Inflation-indexed SPIAs

[FIREd]

My MIL is about 67 years old and in excellent health. She managed to get by until now without touching the $200K she has in an IRA, but she will have to start taking distributions in September. In addition to the IRA, she has about $30K liquid (Emergency Fund) and a paid-for house. She "needs" about $2,500 per month and she is getting about $1,000 a month from SS. That means she only has about 11 x annual expenses in her portfolio which puts her clearly in Otar's "red zone".

She can't stand the volatility of the stock market anymore and she is worried about losing money in bonds. So she wants to annuitize her IRA, which is consistent with Otar's recommendations. She wants to get 2 SPIAs (100K each from 2 insurance companies). She also wants full inflation indexation.

I found this article which gave her some leads:
Annuities for Retirement: The Best, and the Rest - Personal Finance - Retirement - SmartMoney.com

Smartmoney's top picks for inflation-indexed SPIA were Penn Mutual, Nationwide, and Massmutual. I looked at Vanguard too (that's where her IRA money is), but their inflation-indexed SPIA is backed by AIG and I don't think she would trust them.

Vanguard quoted her about $900 a month ($200K, single life only, full CPI-indexation) which, combined with the $1,000 she gets from SS, would give her a monthly income of about $1,900 (fully adjusted for inflation). It's less than the $2,500 a month she would want to have, so she will have to cut some spending to make it work. But it beats having to cut her spending down to $1,000 a month in 11 years.

Do you guys have any other recommendation besides the insurance companies I mentioned above?

 

[youbet]

Sorry, no suggestions regarding the insurance companies. But I will suggest using a reverse mortgage to bring that $1,900 projected income (with SPIA) a little closer to the desired $2500.

 

[FIREd]

Thanks Youbet,

so far she has resisted the idea of using a reverse mortgage. But she might change her mind once she has to start cutting expenses.

 

[youbet]

Thanks Youbet,

so far she has resisted the idea of using a reverse mortgage. But she might change her mind once she has to start cutting expenses.

My MIL (85 yo) resisted too. Although we (and DW's sibs) have her in a nice condo and driving a reliable car, she depleted her savings and her only source of cash was about $12k annual SS. By the time she paid routine expenses, she was broke every month. So we finally convinced her to do a reverse mortgage and now she has a few hundred bux a month she uses to upgrade grocery shopping, buy a few small things for herself, etc. Seems to be working out OK.

Sorry for the diversion. I know you're looking for info on SPIA's.

 

[FIREd]

Sorry for the diversion. I know you're looking for info on SPIA's.

No problem, any recommendation for good reverse-mortgage companies would be appreciated too. Her home is worth about $200K, and some online calculators show that she could receive $400-$500 a month from a reverse mortgage. It could make a big difference for her quality of life.

 

[brewer12345]

Can't point you to specific companies, although I would strongly suggest that she stick to AA-/Aa3 or better rated companies, preferably mutual. Of the three you mention, Penn Mutual and MassMutual fit the bill.

Inflation-indexed SPIAs must be really expensive in this interest rate environment. Is there a big difference if she simply take a flat payout SPIA? If that would get her up to her target budget level, it might be worth considering. The SS portion of her income would still be COLAd and she could always tap the house in the future if need be.

Another possibility is a SPIA with a fixed annual bump in payout, which I suspect a lot more companies sell than is the case for a CPI indexed spia. This would not be a bulletproof CPI indexed stream, but would approximate same and might be a lot cheaper than a CPI indexed product.

 

[brewer12345]

Stumbled across a related blog post from Moshe Milevsky:

- Why Not CPI Linked SPIA Products?

Bottom line, for those retirees who are willing to go the SPIA route with a portion of their nest egg, I would recommend paying for a 3% to 4% COLA adjustment, as opposed to a product whose payments are linked to CPI (U, W or any other letter) increased. I suspect that the price you pay (especially with what TIPS are yielding today) to link to an index that is not a very good hedge for your own personal liabilities might not be worth the cost. Get a lifetime payout immediate annuity (LPIA) with some cost-of-living adjustment (COLA), but not necessarily inflation protection. The two are different.

 

[FIREd]

Thanks Brewer,

Payout for fully CPI-indexed SPIA: about $450/month for a $100K lump sum. Payout for a SPIA with no adjustment: about $600/month for a $100K lump sum. With all the talks about high inflation coming, she refuses to go without inflation protection (she wants it to be just like an extension of her SS). I also got a quote for a SPIA with a 3% annual bump, and the payout was just slightly higher than for the SPIA with full CPI adjustment. So apparently insurance companies do not see a lot of inflation in our future.

 

[brewer12345]

I also got a quote for a SPIA with a 3% annual bump, and the payout was just slightly higher than for the SPIA with full CPI adjustment. So apparently insurance companies do not see a lot of inflation in our future.

I highly doubt they are expressing a view either way. They usually just pass along what the bond market dictates.

 

[Rich_by_the_Bay]

An alternative to a COLA benefit at such a high premium is to by a conventional SPIA and down the road if/when inflation erosion is substantial for her, buy another annuity to close the gap, repeating as needed.

After the initial SPIA purchaase, with your own "inflation adjustment" annuities you get the actuarial benefit of buying when older, you can put it off if inflation fails to increase as much as expected, you spread your interest rate risk, and you can pass on the subsequent purchases if health makes it clear that annuities are no longer a wise choice.

Just some thoughts. Brewer, what think you?

 

[FIREd]

An alternative to a COLA benefit at such a high premium is to by a conventional SPIA and down the road if/when inflation erosion is substantial for her, buy another annuity to close the gap, repeating as needed.

After the initial SPIA purchaase, with your own "inflation adjustment" annuities you get the actuarial benefit of buying when older, you can put it off if inflation fails to increase as much as expected, you spread your interest rate risk, and you can pass on the subsequent purchases if health makes it clear that annuities are no longer a wise choice.

Just some thoughts. Brewer, what think you?

I will let Brewer answer that question but one of the reasons why I think annuitizing her entire IRA right now makes sense is because, if there is money left in her IRA, I know she will fritter it away and I doubt there will be much money left to buy a second annuity later.

 

[smjsl]

I also got a quote for a SPIA with a 3% annual bump, and the payout was just slightly higher than for the SPIA with full CPI adjustment. So apparently insurance companies do not see a lot of inflation in our future.

I recall reading somewhere that some CPI-linked SPIAs had an upper limit on CPI which they would support in a fine print. You may want to make sure there is no such fine print in the ones you are looking at...

 

[brewer12345]

An alternative to a COLA benefit at such a high premium is to by a conventional SPIA and down the road if/when inflation erosion is substantial for her, buy another annuity to close the gap, repeating as needed.

After the initial SPIA purchaase, with your own "inflation adjustment" annuities you get the actuarial benefit of buying when older, you can put it off if inflation fails to increase as much as expected, you spread your interest rate risk, and you can pass on the subsequent purchases if health makes it clear that annuities are no longer a wise choice.

Just some thoughts. Brewer, what think you?

That's not a terrible idea, but in this case the funding is kind of marginal so there may not be that much left in a few years when it comes time to buy the next annuity.

 

[FIREd]

I recall reading somewhere that some CPI-linked SPIAs had an upper limit on CPI which they would support in a fine print. You may want to make sure there is no such fine print in the ones you are looking at...

Good point. I know that for some of the COLA'd annuities I looked at, the maximum COLA I could buy was 5%/year.

Quotes for Vanguard SPIAs (67 year old female, $100K lump sum, single life only):
Full CPI-adjustment: $432/month
3% COLA: $437/month
No COLA: $588/month
No mention of an upper limit on CPI-adjustment.

 

[FIREd]

Apparently, Nationwide does not propose traditional SPIAs with guaranteed CPI adjustment. What they offer is an annuity with variable payout that could "potentially" adjust upward based on market returns (minus 1.8% fees)... So her income might increase faster than CPI or not at all depending on what the market does, though she is guaranteed to always receive at least the initial monthly payout... And that initial payout is lower than the Vanguard SPIA with full CPI-adjustment... Wow, what a freaking mine field... MIL is talking to Penn Mutual now...

 

[dgoldenz]

I'm sure someone will bash this, but have you looked at an equity-linked index annuity with a guaranteed lifetime income benefit? She could begin receiving the lifetime guaranteed income after the first 12 months and would do a lot better than $900/month (though no CPI-indexing). You won't find these types of products with any sort of decent rates from an A+ or A++ company, but if her state has a guaranty fund, she at least has some potential safety with that too. I just ran the numbers for two companies, one an "A" rated and one "A-" rated, and came up with the following taken after 12 months:

A rated: $1034/month if applied for before July 19th, 2010. $958/month after July 19th (rate change).
A- rated: $1093/month

She also wouldn't lose everything if she died the next day. As she is paid out the lifetime income stream, the money is deducted from the "cash account" portion until it reaches $0. After it reaches $0, she still gets the guaranteed lifetime income. If she died shortly after buying the annuity, her beneficiary would still receive almost the entire $200k in a single lump sum.

Just my $0.02.

 

[brewer12345]

Wow, they took a sleazy, complex product (EIA) and made it even more complicated (and presumably sleazier). There is a reason the top shelf companies refuse to sully themselves by writing this crap.

 

[dgoldenz]

Wow, they took a sleazy, complex product (EIA) and made it even more complicated (and presumably sleazier). There is a reason the top shelf companies refuse to sully themselves by writing this crap.

Top shelf companies take less risk and offer lower payouts to maintain their top shelf financial ratings. I would take $1050-1090/month over $900/month all day, but everyone is entitled to their own opinion...

 

[zinger1457]

I recall reading somewhere that some CPI-linked SPIAs had an upper limit on CPI which they would support in a fine print. You may want to make sure there is no such fine print in the ones you are looking at...

I know that the annuity (Met Life) offered with the Federal Government TSP plan has a CPI increase option and it is capped at 3% per year. If I were to select one I would probably go with one that has a fixed increase (1-5%). I believe with the CPI increase option you will also be impacted if the CPI is negative. Your payments won't go down but they will deduct the negative CPI from future increases.

 

[FIRE'd@51]

Before she purchases an inflation-indexed SPIA from an insurance company, I would urge her (you) to take a look at repaying and restarting her SS. Depending upon when she first started taking SS, she can get a nice bump in her monthly payment. If you calculate it out, you will find that the withdrawal rate on the marginal investment (i.e. the amount repaid) will be higher than any commercially purchased annuity, plus it's government guaranteed. If annuitizing is her goal, I think she will come out ahead by first repaying and restarting SS, and then if she needs more, she can purchase enough of a commercially available inflation-indexed SPIA (e.g Vanguard) to get her the rest of the way to her monthly income goal.

For a quick comparison, you say Vanguard is offering her 10.8K per year (with full COLA) on a 200K investment. This is a 5.4% withdrawal rate. Repaying and restarting SS will give her a withdrawal rate in the 8 - 8.5% range on the $ repaid. BTW, she can do a repay and restart now, and another at age 70 to maximize her monthly SS payment.

 

[FIREd]

She started receiving SS only 3 months ago, so I don't think that SS repayment would help much. The lady at the SS office did a simulation and found that, in MIL's particular situation, her SS benefits would not increase very much if she waited another year or two (I was there when the lady explained the reason behind it and it made sense at the time, but I do not remember the details). So she decided to start receiving her SS benefits right then. At the moment, she pays over $200 a month for Medicare (due to her income being so high in 2009), but next year it will go back to roughly $100 a month. So her SS check should go up to $1,100 a month after Medicare payment.

I looked at the brochure for Mass Mutual SPIAs. They do not offer full CPI-adjustment but rather 1-4% COLAs. Which COLA would you choose? I was thinking 3%... Still waiting to hear from Penn Mutual.

After trying to find ways to reduce her expenses, she decided that a reverse mortgage was not a bad idea after all. So we'll be looking into that too...

 

[NW-Bound]

After trying to find ways to reduce her expenses, she decided that a reverse mortgage was not a bad idea after all. So we'll be looking into that too...

If I remember correctly, in the past you have brought up the fact that she does not want to give up living in this house, despite it being too large and expensive to maintain for her. Would she be amenable to downsizing, if the local RE market allows it? Seems to me it would reduce her cash outflow while enriching her savings at the same time.

 

[FIREd]

If I remember correctly, in the past you have brought up the fact that she does not want to give up living in this house, despite it being too large and expensive to maintain for her. Would she be amenable to downsizing, if the local RE market allows it? Seems to me it would reduce her cash outflow while enriching her savings at the same time.

She won't move. End of discussion. We showed her nice condos and townhouses in nice and safe neighborhoods for half the cost of her current house. I thought the units we showed her were very attractive for a single person in her situation, but she found everything "sordid".

 

[chinaco]

You did not mention this.... maybe you already have it covered.

Don't forget extraordinary expenses... for example, the house may need a new roof, or furnace replacement, etc.

Her average life expectancy is 20+ years.

She should probably keep some sort of emergency fund.

 

[brewer12345]

Shop around hard on the reverse mortgage. There are large disparities in fees from different lenders. And then you have to decide whether to take a lump sump, line of credit, etc. You could buy an annuity with the lump sum if the spendthrift thing is an issue.