MarketWatch Article Touting Simple Annuities

[CaptTom]

I tend to be highly skeptical about any annuity advice, but this one does some interesting mathamatical gymnastics:

https://www.marketwatch.com/story/th...ent-2019-04-29

Quote:

My own calculations show that for an investor to be 95% certain of not running out of money with a safe withdrawal strategy from a 60%/40% stock-bond portfolio, the strategy would be to withdraw 3.5% of the initial investment in real (inflation-adjusted) dollars each year. If the portfolio started with $500,000, for example, the average annual lifetime income would be $23,000. With the SPIA, the average annual lifetime income would be $33,500, and the certainty of achieving it is greater than 95%. Thus, both the certainty of not running out of money, and the lifetime income, are much greater with the SPIA than with the “safe withdrawal” strategy. This, of course, assumes that the investor has essentially zero interest in leaving a bequest. But this is the case for many baby boomers. Their children are independent, or they want them to be, or they have no children.

The above quote is near the end of the article, if you want to skip the fluff and read from the source.

So, anyone want to take a shot at proving the author's math wrong?

[GravitySucks]

To start-Trinity, Firecalc, and Bengen all have a higher withdraw rate than 3.5% to even make a 100% success rate. Guess this guy assumes the future will be worse than the past.

[pb4uski]

What about inflation?

[bmcgonig]

One major flaw is that the 3.5% is inflation proof for the 60/40 but not inflation proof for the annuity. Totally different math if he bought an inflation indexed SPIA which would be the appropriate comparison.

[Dtail]

Quote:

Originally Posted by GravitySucks To start-Trinity, Firecalc, and Bengen all have a higher withdraw rate than 3.5% to even make a 100% success rate. Guess this guy assumes the future will be worse than the past.

Firecalc appears to have a 3.67% WR 100% success at a 60/40 AA. so higher than 3.5% but not that much higher.

[marko]

Quote:

Originally Posted by pb4uski What about inflation?

Spoilsport!

This always bothers me.

A lot of financially unsophisticated people would buy into the "guaranteed lifetime income" not realizing that their greatest risk is not running out of money but the deterioration of what that money can buy.

[zinger1457]

I took the point of the article to be how to maximize ones income in retirement for those that aren't looking to leave behind their savings for heirs. Didn't verify the articles numbers for accuracy but if you average $23K/year (inflation adjusted) during retirement or $33.5K/year fixed it seems to me you'll end up with ~$260K more income over a 25 year period with the fixed payment.

[OldShooter]

Quote:

Originally Posted by bmcgonig One major flaw is that the 3.5% is inflation proof for the 60/40 but not inflation proof for the annuity. Totally different math if he bought an inflation indexed SPIA which would be the appropriate comparison.

+1


Too bad that stupid people and/or dishonest people are so plentifully available to mislead readers. I'll bet he makes a lot of money selling SPIAs.

[OldShooter]

Just for grins I brokerchecked this guy. He hasn't been registered for 5 years and prior to that he was registered with a pathetic little firm, now defunct, that appears to have had one employee and maybe 25 clients. It sold insurance. Probably he ran out of relatives and friends.

But, hey, he's a published author. Clients will be impressed!

[razztazz]

The annuity doesn't have to increase with inflation. The assumption is you'd live on the same initial amount as a 3.5% draw. That's your alternative anyway. Then bank the difference to be drawn upon to supplement expenses when inflation starts eating away the purchasing power. In the final analysis that still might not be enough to cover the lifespan but it's not as subject inflation as it looks. That's how I read it.

But I'm still not buying an annuity

[jimbee]

Quote:

Originally Posted by GravitySucks To start-Trinity, Firecalc, and Bengen all have a higher withdraw rate than 3.5% to even make a 100% success rate. Guess this guy assumes the future will be worse than the past.

I think the Trinity study was a 95% success rate at 4%.

[Running_Man]

Make the following assumptions:
Start with 3.5% of the income from the annuity $17,500 annually of the 500 K portfolio,
Invest the annuity payout overage at 2% interest - low I realize but let's just go with that
Increase the withdrawal each year by 3.22%, the average of inflation over the last 50 years.
It would be 43 years before one ran out of the additional "inflation" money

Now the article is implying strongly that you could live on more funding, what happens at 4.5% withdrawal rate?

You would get 26 years to age 91 starting at $22,500 and increasing 3.22% each year a 28% increase over the 3.5% withdrawal rate. There is no upside or leftover portfolio and at age 91 your income falls off a cliff from $49,691 to $33,500. The downside is that anything that would probably make a 60/40 portfolio fail at 3.5% withdrawal drastically risks impairment of the annuity as well.

If the assumption is made you could invest the funds at 1 percent over inflation the payout would last 30 years at a 3.22% annual increase.

I think a far better case can be made for investing the 40% in the annuity, taking the $13,400 payout from that and investing the remainder 100% in stocks. Leaving a 1.4% withdrawal rate on the stock portion of the portfolio.

[CaptTom]

Quote:

Originally Posted by Running_Man I think a far better case can be made for investing the 40% in the annuity, taking the $13,400 payout from that and investing the remainder 100% in stocks. Leaving a 1.4% withdrawal rate on the stock portion of the portfolio.

Interesting. So what you're saying is that instead of a 60/40 allocation, put the 40% into the annuity. About as safe as bonds, similar yield and let the insurance company worry about you outliving the money. I never thought of it that way, but you make one of the better cases I've heard in favor of an annuity.

[samclem]

Quote:

Originally Posted by Running_Man I think a far better case can be made for investing the 40% in the annuity, taking the $13,400 payout from that and investing the remainder 100% in stocks. Leaving a 1.4% withdrawal rate on the stock portion of the portfolio.

Yes, it would be a 1.4% withdrawal rate from the stocks in year 1. But after that, if we want to keep pace with inflation we'll need to increase that withdrawal from the stock portion by 2.3 x the inflation rate, because the stock portfolio has to cover the inflation increase on $13,400 plus the inflation increase on the income from the annuity ($17,500 in year one). Over many time periods, equities have not provided nominal returns that are 230% of inflation, so there's a very good chance the stock portion will lose value (and spending power) over time.

It's still not a terrible approach, but it's not as solid as it might appear at first.

[OldShooter]

We are optimistic critters because that is rewarded by evolution. Most of these calculation will turn out differently with shorter lives, sometimes quite dramatically when the insurance company wins the dice game.

[haha]

Quote:

Originally Posted by marko Spoilsport! This always bothers me. A lot of financially unsophisticated people would buy into the "guaranteed lifetime income" not realizing that their greatest risk is not running out of money but the deterioration of what that money can buy.

I would think that almost anyone old enough to be interested in an annuity is very likely to be personally acquainted with inflation, and many of us with pretty heavy inflation.

I think the flaw is that most people today can't hold onto their own experience when someone makes a strong case that even ignores obvious reality. Not enough people from Missouri anymore.

Even the last decade or so of "low inflation" is clear. When I moved to my current neighborhood about 12-13 years ago I never had a $50 tab at Trader Joe. I still buy the same set of items at Trader Joe and carry them home in the same rucksack as I did then, but now I rarely have a tab less than $50, and they are often $80+.

Apropos of why not invest the fixed allocation in your portfolio into an annuity rather than bonds is that this would give up the very important optionality of moving some portion back and forth into and out of stocks based on relative values or whatever metrics you find appealing.

It also may be that our economy is in its death throes, dying slowly perhaps, but nevertheless dying.

Ha

[marko]

Quote:

Originally Posted by CaptTom Interesting. So what you're saying is that instead of a 60/40 allocation, put the 40% into the annuity. About as safe as bonds, similar yield and let the insurance company worry about you outliving the money. I never thought of it that way, but you make one of the better cases I've heard in favor of an annuity.

Interesting view.
So if I understand correctly, I'm wondering if one were to 'give away' 40% of his portfolio if the remaining 60% of equities would now fall into the 4% withdrawal category.

IOW, if the 40% is 'gone' (same as if it were now an SS payment) would the equity balance allow a 4% WD? Would one be ahead if so?

[capjak]

Depends.....

Wade Pfau research:

"My research article on the efficient frontier for retirement in the Journal of Financial Planning concluded that combinations of stocks and income annuities produce more efficient outcomes than combinations of stocks and bonds. Income annuities effectively serve as a replacement for the fixed-income allocation in a retirement portfolio. When retirees know what they will receive upon purchasing an income annuity, they are in good shape if they have enough saved to lock in their income objective."

https://www.fa-mag.com/news/substitu...ent-21923.html

[audreyh1]

Quote:

Originally Posted by capjak Depends..... Wade Pfau research: "My research article on the efficient frontier for retirement in the Journal of Financial Planning concluded that combinations of stocks and income annuities produce more efficient outcomes than combinations of stocks and bonds. Income annuities effectively serve as a replacement for the fixed-income allocation in a retirement portfolio. When retirees know what they will receive upon purchasing an income annuity, they are in good shape if they have enough saved to lock in their income objective." https://www.fa-mag.com/news/substitu...ent-21923.html

I believe that Kitces later showed that cash did as well as the annuity in Pfau’s scenario. There wasn’t anything magical about the annuity.

[Running_Man]

Quote:

Originally Posted by samclem Yes, it would be a 1.4% withdrawal rate from the stocks in year 1. But after that, if we want to keep pace with inflation we'll need to increase that withdrawal from the stock portion by 2.3 x the inflation rate, because the stock portfolio has to cover the inflation increase on $13,400 plus the inflation increase on the income from the annuity ($17,500 in year one). Over many time periods, equities have not provided nominal returns that are 230% of inflation, so there's a very good chance the stock portion will lose value (and spending power) over time. It's still not a terrible approach, but it's not as solid as it might appear at first.

Starting in 1929 invested in the S&P 500, with the four straight years of losses the $300,000 fell to $101,300 at it's Nadir but by 1959 30 years after the start the portfolio would have 2.9 Million dollars.

Worst year I found to start after was 1969 where the portfolio fell to $211,503 in 1974 but at the end of 30 years the portfolio was at $2,624,707 with a 2.9% withdrawal from the portfolio, the worst year in the 1969 sequence was 1981 where the withdrawal was 8.59% of the $311,000 portfolio at the time. Of course at that time the S&P 500 dividend yield was 5.6%.

In most cases when you start year by year the withdrawal rate never gets above 3% so that in most years you are not even spending all the dividends. Even during the great depression because of the negative inflation the withdrawal rate was under 2 percent - and the dividends then were in the 6-9 percent range, meaning you would have been purchasing stock equal to 4-7 percent of your portfolio at the nadir of all time lows in the stock market.

I do not believe there are any failures with these parameters starting in any year from 1926 forward. If you start at Y2K by end of 2018 Portfolio is at $419,467 and withdrawal rate is 2.78%. Portfolio was at 170K at end of 2008 with a 4.68% withdrawal rate for the low point of the sequence to date.

The advantage of the system is easy to see to me, it is very conservative in nature with the 3.5% withdrawal rate. The annuity provides 77% of the needed funds in the early part of the retirement, avoiding the sequence of returns shock and giving stocks the chance to catch their footing. As time goes by you are for the most part only spending the dividends from the S&P500. And in most years you are purchasing shares not selling shares.