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Mike Piper (Oblivious Investor): Why Not Annuitize?
Old 02-05-2016, 04:41 PM   #1
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Mike Piper (Oblivious Investor): Why Not Annuitize?

I am a fan of Mike Piper (Oblivious Investor). One of the things I like about him is he will provide information and views that are counter to his position on financial issues. In his Investing Blog Roundup e-mail I received this morning, he provides a link to a New York Times business section article of January 29, 2016 that contains counterpoints to his thoughts that too few people buy annuities*. His e-mail contains a link to this article by Christopher Ferrell: http://www.nytimes.com/2016/01/30/yo...fast.html?_r=0. I was able to read the entire article without a subscription so hopefully this link works for those who would care to have a gander. Personally, I do not believe an annuity is in my and my wife's future retirement planning.

What I found interesting in addition to the "don't buy an annuity" discussion was the reference to a Congressional Budget Office (CBO) study published in 2013 by Felix Reichling and Kent Smetters with the easy-to-understand title "Optimal Annuitization with Stochastic Mortality Probabilities" (link:https://www.cbo.gov/sites/default/fi...ling_2_0_1.pdf)

The first sentence of this CBO paper is pretty provocative in my opinion: "The classic paper of Yaari (1965) demonstrated that the demand for annuities should be so strong that life cycle consumers without a bequest motive should invest all of their savings inside an annuity contract." The authors then proceed to demonstrate that their mathematical calculations and inputs show that the majority of individuals with retirement savings should not buy an annuity regardless of wealth ("We find that 63% of households should not annuitize any wealth, even with no transaction costs, ad hoc “liquidity constraints,” or bequest motives. In contrast, the Yaari model predicts 0%." See page 2 of the study).

If you want to know how they came up with 63% as well as their mathematical calculations and inputs, you'll have to read the paper. Hey, it's 46 pages long; I'm not going to summarize the entire thing for you.

The NYT article quoted Kent Smetters as saying that if one is to buy an annuity, he recommends that individual have at least $500,000 in other monies to pay for medical expenses and other unplanned needs as well. OK, its more than a recommendation - he says anyone with that half-million in other savings should buy an annuity.

I know all of this is a long-winded way of saying annuities are not a good deal for most individuals, but I think it might provide additional food for thought for those contemplating purchasing one. Plus, one can always throw the Euler equations in the CBO study at an annuity salesperson who comes a callin' and see if they can disprove them...

*In fairness to Mike, he also says "many people would benefit from exchanging a portion of their liquid assets for a guaranteed stream of lifetime income (most often by delaying Social Security...)

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Old 02-05-2016, 05:57 PM   #2
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Thanks for the links and summary.


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Old 02-05-2016, 06:58 PM   #3
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This is critical:
Quote:
without a bequest motive
and, I'd add, "fully insured for long term care expenses".

If you assume zero utility from money left "on the table" when you die, you get one answer.
But, suppose that pile of money
- gave you the peace of mind that you wouldn't end your life on Medicaid, and
- the general good feeling of knowing "I could spend that pile if I wanted to", and
- the comfort that your kids or favorite charity will enjoy it after you're gone.

If those things matter, then keeping the money, and avoiding the insurance company loads that are hidden in the annuity, makes sense.
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Old 02-05-2016, 07:02 PM   #4
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Google "the annuity puzzle" and get a zillion articles on the subject.
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Old 02-05-2016, 09:21 PM   #5
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The sentence that popped out from the article for me was:

Quote:
“Certainly, there is the dynamic that people who can afford a significant allocation to annuities don’t need to,” says Michael Kitces
If you have ample funds to support your income requirements through the worst imaginable crash then you don't need an SPIA. It's the folks in the middle who could not survive the crash that might benefit from taking some money off the table and buying a guaranteed income. The group without enough to retire have no business with an SPIA because they are terrible investments and they should just keep working.

However, there are studies that show that if an SPIA is used to replace the bond portion of a portfolio the higher resulting equity allocation and lower need to spend from the portfolio can produce better results than a 60.40 portfolio. Of course the assumptions and inputs for the model are critical and you can adjust those to get a wide range of answers.
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Old 02-06-2016, 12:15 AM   #6
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The article indirectly points out the major flaw in the thinking:
1) The average person should not buy an annuity until they have 500K because they risk financial ruin because average medical is $245,000 for a couple
a) Median retirement balance for a retired couple is $138,000

That is the median almost half of retirees do not have enough money, and what do are they do? Work part time jobs to age 70 to save 1/2 million. Please, hard to believe this is financial advice. Look at the thread about the retirees in trailers working jobs and spending their last dollars and having $50,000 in CC debt. I find it impossible to believe those people are not better off if they would convert whatever savings they have in their 60's into a lifetime earning stream, and develop a savings plan by not spending all of that stream.

$138,000 will get 8-9K per year for life for a couple with the average couple getting $25K in SS that means 33-34 K income versus perhaps 10-15 years before they spend the entire amount to zero and probably are down to one survivor and 15K income. I have seen my father live this exact story he spent his 200K savings and 80K house to zero in 10 years and lived his final 13 years on the equivalent of 1600 per month.

Now if you have over 500K you are now in the top percentage of retirees and the retirement funding options are entirely different. But I think more should be done to help the average citizen who gets to age 62 after losing a job and can't get hired except for working seasonal jobs .... commonsense mitigation factors and expense control instead of the bad advice that annuities are no good and depleting only savings they have.
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Old 02-06-2016, 12:28 AM   #7
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Originally Posted by Running_Man View Post
... commonsense mitigation factors and expense control instead of the bad advice that annuities are no good and depleting only savings they have.
I'm a fan of having a secure income floor and some longevity insurance. If SS is enough then an annuity might not be appropriate, but I think an SPIA should be in far more people's portfolios and that they are not diversified enough by just holding cash, bond and equity funds. Having some liquid assets is important for emergencies and large one time costs so I would recommend partial annuitization.

Also I'm sad that thrift has gone out of fashion. Saying someone is thrifty is almost an insult today, it certainly isn't something the proudly proclaim anymore and probably wouldn't be a plus in the dating world. How much you spend is one of the few financial factors you can actually control.
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Old 02-06-2016, 06:53 AM   #8
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Quote:
Originally Posted by nun View Post
I'm a fan of having a secure income floor and some longevity insurance. If SS is enough then an annuity might not be appropriate, but I think an SPIA should be in far more people's portfolios and that they are not diversified enough by just holding cash, bond and equity funds. Having some liquid assets is important for emergencies and large one time costs so I would recommend partial annuitization.

Also I'm sad that thrift has gone out of fashion. Saying someone is thrifty is almost an insult today, it certainly isn't something the proudly proclaim anymore and probably wouldn't be a plus in the dating world. How much you spend is one of the few financial factors you can actually control.
This, both paragraphs.

Particularly the expense control part. I'm always gob-smacked how people spend their days trying to wiggle an additional 1% raise out of their employer but never turn a thought to where their spending goes. Getting control of structural spending (car costs, investments costs, home costs) which are largely in post-tax dollars is a way better and more sustainable use of effort than worrying about whether a raise nets you $75/mo or $100/mo.

Don't get me wrong, I'm all for raises and aggressively seeking higher incomes, but way too many people let their wealth just leak out around their feet.
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Old 02-06-2016, 07:05 AM   #9
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Quote:
Originally Posted by Running_Man View Post
$138,000 will get 8-9K per year for life for a couple with the average couple getting $25K in SS that means 33-34 K income versus perhaps 10-15 years before they spend the entire amount to zero and probably are down to one survivor and 15K income. I have seen my father live this exact story he spent his 200K savings and 80K house to zero in 10 years and lived his final 13 years on the equivalent of 1600 per month.

Now if you have over 500K you are now in the top percentage of retirees and the retirement funding options are entirely different. But I think more should be done to help the average citizen who gets to age 62 after losing a job and can't get hired except for working seasonal jobs .... commonsense mitigation factors and expense control instead of the bad advice that annuities are no good and depleting only savings they have.
Once again the lack of COLA is ignored in the advice for annuities. While your numbers sound semi-reasonable at age 62, even 10 years later the income from the annuity has been seriously eroded, and the odds are one of the couple will last significantly longer than that. Also, since the annuity is only on one person unless you spend extra for a last to die annuity, you've got to get the bet right on who goes first. Plus the SS income from one of the couple will be gone. While I agree with your sentiment that it would be a positive thing to allow a little forced self-discipline into the lives of people who don't always make the best decisions, I just don't see the annuity accomplishing that. Although maybe it is better than the alternative. I don't really have an answer to the problem.
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Old 02-06-2016, 10:28 AM   #10
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Originally Posted by harley View Post
Once again the lack of COLA is ignored in the advice for annuities. While your numbers sound semi-reasonable at age 62, even 10 years later the income from the annuity has been seriously eroded, and the odds are one of the couple will last significantly longer than that. Also, since the annuity is only on one person unless you spend extra for a last to die annuity, you've got to get the bet right on who goes first. Plus the SS income from one of the couple will be gone. While I agree with your sentiment that it would be a positive thing to allow a little forced self-discipline into the lives of people who don't always make the best decisions, I just don't see the annuity accomplishing that. Although maybe it is better than the alternative. I don't really have an answer to the problem.
A couple should almost always buy a joint life annuity. The inflation problem is real, but might be over emphasized as there are studies that show as we get older the increase in personal spending is less than the inflation rate. Still having some other assets invested in the market can help cover inflation is a good idea. Right now COLAed annuities are just too expensive for most people to consider.
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Old 02-06-2016, 03:03 PM   #11
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Originally Posted by nun View Post
Also I'm sad that thrift has gone out of fashion. Saying someone is thrifty is almost an insult today, it certainly isn't something the proudly proclaim anymore and probably wouldn't be a plus in the dating world. How much you spend is one of the few financial factors you can actually control.
For us the thrift part has been true as well. Our biggest factor for a secure retirement has been working on low overhead - figuring out how to live well for less, and not so much how our money is invested or even working one or two more years, though part-time income doesn't hurt. With low fixed overhead we can invest conservatively and still save money in retirement.

We took our mostly non-COLA pensions as annuities and they are offset with a low interest fixed rate mortgage.
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Old 02-06-2016, 05:05 PM   #12
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Originally Posted by daylatedollarshort View Post
For us the thrift part has been true as well. Our biggest factor for a secure retirement has been working on low overhead - figuring out how to live well for less, and not so much how our money is invested or even working one or two more years, though part-time income doesn't hurt. With low fixed overhead we can invest conservatively and still save money in retirement.

We took our mostly non-COLA pensions as annuities and they are offset with a low interest fixed rate mortgage.
+1 I'm doing the same.

I have low outgoings and paid off the mortgage well before I retired. I enjoy cooking and can bake a chicken pie using $2.50 of chicken quarters, making stock from the bones, some onions, carrots, potatoes, and tarragon with short crust pastry that will feed me well for three days. Now I'm off to turn a couple of pounds of apples into an apple pie and I'll make some custard to go with it.
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