Interesting comments on annuities

[M Paquette]

I go with "measure twice, cut once" .

When it comes to annuities (I'm talking immediate type), to continue with the tool analogy, annuities are neither right nor wrong. Just need the right tool for the job.

Oh, sure. That's what we all say. But then that electric hammer salesman invites us all to lunch, and before ya knows what happened...

 

[easysurfer]

Oh, sure. That's what we all say. But then that electric hammer salesman invites us all to lunch, and before ya knows what happened...

Who knows...If you have a bum wrist, an electric hammer might be handy..

Or you can just hire a handyman..but those darn fees

 

[obgyn65]

Thank you for your comments, Meadbh.

1. yes, my individual deferred annuity purchases will be quite small over the next 15 years, the rest of the money I save goes to CDs laddered until I am 62. This is my own way of taking my mortality credit into account. Don't want my annuities to exceed $250-300k either for reasons discussed in other threads.

2. I understand that my approach (annual small deferred annuities until 62 and laddered SPIAs in retirement) would not work for everyone. But I found that using this approach optimizes my annual withdrawal.

3. please can you let me know more about how you start ER by withdrawing from your RRSP early to minimize your mandatory minimum withdrawals later ? I don't understand. Thank you.

Given that you are a long way from 62 IIRC, your individual annuity purchases must be quite small.

Of course we live in different countries, but I don't think that approach would work well for me for three reasons. First, by spending the interest now, I would lose the opportunity to reinvest it. Second, I would not benefit that much from additional deferred income in retirement because income is taxed at a higher rate than dividends or capital gains. My goal will be to keep taxable income as low as possible. This may mean starting ER by withdrawing from my RRSP early (within the lowest tax bracket) to minimize mandatory minimum withdrawals later. If I do buy annuities it will be with money from my RRSP, exchanging one form of taxable income for another. Finally, I think it would be more advantageous to buy annuities in a higher interest rate environment, and when I am older, both of which would increase the ROI.

Different strokes for different folks. I do agree with diversifying annuity purchases.

 

[obgyn65]

Your points are well taken, ERD50.

As mentioned above, buying small deferred annuities until I reach 62 is one way of factoring in my mortality risk. I will buy these small deferred annuities with about a third of my annual interest payments from my investments. The SPIAs included in my model after age 62 are larger.

Yes, I agree re : inflation offset by part time work, possibly mixing apples and oranges. But do the other three reasons I gave in my post seem reasonable to you ? What inflation number do you use for the duration of your retirement and why ?

Also, I think you are mixing apples/oranges with your inflation offset by part time work. True, that mitigates the effects of inflation on your total NW, but (depending on your spreadsheet construction), it might be making the annuity look better than it really is? The inflation still affects your real annuity return, work or no work.

 

[Meadbh]

3. please can you let me know more about how you start ER by withdrawing from your RRSP early to minimize your mandatory minimum withdrawals later ? I don't understand.

No problem obgyn, I will attempt to explain. An RRSP (registered retirement savings plan) is similar to an IRA, but of course not all the rules & regulations are the same. Gains, income and dividends within the RRSP are all tax-sheltered. There are no restrictions on taking money out of an RRSP, except that whenever you do, it will be taxed as income at your marginal rate. Many people use their RRSP to put a downpayment on their first home but they must replace the money within a fixed time to avoid the taxes.

RRSPs work most effectively when you invest in them while you have a high personal income (when the amount invested will be tax deductible), defer withdrawals for many years, and take out money during retirement, when your income will be minimal and your marginal tax rate will be low. But what if your RRSP is too big? Once you reach 72, you must convert it to an RRIF (registered retirement income fund) or an annuity. The RRIF is more flexible, but in the first year, you must withdraw over 7%, with gradually increasing mandatory minimum withdrawals. Add that mandatory withdrawal to CPP (Canada Pension Plan) and OAS (Old Age Security) and you can find yourself back in a higher tax bracket, with OAS clawed back. You have still deferred taxes, and hopefully your money has grown, but perhaps there's is a better way to minimize taxes and preserve those government benefits.

Now let's suppose you ER at 55. There are 17 years till age 72, when you must begin to withdraw from the RRSP. 17 years of minimal income. During that time you could draw down on the RRSP to the extent that you can while staying in the lowest income tax bracket, topping up if need be with other investments. By the time you reach 72, the amount left in the RRSP is considerably less than it otherwise would have been. And mandatory withdrawals, being smaller, are thus less likely to generate a significant tax liability. Meanwhile, your taxable portfolio is larger than it would otherwise have been and can be tapped without tax consequences.

My understanding is that IRAs cannot be drawn down early in the same way, but please correct me if I'm wrong.

If people want more detail, there are extensive discussions and modeling of this issue over at the Financial Webring Forum, which has a Canadian focus. You have to join to read the forum. Also, I recommend Googling "your retirement income blueprint" by Darryl Diamond. He calls this strategy "topping up to bracket".

I hope that is helpful!

Meadbh

 

[samclem]

What is your approach, samclem?

Our situation is a bit different. I receive COLA'd retirement pay now, and hope to receive COLA'd Social Security starting in about 16-19 years. I'm dependent on my investments (and my present PT income) to fill the gap until we collect SS and to provide additional funds above these monthly checks so we can maintain our present spending level. I don't plan to buy any annuities unless our portfolio performance, spending, and attained age line up such that annuities provide the best way for us to maintain our standard of living. If it happens at all, it won't be for quite a while and they will be SPIAs.

 

[ERD50]

Your points are well taken, ERD50.

As mentioned above, buying small deferred annuities until I reach 62 is one way of factoring in my mortality risk. I will buy these small deferred annuities with about a third of my annual interest payments from my investments. The SPIAs included in my model after age 62 are larger.

Yes, I agree re : inflation offset by part time work, possibly mixing apples and oranges. But do the other three reasons I gave in my post seem reasonable to you ? What inflation number do you use for the duration of your retirement and why ?

I don't use a number for inflation, I use FIRECALC. Inflation isn't "a number", it changes over time, and is likely correlated with other things (interest rates for sure). So I'd rather let history be a guide for that.

If I'm doing some calcs and just want to ballpark the effects of inflation for comparison purposes, I use 3%.

Certainly more earnings and adjusting spending will help mitigate the effects of inflation, or poor returns. Even if on average people spend less as they age, I don't want to count on that for myself (recall the 6 foot tall statistician who drowned in the average 4 foot deep pool). Same with trying to predict the date of my demise.

-ERD50

 

[rkser]

Hi Obgyn65 and Rescue me,

This thread has been an education to me on the often ill understood subject of annuities. I am considering annuities in my ER plan and knowing which respective annuities you both have purchased will be a great help to me and other members on the Board.

You two have obviously done an exhaustive research on this subject and if you do not mind sharing the respective specific annuity product from the specific Ins. company, I will be thankful for the benefit of knowing.

Thanks and regards

 

[samclem]

My understanding is that IRAs cannot be drawn down early in the same way, but please correct me if I'm wrong.

Those with (U.S.) IRAs can withdraw money from them without penalty before reaching 59 1/2 years old, but there are limitations on how much. It's called a "72(t)" withdrawal and there are several rules. You must withdraw "substantially equal periodic payments" (SEPP) (these are based on your life expectancy), you must withdraw at least once per year, once you start you have to take the payments for 5 years or until you reach 59 1/2 YO whichever is longer. Like all Traditional IRA withdrawals, these are taxed as normal income. There's lots more info in other posts about these withdrawals. As you point out, they can be an effective way for some people to avoid larger mandatory withdrawals (and the tax hit that can come with them) in their later years.

 

[Meadbh]

Thanks for the clarification, samclem.

 

[obgyn65]

Hello rkser - I may be the wrong person to ask because I am not in finance at all, and I am one of the most conservative investors here. Additionally, I am sure other participants on this board are more willing (and able) to guide you in your choices. All I can say is :

1. after a couple of years on this website, I have discovered the importance of budgeting, interest compounding, and diversification. The deferred annuity I got is close to 12% payout in 15 years' time;

2. after several discussions about annuities in different threads, I realized I needed to optimize my retirement model from a mathematical standpoint. Instead of deciding to go down one path, I decided to adopt a hybrid approach as described above (i.e. some deferred annuities until I am 62 without exceeding $250-$300k, then large SPIAs every 10 years or so);

3. this approach might not be suitable to you if you are already in your 60s or older (in which case SPIAs may make more sense), or if you wish to leave money to heirs (I don't have children) or if you have a large SS check (I don't because I have spent many years abroad), or if you have a large pension (I don't, but I sit on a lot of cash). In my case, this hybrid approach has made it possible to increase with net withdrawal to about $90k-$100k a year on average until I reach 95;

4. when doing some research, I found out there are only three companies that are worth investigating further re: deferred annuities : Metlife, Hartford, and New York Life. I found they were more or less actuarially similar but with different timelines, etc.

I hope this helps. Please let us know what you find out.

Ob

Hi Obgyn65 and Rescue me,

This thread has been an education to me on the often ill understood subject of annuities. I am considering annuities in my ER plan and knowing which respective annuities you both have purchased will be a great help to me and other members on the Board.

You two have obviously done an exhaustive research on this subject and if you do not mind sharing the respective specific annuity product from the specific Ins. company, I will be thankful for the benefit of knowing.

Thanks and regards

 

[rescueme]

You two have obviously done an exhaustive research on this subject and if you do not mind sharing the respective specific annuity product from the specific Ins. company, I will be thankful for the benefit of knowing.

I'll try to give you a summary of the process DW/I went through. Remember that it's been over five years, so hopefully I don't forget something critical.

As I said in previous posts, we had been researching the subject of annuities a few years before retirement, and certainly did not know (or understand) that there were many different products under the annuity "umbrella".

To that end, once getting a little knowledge on the subject, our first action was to determine if we even wanted an annuity (yes) and what annuity to be chosen (in our case, an SPIA).

The second thing was to define the terms of the annuity in order to meet our primary goals (to act as a pension and aid in delay of filing for SS) and under what conditions (for us, it was a joint life annuity, payments to continue at 100% for the survivor, a minimum term that was guaranteed to pay at least till the end of our computed joint lifespan, and have remaining payments go to our named beneficiary if we both passed before the minimum computed year of final benefit).

Why do you need to do this first? Simply that there are a lot of SPIA's available, but not all are created equally. Why give your money for a product that did not suit your needs?

After that, we went with http://www.immediateannuities.com/ along with contacting both FIDO and Vanguard (we invest with both companies) to get a quote and state our needs.

As it is, Vanguard offered an SPIA from one provider (MetLife, if I remember), while FIDO had five different companies that they used as "suppliers", even though the SPIA would be issued under their name.

I took the results from 3-4 companies and put the results into an Excel spreadsheet, using the IRR function (not XIRR!) to compute a return rate of the paid monthly amount vs. premium paid.

While the returns were low (due to current interest rates at the time), you must remember that unlike a CD, the principal is constantly being reduced (returned to you, on a monthly basis) so there is less money to be kept in the investment pool.

BTW, all the return rates were quite close - all just under 5%. You may not think that's much, but compare it to today, some 5 years later.

As I mentioned in an earlier post, we also took the results and plugged them into various retirement income forecast tools (our primary is FIDO's RIP tool), both reducing the value of our joint investment portfolio to reflect the preimum to be paid, along with adding an entry for the SPIA income that would simulate a fixed life pension (which an SPIA normally acts as) to validate our initial findings.

As it turned out, the best (for us) was from a company that was used by Fidelity. We filled out the application and sent it back in, and received a contract for signature within a few days. The funny thing is the same day I was to send the contract back to Fidelity, they contacted me to tell me not to sign. It turned out that one of their "suppliers" had changed their payout rate by a fraction (works the same way as a note/mortgage - rates change every week) and they were able to get me a "better deal". They sent a revised contract (overnight) and we turned it around to them in the same manner (they paid all FEDEX charges).

That, in a nutshell, is what we did for our current SPIA. While any current experience will be different (based upon companies and offerings), the background "soul searching" for a product that suits your needs should remain the same.

Good luck to you, regardless of what you decide to do in the future...

 

[rkser]

Thanks

Thanks rescue me for sharing the process, the logic behind the calculations and the methods to go about it. I am sure this will be of great help to me when I file for getting my annuity and also to other board members, thank you for your help.

Thank you Obgyn, for sharing your thoughts on the subject.

 

[brewer12345]

Hello Brewer - well I have been learning a lot about modeling from this website over the last couple of years. To answer your question, as you know, it is difficult to take inflation into account over a 40+ year retirement period and quantify it with a high degree of confidence, as discussed here in many threads and at Bogleheads also. Right now I am using 1% inflation rate for four main reasons: 1) I plan to continue with part time work (maybe one or two days a week) which would mitigate a hyperinflation risk 2) I can adapt when I stop working completely and be more frugal if the cost of living increases dramatically 3) as I get (much) older, my expenses are likely to remain stable or even go down as discussed in other threads here. 4) I also believe that I won't make it to 95, so seeing a negative cash flow balance on my last spreasheet row when I enter a 3% inflation over 48 years does not bother me too much... What about you - what inflation rate do you use and how confident are you in your approach ?

ob

I don't think there is a silver bullet on this one unless maybe you could buy an inflation adjusted SPIA from a AAA rated entity.

Personally, I choose to hedge inflation in orther ways than trying to guess what the rate will be. I invest a portion of my portfolio in commodity futures and commodity producing firms, I expect to maintain some part time work when I hang up my spurs, and I have the option to purchase additional service credit from my cash balance pension plan which offers an inflation-adjusted payout option and is a very secure plan.

Since I really don't think there is an obvious silver bullet on this one, it is more important that you are thinking about the risk and working out ways to deal with it than anything else. Your solutions seem reasonable to me.

 

[Chuckanut]

Here is a quote from a recent e-mail from Dr. Pfau. I am still very wary of annuities and can't find it within myself to either buy one or recommend one to others. But, I must admit he has me thinking I should look into this at a future time:

In all the cases, the general shape of my efficient frontier holds up, which is that retirees may be best served by combinations of stocks and fixed SPIAs. A part of the frontier I hadn't discussed also does include that particularly risk averse retirees may benefit instead from combinations of real SPIAs and fixed SPIAs.

Here is his blog entry on the subject: Retirement Researcher Blog: An Efficient Frontier for Retirement Income

 

[mathjak107]

according to dr pfau the inflation adjusted annuities are just way to expensive compared to the standard ones to make the adjustments worth it..

 

[obgyn65]

Just wanted to resuscitate this thread with a new article, in case some participants are interested. It seems the deferred annuity market has been taking off nicely : The next big rollover vehicle? Longevity insurance

 

[youbet]

It seems the deferred annuity market has been taking off nicely :

As measured by the number of annuity salespeople paying cash for their BMW's........

 

[youbet]

according to dr pfau the inflation adjusted annuities are just way to expensive compared to the standard ones to make the adjustments worth it..

Yet, without the inflation adjustment feature, an annuity is an extremely risky investment if the objective is longevity protection.

It's a bit of a catch 22.

 

[mathjak107]

Inflation is the reason annuities work better as vehicles for smoothing out the peaks and valleys in the markets.

if you are spending down filling the drops with a pensionized income can help. The investments run with the ball and the annuities only assist.