 02:01 PM   #9
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Thanks for all of the responses. I learned a few things.

The value of the annuity is currently $65700, but we'll take a $2000 loss in value if we roll the money over elsewhere now. In two years, we can transfer the full value with no loss or penalty. Might as well wait.

I believe I'll keep ignoring it as far as the AA goes, and when it's time, roll it over to a Vanguard account - whichever fund is appropriate at the time.
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Old 12-13-2012, 02:43 PM   #10
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Thanks for all of the responses. I learned a few things.

The value of the annuity is currently $65700, but we'll take a $2000 loss in value if we roll the money over elsewhere now. In two years, we can transfer the full value with no loss or penalty. Might as well wait.

I believe I'll keep ignoring it as far as the AA goes, and when it's time, roll it over to a Vanguard account - whichever fund is appropriate at the time.
Sounds excellent. Then, however you have it invested in your rollover IRA, that's the AA.

I'm sure the folks at Vanguard will be glad to help you do a direct rollover so there's no chance of having any issues with the friendly folks at the IRS.

From you note, I know you understand this, but I'll repeat anyway........ The 403b is called an annuity during accumulation stage. But, in this case, it hasn't been, and won't be, annuitized. It will be converted to a rollover IRA which will have an AA of your chosing. It won't be converted, that is "annuitized," into a stream of monthly payments.
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Old 12-13-2012, 02:50 PM   #11
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I think the answer is: it depends.

From the POV of net worth, the annuity payment is no longer yours, so once purchased, it should not be counted in NW.

From the POV of income, as others have said, it's fixed income. Does FI have a present value? Sure, just like a pension.

From the POV of asset allocation, the asset now belongs to the annuity provider, but it can be invested in a combination of financial instruments. And the research paper below suggests that the optimal asset allocation is identical to what it would be had the annuitant kept the money. So what's the difference? The annuitant has exported longevity risk.

The attached pdf was an allocation for a VA.... not the same as the OP question....

Also, you state that the annuity is no longer owned by you, but is an income stream... this is true to a point... you can sell an income stream and get a lump sum payment.... it is not smart to do so as they do not give you full value for it, but it can be done....

So, for a large pension I think it is foolish to ignore the PV of that pension in an AA... an example is someone who has a pension of $60K per year and only $200K of investments (someone I know).... they have almost all of their savings in stocks because the PV of that $60K is huge compared to their other investments....
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Old 12-13-2012, 03:18 PM   #12
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an example is someone who has a pension of $60K per year and only $200K of investments (someone I know).... they have almost all of their savings in stocks because the PV of that $60K is huge compared to their other investments....
Definitely agree. If that nice $60k pension is not COLA'd, he had better be investing the paltry $200k of investments focusing on beating inflation, stocks for example, since the real cash flow of the pension will likely be half or less of it's current value in a couple of decades. A non-COLA'd annuity of any type (DBP pension, SPIA, etc) is not longevity insurance as a couple decades of modest inflation will cut it in half. The balance of your FIRE investments needs to be positioned to offset that.

We definitely consider the PV of DW's pension and my SS as fixed investments in our AA.
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Old 12-13-2012, 07:56 PM   #13
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Originally Posted by youbet

Definitely agree. If that nice $60k pension is not COLA'd, he had better be investing the paltry $200k of investments focusing on beating inflation, stocks for example, since the real cash flow of the pension will likely be half or less of it's current value in a couple of decades. A non-COLA'd annuity of any type (DBP pension, SPIA, etc) is not longevity insurance as a couple decades of modest inflation will cut it in half. The balance of your FIRE investments needs to be positioned to offset that.

We definitely consider the PV of DW's pension and my SS as fixed investments in our AA.
Now I am not saying I am correct, but I have done the exact opposite. I have a COLA'd pension of 75k, and have an even more paltry amount under 200k. My reasoning is the only reason why my pension would be cut is because the stock market rolled and didn't come back over a period of time. I would in effect be doubling down more on the market with my assets. I only live on about 60% of my pension so I slowly continue to add to my stash and probably will until I die.
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Old 12-13-2012, 10:43 PM   #14
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My reasoning is the only reason why my pension would be cut is because the stock market rolled and didn't come back over a period of time.
I suppose it might be worth finding out more about the investments that support your pension (and to continue to monitor them--things can change). If, say, they have elected to avoid the volatility of the stock market and have loaded up on "safe" bonds, they might get really hammered if interest rates (and inflation) rise 5%. If that were the case, you'd want to own stocks to complement the portfolio chosen by the pension fund managers in order to reduce your total risk.

Maybe you've already done all that and found out that the pension depends on stocks.
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Old 12-14-2012, 12:13 AM   #15
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Now I am not saying I am correct, but I have done the exact opposite. I have a COLA'd pension of 75k, and have an even more paltry amount under 200k. My reasoning is the only reason why my pension would be cut is because the stock market rolled and didn't come back over a period of time. I would in effect be doubling down more on the market with my assets. I only live on about 60% of my pension so I slowly continue to add to my stash and probably will until I die.
What are you doing that is the exact opposite?
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Old 12-14-2012, 07:58 AM   #16
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Since DW and I are taking early retirements, it will reflect in our pensions - both will be calculated at 25 years of service - and will equal a COLA'd amount of about $60k in pre-tax dollars. It also permits the survivor to continue collecting the deceased spouse's paycheck. DW's family is long-lived. I calculate at a post-retirement 40 year time horizon.

As of May, when I retire, we anticpate a $900k investment portfolio which will be split 60 stock/40 bonds in total market index funds (about 18% total international stocks). Another $40k in cash/equivalencies. Currently, about half that money is tied up in employer sponsored accounts over which I have no control: but most of it was in a guaranteed/stable account earning 5% so I had no complaint. Come May, it's available to roll over. (unfortunately, it stopped earning 5% in April and became a floating figure equivalent to the 10 year T bill *sigh*). DW is also receiving - in addition to pension - a $1225 monthly contribution to Oppenheimer (no choice there) funds which will continue for five years. I did not not include that money in the portfolio figure, as we don't have it yet. It is being invest at the same 60/40 AA automatically.

No significant debt - just a new truck to haul our camper. 0% interest (or interest pre-paid in the purchase price, whichever you prefer lol). Our largest expenses, of course, will be health and long term care insurance - about $1150 a month. Plus, about $6k (future) a year in SS benefits from my high school and college jobs (mostly).

We can live on the pension, but our plan is a $20k annual withdrawel designed to supplement our love of travel in the camper. The expectaion is that the investments will continue to grow at a minor rate over time. That will also keep us under $85k a year, and avoid Obama's increased Medicare tax for the 'more affluent'.


Well, that's the game plan, anyway...

Any thoughts or suggestions are always appreciated.
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Old 12-14-2012, 08:09 AM   #17
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As to the OP's question, we look at our SPIA (joint lilfe) as an income stream, such as SS or a (non-COLA'ed) pension.

We don't use it in any manner as related to our joint retirement portfolio, regardless that it currently has significant cash value if we would both pass tomorrow (we took the guaranteed life/term option, rather than have the remainder go into the annuity pool).

Some would say that DW/me could have more in equities based upon our current/future income streams (which includes the SPIA, two small DB pensions for DW, and our respective future SS). We don't do that, in our case. Our AA target (currently at 50% equity/50% bond/cash) is only based upon our joint retirement portfolio, regardless of any other "outside" income.
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Old 12-14-2012, 05:40 PM   #18
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Originally Posted by youbet

What are you doing that is the exact opposite?
I max out my I Bonds each year and make yearly CD deposits. Close to 70% of the pension fund is in stocks, and a small amount of "illiquid invests" (God only knows what that entails, and I am not sure I would want to know). Though I am getting wild and crazy with my yearly 5k Roth (work part time) and put it in STAR fund. Started 2 years ago putting $500 a month in total stock index, so I am slowly building up a little. The retirement landscape has changed greatly since I entered the work force back in mid 80's and I am probably at the tail end of the pension era. The older people and family that I have been around all have been about the same concerning retirement. Retired with little money, but have a nice pension. The most money you ever have will be the day you die (which is still overall a modest amount). It is completely the opposite of today, where you have to build up big early, then draw down.
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Old 12-14-2012, 06:34 PM   #19
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I max out my I Bonds each year and make yearly CD deposits. Close to 70% of the pension fund is in stocks, and a small amount of "illiquid invests" (God only knows what that entails, and I am not sure I would want to know). Though I am getting wild and crazy with my yearly 5k Roth (work part time) and put it in STAR fund. Started 2 years ago putting $500 a month in total stock index, so I am slowly building up a little. The retirement landscape has changed greatly since I entered the work force back in mid 80's and I am probably at the tail end of the pension era. The older people and family that I have been around all have been about the same concerning retirement. Retired with little money, but have a nice pension. The most money you ever have will be the day you die (which is still overall a modest amount). It is completely the opposite of today, where you have to build up big early, then draw down.
I concur with what you're doing Mulligan. But you're not doing "the opposite."

Your pension is COLA'd. I was talking about non-COLA'd pensions which decrease in real value over time and therefore require an offsetting increase in portfolio income to maintain a level standard of living. Over a couple of decades, the real value of a non-COLA'd pension will likely drop by 50% or more.

Sadly, I have friends who just don't get this concept and feel their non-COLA'd pensions, which they began in their late 50's, will still be "close enough" when they're in their 80's. Uhhhhh..... Noooooo......

In your case, since you COLA'd pension more than covers your expenses, as long as the COLA formula being used winds up more or less covering what your personal rate of inflation actually turns out to be, you're good to go regardless of your portfolio size or investment performance.

I wish my pension was COLA'd!!
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Old 12-14-2012, 06:51 PM   #20
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Since DW and I are taking early retirements, it will reflect in our pensions - both will be calculated at 25 years of service - and will equal a COLA'd amount of about $60k in pre-tax dollars. It also permits the survivor to continue collecting the deceased spouse's paycheck. DW's family is long-lived. I calculate at a post-retirement 40 year time horizon.

As of May, when I retire, we anticpate a $900k investment portfolio which will be split 60 stock/40 bonds in total market index funds (about 18% total international stocks). Another $40k in cash/equivalencies. Currently, about half that money is tied up in employer sponsored accounts over which I have no control: but most of it was in a guaranteed/stable account earning 5% so I had no complaint. Come May, it's available to roll over. (unfortunately, it stopped earning 5% in April and became a floating figure equivalent to the 10 year T bill *sigh*). DW is also receiving - in addition to pension - a $1225 monthly contribution to Oppenheimer (no choice there) funds which will continue for five years. I did not not include that money in the portfolio figure, as we don't have it yet. It is being invest at the same 60/40 AA automatically.

No significant debt - just a new truck to haul our camper. 0% interest (or interest pre-paid in the purchase price, whichever you prefer lol). Our largest expenses, of course, will be health and long term care insurance - about $1150 a month. Plus, about $6k (future) a year in SS benefits from my high school and college jobs (mostly).

We can live on the pension, but our plan is a $20k annual withdrawel designed to supplement our love of travel in the camper. The expectaion is that the investments will continue to grow at a minor rate over time. That will also keep us under $85k a year, and avoid Obama's increased Medicare tax for the 'more affluent'.


Well, that's the game plan, anyway...

Any thoughts or suggestions are always appreciated.
seraphim....

Sounds great! You folks are really on the right track.

Be sure you've taken WEP into account when estimating your future SS.

Definitely spend that $20k above your pension amounts annually. You'll never regret spending it on travel and, if you're like us, you may find that as the years role by, your desire to be out on the road camping will start to diminish and you'll wish you had done more earlier.

Live big right up front and enjoy, enjoy, enjoy!
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