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Managing a Retirement Portfolio: Do Annuities Provide More Safety?
Old 10-07-2011, 07:39 AM   #1
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Managing a Retirement Portfolio: Do Annuities Provide More Safety?

Here is a Research paper by John Spitzer.

Title: Managing a Retirement Portfolio: Do Annuities Provide More Safety?

His research provides some insight into issues that might be considered when making decisions about portfolio or annuity or portfolio plus annuity.

He focuses most of the comparison using a 30 year time horizon (i.e., 4% SWR). There are some comments about longevity and other factors that could influence decisions one way or the other.... but the primary focus seems to be: Portfolio failure risk reduction (with an annuity) vs Legacy Motive (Estate and ending portfolio size).

Worth reading IMO. However, it is also worth noting that his focus is narrow in order to do a comparison related to his topic... but there are other considerations and risks that are not covered in the paper that (IMO) many people should consider.

You will see the link on this page with the title of the paper.

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Old 10-07-2011, 08:06 AM   #2
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Thanks for the post.

Hey, who knew that when we used FIRECalc we were "bootstrapping"?!

I'm surprised, coming so recently after the little scare we just had, that Spitzer doesn't address the risk of annuity default since this certainly is on the minds of many folks. His paper addresses the issue of portfolio underperformance, and posits that an annuity can come to the rescue. I think a lot of investors just saw that these are not independent variables--that the same factors that can knock your portfolio on its butt can also bring insurance companies (and even the government bailout funds) to their knees.

If your airplane has two engines for redundancy, but they both rely on a single fuel pump, maybe you don't have all the redundancy you expected.
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Old 10-07-2011, 08:57 AM   #3
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If your airplane has two engines for redundancy, but they both rely on a single fuel pump, maybe you don't have all the redundancy you expected.
That's what would worry me. I like the concept of an SPIA to "assure" survival if things really go south (i.e. quite a bit worse than they seem today). But, if things really go south how reliable will the annuity be? In other words, if we get outside the bounds of historical precedent ala Firecalc should we expect insurance companies and state guarantees to survive? If we don't get outside those boundaries, why get an annuity?
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Old 10-07-2011, 09:18 AM   #4
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That's what would worry me. I like the concept of an SPIA to "assure" survival if things really go south (i.e. quite a bit worse than they seem today). But, if things really go south how reliable will the annuity be? In other words, if we get outside the bounds of historical precedent ala Firecalc should we expect insurance companies and state guarantees to survive? If we don't get outside those boundaries, why get an annuity?
......and if you buy a SPIA now you will be getting the worst return ever. I like the risk reduction aspects of an SPIA, but not the income they currently produce.
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Old 10-07-2011, 09:38 AM   #5
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Interesting reading. I did not ‘know’ that –
People (presumably retired) can continue to contribute to a ROTH IRA while taking RMDs (page59)
Neal and Anna Singer can withdraw from their TDAs at the beginning of each year and ( presumably with no penalty?) make no tax payments until the end of each year (page 61)
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Old 10-07-2011, 10:28 AM   #6
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Interesting reading. I did not ‘know’ that –
People (presumably retired) can continue to contribute to a ROTH IRA while taking RMDs (page59)
Neal and Anna Singer can withdraw from their TDAs at the beginning of each year and ( presumably with no penalty?) make no tax payments until the end of each year (page 61)
AFAIK you have to have earned income to contribute to a Roth although you could do conversions from a traditional IRA after taking the RMD.
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Old 10-07-2011, 10:36 AM   #7
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AFAIK you have to have earned income to contribute to a Roth although you could do conversions from a traditional IRA after taking the RMD.
AFIAK also.
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Old 10-07-2011, 12:50 PM   #8
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......and if you buy a SPIA now you will be getting the worst return ever. I like the risk reduction aspects of an SPIA, but not the income they currently produce.
My thoughts on this, as stated before:

Another annuity question
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Old 10-07-2011, 02:05 PM   #9
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My thoughts on this, as stated before:

Another annuity question
Sure, interest rate is only one of the factors, and if you prioritize risk reduction and steady income they are useful. I have TIAA traditional that has a guaranteed minimum return of 3% and is currently paying 3.35% so that is the annuity I'll use along with SS and other pensions to cover my minimum retirement income. Wellesley type dividend and intermediate bond investments will produce medium risk returns with equity index funds as long term investments.
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Old 10-07-2011, 05:44 PM   #10
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That's what would worry me. I like the concept of an SPIA to "assure" survival if things really go south (i.e. quite a bit worse than they seem today). But, if things really go south how reliable will the annuity be? In other words, if we get outside the bounds of historical precedent ala Firecalc should we expect insurance companies and state guarantees to survive? If we don't get outside those boundaries, why get an annuity?
+1

I think one of the biggest lessons we should learn from the last few years as there are NO RISK FREE investments. We are seeing this in spades with European debt crisis, with banks getting in trouble by assuming that all of their loans to countries like Greece were risk free, when they clearly were not. Before that it was AAA rate Mortgage Back Securities.

An annuity is roughly the equivalent of buying a bond from an insurance company with an extra layer of security (from regulators, state guaranty associate etc.) The same rules for diversification as any other investment apply spread your risk across different companies and different industries. Studies need to account for this risk.
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Old 10-07-2011, 06:47 PM   #11
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Annuities do provide some management of risk. They do not operate within a vacuum and they can't defy gravity (i.e., they ain't perfect or magical).

Lots of folks could stand to utilize their income producing benefits. Lots of folks survived the 2008-09 crash by allowing their nest eggs to bounce back because they felt more "safe" with their annuity income guarantees. Likewise, lots of other folks have needlessly been paying the high fees for no good reason.

In my gut, I'm not so sure how worried I'd be about the solvency of the highly rated, major annuity companies (and all their re-insured folks and/or the government backers) with regards to their ability to make good on their payouts. If I were, I might even add a separate layer by hedging the risk and using 2 different companies.

I also wouldn't put the entire nest egg in them. There were some pretty compelling papers/studies done that suggested letting social security and annuity payments take care of a good portion of your fixed expenses while keeping the rest of your portfolio invested in other things. That seems fairly reasonable.
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Old 10-07-2011, 07:00 PM   #12
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In my gut, I'm not so sure how worried I'd be about the solvency of the highly rated, major annuity companies (and all their re-insured folks and/or the government backers) with regards to their ability to make good on their payouts. If I were, I might even add a separate layer by hedging the risk and using 2 different companies.
Some of these insurance companies had some sickly balance sheets as recently as 3 years ago. I haven't seen any "big fixes" that lead me to believe we've had meaningful structural reform. And having annuities at two or more companies would only work if they had different underlying investments backing their products--good luck in getting that info, and in assuring they don't change their investment philosophy in a decade or so (after you've given them your money and are no more than a helpless observer).
Risk of default is just one kind of risk, but it's not something we can ignore as easily as we did a few years ago. I think the case can be made that having a claim to the income stream from some types of companies offers security that exceeds the security offered by an annuity. The trick would be to identify those companies in advance.
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Old 10-07-2011, 08:08 PM   #13
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Studies need to account for this risk.
I wonder how far back we'd need to go to find an insurance company that failed to pay out on its annuity contracts.

I guess the stat would be "$ of failed annuity contracts divided by $$$s of annuity contracts that paid out during the same time period".
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Old 10-08-2011, 06:24 AM   #14
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Some of these insurance companies had some sickly balance sheets as recently as 3 years ago. I haven't seen any "big fixes" that lead me to believe we've had meaningful structural reform. And having annuities at two or more companies would only work if they had different underlying investments backing their products--good luck in getting that info, and in assuring they don't change their investment philosophy in a decade or so (after you've given them your money and are no more than a helpless observer).

There are some weak insurance companies. Just like there are some weak mutual funds, banks, etc.

I don't think it would be a good financial move to put one's money with a low rated insurance company? It would increase risk. Just like some mutual funds.

But what about the really solid and highly rate ones that have been around 100+ years. And even with that, they are backstopped with the state guaranty fund (which the insurance companies pay into).



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Risk of default is just one kind of risk, but it's not something we can ignore as easily as we did a few years ago. I think the case can be made that having a claim to the income stream from some types of companies offers security that exceeds the security offered by an annuity. The trick would be to identify those companies in advance.

It is a tool... It can be used to solve certain problems.

Like any financial instrument... they are complicated and the problems are complicated.

People need to clarify their goals and risks (i.e., the job)... then find the right tools for the job.

On investments.. many think because the mutual fund company takes their money they are investors. Their investment expectations... the 90s superbull will come back... what happens if the market goes sideways for the next 10 years (it did it the last 10 years)?

There are tools availble! What problems do you need to solve? Did it ever occur to you that you might be trying to solve a different problem?

IMO - SPIAs (or other forms of guaranteed income) can solve certain problems. However, I would not be inclined to put all of my eggs in any basket. I would also wait for better rates to purchase a SPIA because of my situation... I can do that.

There is no doubt that each of us will look back on many decisions (historically) and see what we could have done better.

I intend to build a base income with SSx2 + Pension + SPIA. The SPIA will cost a small portion of our portfolio. I know what my problems and risks are, what the basic tools are and how to apply them. I am trying to avoid letting fear or greed overly influence my decisions. I see value in trying to ensure a degree of certainty.
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Old 10-08-2011, 07:35 AM   #15
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...However, I would not be inclined to put all of my eggs in any basket....

...The SPIA will cost a small portion of our portfolio.....
True. When we purchased our first SPIA, it consisted of only 10% of our then joint retirement portfolio value.

In fact, I had to signify on the application that the SPIA, along with all other "annuities" (any type) did not exceed 50% of our joint retirement investments at the time. BTW, since it was a joint (e.g. survivorship SPIA) the question did refer to our joint retirement investments.

I noted "first SPIA" since we've been pleased on how it has worked out thus far, as far as covering our income needs until our respective SS and DW's two small pensions kick in, and certainly will consider another as we proceed through our "journey" - especially if (as expected) I'll pass first. It will remove the requirement for DW to manage a portion of the survivor portfolio, or pay to have somebody else manage it since she has little interest in managing it on her own.
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Old 10-08-2011, 09:14 AM   #16
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... It will remove the requirement for DW to manage a portion of the survivor portfolio, or pay to have somebody else manage it since she has little interest in managing it on her own.

That is one of the potential problems I intend to solve too. DW is careful with money and spending. But she is not a savvy investor. If anything happened to me... she might cut her spending out of fear.

Annuities have an administrative and overhead cost. But if something happened to me, DW would either have to go to a bank (e.g., JPM) for some sort of investment services help or hire an independent financial adviser... Those alternative options have real ongoing costs too. If I make the purchase as planned (next few years)... I controlled the decisions about the company and product how much, etc. I will consider her income to be handled and fairly low risk. The guaranteed income deposits will be made to the checking account automatically... she should not have to worry about it.

I look at it as part of a fixed bucket.
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Old 10-08-2011, 12:05 PM   #17
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......and if you buy a SPIA now you will be getting the worst return ever. I like the risk reduction aspects of an SPIA, but not the income they currently produce.
Yes, and if you buy long term bonds/CDs today you may also be getting the worst return ever.

If you consider SPIAs as a substitute for a laddered bond portfolio, the fact that rates are low today is the same issue as deciding to have bonds in your AA today.

If you own long term bonds that you can sell to buy the SPIA, then the interest issue is mostly a wash.
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Old 10-08-2011, 01:14 PM   #18
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If things really go South, I mean VERY, VERY SOUTH, who says any organization is going to honor its commitments and pay you what is due?

Note: If you are in Australia, worry about things going NORTH instead.
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Old 10-08-2011, 02:59 PM   #19
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If things really go South, I mean VERY, VERY SOUTH, who says any organization is going to honor its commitments and pay you what is due?
And we're back to a few acres of farmland, ammunition, and MREs. Maybe toilet paper.

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Note: If you are in Australia, worry about things going NORTH instead.
Australians know what's coming--Mad Max was from down under.


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Old 10-08-2011, 07:54 PM   #20
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I wonder how far back we'd need to go to find an insurance company that failed to pay out on its annuity contracts.

I guess the stat would be "$ of failed annuity contracts divided by $$$s of annuity contracts that paid out during the same time period".
Doing a bit of googling (and with caveat that most of this info comes from Insurance brokers websites along with Congressional testimony from 2002) I can say that the notable exception of the Executive Life that it appears in the last 20 years of the 42 life insurance companies that have failed only one companies failure resulted in loss to annuity holders and that was only for policy above 100K (which is the minimum for state guaranty associations.)

However, the Executive Life failure back in 1991 is worth discussing. California based Executive Life was one of the largest life insurance in the 80s with 300,000 policy holders 180K in California. One of the reasons that Exec Life grew so quickly was that it was offering SPIA and GIC with a 13% interest rate when most of the competitors were offering 10%. The reason
they could make such an offer is that had a large portfolio of junk bonds. The NY insurance commissioner felt this was risky and put a cap of 20% on the assets of insurance company in junk bonds. The CA insurance commissioner didn't.

In 1990, Michael Milken's junk bond firm Drexel Burnham Lambert went under taking the junk bond market with him. (See Lewis's Liar Poker for details). The collapse of the junk bonds also triggered the failure of Exec Life.
The CA insurance commissioner was under a lot of pressure from the State Guaranty Association (i.e. other insurance companies) to minimize the cost of the restructuring. So he took an offer from a new insurance company (Auroa) which was actually a shell company owned (illegally) by French bank Credit Lyonnais. As part of the deal the insurance commissioner instead of selling off the entire junk bond made a deal to allow a former Michael Milken assistant to cherry pick the best bonds (For those of you who familiar with the 2008 the same situation as happened with Goldman Sachs and mortgage backed securities) from the portfolio and give back the bonds he didn't want. So on one side of the transaction you have the lawyers from the California insurance commissioner and on the other side you have a big French bank working with junk bond experts. Any guesses who got the better deal .


Now I couldn't find much of the way of hard data, but it does appear that most Exec Life annuity holders, and structured settlement beneficiary saw a 30-50% reduction in their monthly payments after all of the lawsuits were done. In the case of disabled people (e.g. accident victims) this was typically almost all of their income.

This to me illustrates the, admittedly pretty small, dangers of a large insurance company acting stupid/greedy and failing. It doesn't account for the possibility of systemic failures in the insurance business if we continue to have a period of poor returns on capital and insurance companies find themselves lock in annuities promising 6,7,8% returns written many years ago.

Back in late 2007, early 2008, I touted BBT. At the time this conservative bank was yielding 6% had a 110 year history of paying dividends a 35 year history of raising them, had only cut dividends once by a penny during the depression. Now my assessment of BB&T as good bank was spot on. It avoided making the really stupid loans like Option ARM etc. The banks continued to make money every quarter, it has gained market share by taking over its weaker former competitors. Unlike most big banks which cut dividends to a $.05 a quarter or $.01 for BAC or Citi, BBT "only" slashed its dividend to $.15 from $.47. The stock price "only" fell from $35-40 to $20. So do pat myself on the back for picking one of the few 1/2 rotten apples out of a the barrel rotten ones? (I am not talking about the many other banks I owned during that time that performed much worse) Or do I say damn that was dumb of me to invest so heavily in one sector?

Insurance companies are financial institution much like banks. We don't even need a black swan to severely hurt the whole sector just a decade or so of sub-par par investment performance. I have no confidence that state regulators do a better job watching them than the Feds did with banks, and brokerages. Which is why I think SPIA should be treated as a fixed income, annuities should purchased from multiple companies and the total should not exceed the 25-35% of assets.
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