Interesting comments on annuities

[MasterBlaster]

The best argument against anuities is that reasonably priced inflation adjusted annuities are not available, and without this, inflation will kill the value of annuities.

I know this is not mainstream thinking, but bookmark this post and check back in 15 years.

Ha

perhaps bonds fit in that category as well. And stocks are just too risky.

I'm going to go hide under the covers for now.

 

[youbet]

The best argument against anuities is that reasonably priced inflation adjusted annuities are not available, and without this, inflation will kill the value of annuities.

I know this is not mainstream thinking, but bookmark this post and check back in 15 years.

Ha

I agree Ha. While inflation seems tame these days, it'll be back. A significant portion of our current income is from non-cola'd sources. Moving a chunk of our portfolio into a non-cola'd annuity seems to defy the concept of diversification. Faced with a period of significant inflation, I'd be dealing with rising expenses funded by a non-cola'd pension and a non-cola's annuity with only a small inflation-fighting portfolio left after funding the annuity.

 

[obgyn65]

As someone who bought his first deferred annuity this year (already mentioned above), I have been enjoying reading this thread. Thank you to everyone for their advice and sharing their views.

 

[obgyn65]

Thank you, rescueme, for sharing this. I feel the same way as you do. Now that I have bought my first deferred annuity this year, I have been performing different simulations with my Excel file and noticed that small laddered SPIAs at later stages in life (say at age 65, 75, 85 and 90) instead of a larger SPIA bought at age 62 increase my net annual withdrawal by another $5k a year. Have you noticed something similar in your own calculations or am I missing something ?

But no, I'm not saying everybody (or anybody), should follow our lead. I'm just trying to show a situation where the product is actually used, not just part of a study or personal opinion by folks without any "skin" in the game. What you do is up to you.

 

[rescueme]

...am I missing something ?

No. Assuming your spreadsheet calculations are correct and using a current interest rate along with a reduced payout period (since you will have less total payments as you age, for a life SPIA) your observation should stand. Your annual net withdrawal will increase quite naturally, without much aid from current interest rates at that time.

One of the areas a lot of folks get hung up on is thinking that waiting until a later age you will be better off since the payments will be higher. As you observed, this is true but not necessarily for the reasons why a later age buy in is better.

Monthly payments will be higher, but there is a slight impact of both interest/return rates taking it at a later age. Much of that "higher payment" at a later age is a return of "your money" over a shorter period of time rather than a long term policy (as DW/I have). Interest rates (better or worse) have less of an impact since it will be a shorter term to consider.

In our case, using the minimum term (28 years) at our IRR rate, we will "get back" our total premium, along with a matching sum - or 100% ROR from a simplistic view (disregarding inflation). If we assume the same interest rate at the time of a policy in the future (since we don't know what the future will bring, as far as interest rates), your "earnings" would be less, but your payments will be higher. BTW, a lot of folks will look at our return as less as acceptable and that is natural since most folks look at it the same way an investment would be. However, an SPIA is not an investment, but an income vehicle with your "principal" (e.g. premium) being reduced every month to provide you income. Unlike a standard return product (such as a CD or even bond), the amount of your "investment" available for "interest calculation/return" is reduced the longer it is in force.

As for your idea of buying SPIA's along the way (after you are retired) is the same thinking as us. Why our initial SPIA was purchased primarily as "income gap insurance" for early retirement (to cover the 11 year period from retirement until all our retirement income sources come on-line), and acts the same as a private company pension (e.g. not COLA'ed), we can see as we age putting more of our joint retirement portfolio on "automatic" by use of an SPIA rather than count on the portfolio/market to meet a portion of our retirement income needs. However, it will have to be an "established need" before we perform such additional purchases.

Consider the purchase an SPIA/SPDA if it fits your needs at the period of time of your life, be it a pre-retirement "product" as you have done, or later as the need arises. Again, it is just another tool for income and should only be considered if it fits your situation. It's not a "magic bullet" for everybody/every situation.

 

[ERD50]

The best argument against anuities is that reasonably priced inflation adjusted annuities are not available, and without this, inflation will kill the value of annuities.

I know this is not mainstream thinking, but bookmark this post and check back in 15 years.

Ha

I agree Ha. While inflation seems tame these days, it'll be back. A significant portion of our current income is from non-cola'd sources. Moving a chunk of our portfolio into a non-cola'd annuity seems to defy the concept of diversification. Faced with a period of significant inflation, I'd be dealing with rising expenses funded by a non-cola'd pension and a non-cola's annuity with only a small inflation-fighting portfolio left after funding the annuity.

Certainly this is (or should be) an important consideration for anyone looking to buy an annuity. But could we look at it a bit differently?

When I compare COLA'd versus non-COLA'd pensions in FIRECALC, I find that a a non-COLA'd is worth about 1/2 what a COLA'd pension is, over a 30 year retirement. This might not always be the case for every time period run, but in terms of providing protection against failures, it seems to hold. And the spread of results is tighter with a COLA'd pension.

So in general terms, if one wants to adjust the long-term 'value' of that non-COLA'd annuity or pension, consider it to be ~ 1/2 the value of a COLA'd version. So an initial 12% payment at 65 (or whatever), should probably be looked at as ~ 6%, and then you need to bank the rest to grow, and eventually pull as an inflation offset. And if you live longer, and your costs mirror inflation, you might run out of inflation buffer anyhow.

But that needs to be measured against a conservative 3~3.5% WR from a portfolio. Hey, if the numbers work, putting 1/3 or 1/2 of your portfolio towards an annuity might be attractive. Is the insurers default risk (after their insurance pays up) really any greater than portfolio depletion at 3% WR?

-ERD50

 

[brewer12345]

Thank you, rescueme, for sharing this. I feel the same way as you do. Now that I have bought my first deferred annuity this year, I have been performing different simulations with my Excel file and noticed that small laddered SPIAs at later stages in life (say at age 65, 75, 85 and 90) instead of a larger SPIA bought at age 62 increase my net annual withdrawal by another $5k a year. Have you noticed something similar in your own calculations or am I missing something ?

obgyn, it sounds like you have done some serious modelling. How do you take into account inflation over time? I like the idea of SPIAs, etc., but this is one of the things that kills the deal for me at ~40 YO.

 

[samclem]

Now that I have bought my first deferred annuity this year, I have been performing different simulations with my Excel file and noticed that small laddered SPIAs at later stages in life (say at age 65, 75, 85 and 90) instead of a larger SPIA bought at age 62 increase my net annual withdrawal by another $5k a year.

And this as-you-go approach would make it easy to buy from different insurers and evaluate them according to the most recent info (reducing risk) and would provide a benefit in a rising interest rate environment (which is also likely to be an inflationary environment--thus allowing you to combat a main shortfall with annuities).

 

[rescueme]

(snip) I like the idea of SPIAs, etc., but this is one of the things that kills the deal for me at ~40 YO.

Heck, at your age, any type of SPIA would not be in the cards for us. At that time, we were both employed, contributing a good deal to our respective 401(k)/IRA's, and running an AA of 90-95% equities in an effort to build our retirement "number". Our current income needs at that time were met by our respective j*bs.

SPIA's are used to manage the distribution of your assets, not build them, during the time you no longer have a j*b.

You're too young, grasshopper ...

 

[rescueme]

obgyn, it sounds like you have done some serious modelling. How do you take into account inflation over time?

Not the person who you asked the question, but I'll just tell you what we did to help us decide.

Using a site, such as http://www.immediateannuities.com/ and selecting an option for your situation (e.g. single/joint, life/term, etc.) for the state you reside, plug the result into the retirement income calculator of your choice (for us, it was FIDO's RIP tool).

Enter it as a pension, non-COLA. I'm assuming you can't get an inflation adjusted SPIA, so it will look like any private non-COLA'ed pension income.

Be sure to subtract the premium to be paid from your portfolio value, assuming it comes from there and the funds are coming from qualified funds (retirement plan funds that receive favorable tax treatment under Sections 401, 403, 408 or 457 of the Internal Revenue Code).

If you are funding it with non-qualified funds (e.g. after tax), you can use the BRK annuity calculator http://www.brkdirect.com/spia/ezquote.asp but this is somewhat unusual, IMHO.

By running the retirement income forecast with/without the SPIA income, along with the addition/reduction in total portfolio value will at least give you a ballpark result and may help you make the decision.

We were pleased with our results, but again we did the final calculation a few months before actual retirement (when all the factors related to portfolio value, current interest rates, and actual monthly payment) were known, even though we had been researching the subject 2-3 years before actual retirement.

It might be a bit easier than building a spreadsheet if you just want to get a quick result.

 

[obgyn65]

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

obgyn, it sounds like you have done some serious modelling. How do you take into account inflation over time? I like the idea of SPIAs, etc., but this is one of the things that kills the deal for me at ~40 YO.

 

[obgyn65]

Agreed. This is why I also plan to continue to buy deferred annuities once annually until age 62 (up to the limit of $250k-300k in all) with between 1/4 and 1/2 of my annual interests from investments. This simple approach should increase my annual withdrawal at age 62 by $30k. What is your approach, samclem?

And this as-you-go approach would make it easy to buy from different insurers and evaluate them according to the most recent info (reducing risk) and would provide a benefit in a rising interest rate environment (which is also likely to be an inflationary environment--thus allowing you to combat a main shortfall with annuities).

 

[obgyn65]

Exactly the way I see it also. Thanks for sharing.

Why our initial SPIA was purchased primarily as "income gap insurance" for early retirement (to cover the 11 year period from retirement until all our retirement income sources come on-line), and acts the same as a private company pension (e.g. not COLA'ed), we can see as we age putting more of our joint retirement portfolio on "automatic" by use of an SPIA rather than count on the portfolio/market to meet a portion of our retirement income needs. (...) Again, it is just another tool for income and should only be considered if it fits your situation. It's not a "magic bullet" for everybody/every situation.

 

[Meadbh]

Agreed. This is why I also plan to continue to buy deferred annuities once annually until age 62 (up to the limit of $250k-300k in all) with between 1/4 and 1/2 of my annual interests from investments. This simple approach should increase my annual withdrawal at age 62 by $30k. What is your approach, samclem?

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.

 

[ERD50]

... 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, ....

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...

ob

... plan to continue to buy deferred annuities once annually until age 62

I question buying so many annuities in small amounts. Maybe I have this wrong, but I thought there was a fairly high fixed component to the costs. IOW, an annuity at 5x the benefit will cost somewhat less than 5x. Cheaper by the dozen?

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. The work is offsetting spending (or adding to savings). The annuity calcs are separate from that. Maybe that's not clear.... what I'm trying to say is, if we average 3% inflation, your annuity payment would be degraded by that amount each year (divide by 1.03^years). Working does not change inflation form 3% to 1% (though it might have that same final result), it changes your income.

When I model things like this, inflation is one component, income is another. One does not affect the other, they each affect the overall result.

-ERD50

 

[rescueme]

When I model things like this, inflation is one component, income is another. One does not affect the other, they each affect the overall result.

-ERD50

I agree with your comment, FWIW...

Income can overcome any "shortage" regardless of investment vehicle.

You need to measure each retirement income source (be it an SPIA, a company pension, withdrawls from a retirement portfolio, social security, etc.) on its own merit, and see if the total income meets your retirement income needs.

It's a bit like saying that I can retire, but I'll get a j*b ...

It does not compute...

 

[Meadbh]

I agree with your comment, FWIW...

Income can overcome any "shortage" regardless of investment vehicle.

You need to measure each retirement income source (be it an SPIA, a company pension, withdrawls from a retirement portfolio, social security, etc.) on its own merit, and see if the total income meets your retirement income needs.

It's a bit like saying that I can retire, but I'll get a j*b ...

It does not compute...

+1

 

[Midpack]

When I model things like this, inflation is one component, income is another. One does not affect the other, they each affect the overall result.

There is some correlation, though it seems to break down most often during periods of high inflation (understandably as that squeezes profits more acutely than normal). Not going to debate it, so FWIW...just one of many discussions Is There a Correlation Between Inflation and the Stock Market | InflationData.com

 

[ERD50]

Originally Posted by ERD50
When I model things like this, inflation is one component, income is another. One does not affect the other, they each affect the overall result.

There is some correlation, though it seems to break down most often during periods of high inflation (understandably as that squeezes profits more acutely than normal). Not going to debate it, so FWIW...just one of many discussions Is There a Correlation Between Inflation and the Stock Market | InflationData.com

Sure, there is probably correlation between inflation and earnings - I was getting some pretty big % raises back in the 80's. But in the context of the poster, he's looking at part-time work. I think the hours worked is the prime variable in that scenario, not wage inflation versus price inflation.

Interesting link, I'll read that in more detail later.

-ERD50

 

[haha]

Measure with a micrometer, cut with an axe.

Always works!

Ha

 

[ERD50]

Measure with a micrometer, cut with an axe.

Always works!

Ha

I don't think is really about measuring or cutting, as much as it is just trying to understand the effects.

To keep with the analogy, I know that this piece of wood I'm cutting will expand with humidity. I might even look up the reference books which give typical rates for that species. But I don't know the exact humidity, or how much this wood has absorbed, or how high the humidity might get, and each piece of wood is going to vary.

But if I know it's been in low humidity for weeks, I know to cut it a bit small to allow for expansion when it does get humid. You don't need to get down to microns, but it helps to understand about where you are and about which way things are likely to go. It's better than not knowing/accounting.


-ERD50

 

[haha]

Internetizens have a touching faith in the constancy of history, and it's efficacy at predicting the future.

All of our members analytic skills and modeling abilities are outstanding. It's the relevance of these methods to the task given to them that I question.

My remarks were not directed at you or any other individual, ERD50. Your post just happened to be the one above mine

Ha

 

[REWahoo]

Measure with a micrometer, cut with an axe.

You left out the critical second step: "mark it with a grease pencil, ..."

 

[ERD50]

Internetizens have a touching faith in the constancy of history, and it's efficacy at predicting the future.

All of our members analytic skills and modeling abilities are outstanding. It's the relevance of these methods to the task given to them that I question.

My remarks were not directed at you or any other individual, ERD50. Your post just happened to be the one above mine

Ha

That's fine, and I agree that often the math can be correct, but maybe not relevant.

But when it comes to trying to evaluate our financial options, you need to make some assumptions - what else can you do?

-ERD50

 

[easysurfer]

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.