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View Poll Results: A what interest rate would you buy an annuity
4% 1 1.56%
5% 8 12.50%
6% 17 26.56%
7% 15 23.44%
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Old 11-24-2014, 09:29 PM   #61
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Ok, I have definitely learned something new today. I had been vaguely aware that lottery jackpot winners are given a lump sum option that tends to be roughly half the annuity option, and that the winners, without any exceptions that I have ever heard of, always prefer the lump sum. I now believe I know why.

Let's take the Powerball rules as an example. Using the following link, I see that Wednesday's Powerball drawing is expected to be $80 million, payable to the winner in 30 installments. But the installments aren't equal. The first one is $1,426,408 and the others seem to be the same $1,426,408, except that each year the amount is credited with 4% compounded growth. So the second payment is $1,483,464 and the 30th is $4,448,469 - more than three times the first payment, but you have to wait 29 years to get it. Ouch! Adding up all 30 payments, you get $80,000,000.

In contrast, the lump sum is $49,700,000. If you invested this amount, getting a 1.655% return per year, after 29 years you would have the same $80 million as you get from the 30 installment payments.

https://www.usamega.com/powerball-jackpot.asp

No doubt taking taxes into consideration would alter this calculation some. But there is no doubt in my mind that even financially unsophisticated winners have an intuitive sense that they aren't getting enough extra money to make it anywhere near the 29 year wait to collect all 30 installments.
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Old 11-24-2014, 10:35 PM   #62
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The few inflation adjusted annuities I looked at years ago seemed very expensive.
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Old 11-24-2014, 10:45 PM   #63
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The few inflation adjusted annuities I looked at years ago seemed very expensive.
Yes they are...which is why I'm amazed that I get the chance to use $263k of my state retirement DC money to buy back into my state's DB pension and get $19.6k/year (70% of which gets a COLA) starting at 55. It seems that many people would like to have an inflation adjusted annuity in their portfolio if they were better value for money.
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Old 11-25-2014, 07:47 AM   #64
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Yes they are...which is why I'm amazed that I get the chance to use $263k of my state retirement DC money to buy back into my state's DB pension and get $19.6k/year (70% of which gets a COLA) starting at 55. It seems that many people would like to have an inflation adjusted annuity in their portfolio if they were better value for money.
If I used the annuity PV calculator from your link correctly, a standard market quote (Immediate Annuities website) would yield this.

Immediate Annuity for 55yo male, not COLAd, produces:
Initial payment of $263k = ~$14.4k/year (not COLAd)
Discount rate ~ 3.5%

Compared to this, your DB purchase is a great deal. It's a shame all of us can't find such a deal.
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Old 11-25-2014, 08:20 AM   #65
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If I used the annuity PV calculator from your link correctly, a standard market quote (Immediate Annuities website) would yield this.

Immediate Annuity for 55yo male, not COLAd, produces:
Initial payment of $263k = ~$14.4k/year (not COLAd)
Discount rate ~ 3.5%

Compared to this, your DB purchase is a great deal. It's a shame all of us can't find such a deal.
It's not quite that bad.

I'm paying $263k at age 53.5 and the pension won't start until I'm 55. So my $263 can compound a bit. Putting age 53 and $263k into Immediate Annuities site, but waiting until age 55 to start the annuity I get annual income of $15.6k.....still a lot less than the $19.6k my employers pension will provide and there's no COLA.

With no COLA the calculated discount rate on my pension is ~5.7% and with the COLA of 3% that jumps up to 7%.
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Old 11-25-2014, 09:13 AM   #66
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Ok, I have definitely learned something new today. I had been vaguely aware that lottery jackpot winners are given a lump sum option that tends to be roughly half the annuity option, and that the winners, without any exceptions that I have ever heard of, always prefer the lump sum. I now believe I know why.

Let's take the Powerball rules as an example. Using the following link, I see that Wednesday's Powerball drawing is expected to be $80 million, payable to the winner in 30 installments. But the installments aren't equal. The first one is $1,426,408 and the others seem to be the same $1,426,408, except that each year the amount is credited with 4% compounded growth. So the second payment is $1,483,464 and the 30th is $4,448,469 - more than three times the first payment, but you have to wait 29 years to get it. Ouch! Adding up all 30 payments, you get $80,000,000.

In contrast, the lump sum is $49,700,000. If you invested this amount, getting a 1.655% return per year, after 29 years you would have the same $80 million as you get from the 30 installment payments.

https://www.usamega.com/powerball-jackpot.asp

No doubt taking taxes into consideration would alter this calculation some. But there is no doubt in my mind that even financially unsophisticated winners have an intuitive sense that they aren't getting enough extra money to make it anywhere near the 29 year wait to collect all 30 installments.
Your 1.655% looked kind of low given current interest rates. So I did my own math.

Suppose I took the $49.7 million today, put it into some investments that earn x%, and withdrew $1,426,408 immediately, then $1,483,464 the next year, and so on until I withdraw $4,448,469 at the beginning of the 30th year.

What x is just enough that the last payment cleans out my account? My answer is 2.96%. Today's 5, 10, 20, and 30 year treasury yields are 1.63%, 2.36%, 2.80%, and 3.07%. The the 2.96% IRR on the lottery payout seems "reasonable" given those yields.

Of course, most people feel they can beat treasury yields.
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Old 11-25-2014, 09:45 AM   #67
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Your 1.655% looked kind of low given current interest rates. So I did my own math.

Suppose I took the $49.7 million today, put it into some investments that earn x%, and withdrew $1,426,408 immediately, then $1,483,464 the next year, and so on until I withdraw $4,448,469 at the beginning of the 30th year.

What x is just enough that the last payment cleans out my account? My answer is 2.96%. Today's 5, 10, 20, and 30 year treasury yields are 1.63%, 2.36%, 2.80%, and 3.07%. The the 2.96% IRR on the lottery payout seems "reasonable" given those yields.

Of course, most people feel they can beat treasury yields.
This analysis assumes spending all the money which, is of course, not the prudent thing to do with a $50M windfall. The prudent person would spend a portion and set aside the remainder (likely a lot of the $49.7M). In those circumstances, 2.96% is not a good return, as we could all do better.

Oh wait, did I say "prudent?" That excludes most/all lottery winners.
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Old 11-25-2014, 09:57 AM   #68
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Your 1.655% looked kind of low given current interest rates. So I did my own math.

Suppose I took the $49.7 million today, put it into some investments that earn x%, and withdrew $1,426,408 immediately, then $1,483,464 the next year, and so on until I withdraw $4,448,469 at the beginning of the 30th year.

What x is just enough that the last payment cleans out my account? My answer is 2.96%. Today's 5, 10, 20, and 30 year treasury yields are 1.63%, 2.36%, 2.80%, and 3.07%. The the 2.96% IRR on the lottery payout seems "reasonable" given those yields.

Of course, most people feel they can beat treasury yields.
I also had second thoughts about my calculations after I posted my results, and I think your calculations are a much fairer way of comparing options. My 1.655% answer ignores the fact that most of the installment payments are available before year 29 and can be invested in whatever the prize winner wants. If I take the installments as they are paid and invest them with an assumed 2.96% growth, the money will grow to $115,793,491.87 after 29 years. This compares to a lump sum of $49.7 million that will grow to $115,809,416.04 at the same 2.96% compounded growth. So your calculation is correct to within the three significant figures that you performed the math.

That makes it much less financially ridiculous to choose annuitizing the payments, but I still can see why no one picks this option. Not only would almost everybody think they can invest their money and get more than 2.96% return, but the fact that the installment payments are heavily backloaded to the tail end of the 29 year period would make almost anyone wonder if they would live long enough to enjoy the full amount of their winnings.
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Old 11-25-2014, 10:56 PM   #69
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That makes it much less financially ridiculous to choose annuitizing the payments, but I still can see why no one picks this option. Not only would almost everybody think they can invest their money and get more than 2.96% return, but the fact that the installment payments are heavily backloaded to the tail end of the 29 year period would make almost anyone wonder if they would live long enough to enjoy the full amount of their winnings.
Looks like 29 year payouts from state lotteries are even worse than the deal you get on current annuities....it would be a nice problem to have though.

So have the recent studies on the use of SPIAs and DIAs in a portfolio instead of bonds changed anyones plans? With my DIA from TIAA-Traditional, the potential of DB pensions from two ex employers and social security from two countries I'm pension/annuity heavy.
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Old 11-25-2014, 11:32 PM   #70
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So this pension blog post shows why my employer would offer me a lump sum from my pension in 2014, looks like the IRS rates for 2014 make it affordable for the plan

Preview of 2014 Lump Sum Interest Rates « The VIA retirement plan blog

PS I now know how they come up with the lump sum amount having worked through the maths using the IRS segmented interest rates. nice little trick to link the rates to corporate bonds rather than 30 year treasuries so the payouts can be less......
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Old 11-26-2014, 10:10 AM   #71
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I used online calculators for the present value of an increasing annuity and compound interest using the same interest rate for both calculations and adjusted the rate until the income match my pension income. I used the IRS life expectancy tables to come up with the number of periods. I then checked it with excel.

Present Value of a Growing Annuity

This way you can back out the interest rate as distinct from the payout rate, which is simply the ratio of the principal to the annual income you get....for a COLAed annuity/pension the payout rate changes....on my DB pension that starts at 7% at 55 and increases to 12% when I'm in my 80s.
I am 59 and recently semi-FIREd, which is relevant for this question. So, in today's interest rate environment, for an "increasing" (COLA adjusted) annuity, I would consider it seriously at a 6% interest rate, and almost certainly buy one with a 7% interest rate. Unfortunately, I think Mr. MooreBonds is correct; the chances of finding such a deal applicable to me are slim.

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I said 6%.
Alternative rates - You'd also have to consider what other interest rate options are. If the annuity 'yield' is only 3%, and I can get 3% on a 10 year CD, I'm going with the CD. If I happened to find an annuity that paid reasonably higher than other rates I could find, I'd look very closely at it....but, the odds of such an annuity existing outside of a sweetheart pension clause in some small municipality's pension set-up are probably slim.
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Old 11-26-2014, 02:41 PM   #72
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If anyone is getting a lump sum offer in place of a pension, here are the interest rates used to calculate the amount.

Minimum Present Value Segment Rates

you can check that the amount is correct using this calculator and entering the segment interest rates. With the rates being quite low right now it's probably a good time to take a buy out.

https://www.pensionbenefits.com/calc...06_lumpsum_cal
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Old 11-26-2014, 03:46 PM   #73
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Don't believe that I will ever have a need for an annuity, no matter what the rate offered. No place to vote.
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Old 11-26-2014, 04:04 PM   #74
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Don't believe that I will ever have a need for an annuity, no matter what the rate offered. No place to vote.
Not even if you got one with a 7% interest rate for an actuarial mortality and used it in place of other fixed income in your portfolio, al a Wade Pfau?
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Old 11-26-2014, 04:23 PM   #75
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Not even if you got one with a 7% interest rate for an actuarial mortality and used it in place of other fixed income in your portfolio, al a Wade Pfau?
I'm with mikeyd above. I just don't want to hand someone a big wad of cash that took years of hard labor to produce with the the caveat that I was going to be alive many years down the road and that the new owners of my cash will be around too (and still making payments).

I'll take my own chances with large sums of money,
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Old 11-26-2014, 04:33 PM   #76
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I'm with mikeyd above. I just don't want to hand someone a big wad of cash that took years of hard labor to produce with the the caveat that I was going to be alive many years down the road and that the new owners of my cash will be around too (and still making payments).

I'll take my own chances with large sums of money,
I can certainly appreciate your opinion, the last 30 years of DC retirement savings and efficient market investing dogma have made the idea of the annuity rather passe. It's interesting, then, to see people like Wade Pfau considering them in place of bonds and also that the UK is just now moving away from them as the default for retirement income. Sometimes the winds of change blow in different directions in different places.
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Old 11-26-2014, 08:55 PM   #77
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Funny how we differ. I have been quite comfortable turning over a considerable wad of cash in the very high six figures to secure SPIA's approaching 10% for the rest of my life. It's insurance, not an investment, and if it turns out to be unprofitable because of my premature death, I'll have had the security of that income my entire life. I didn't commit over 25% of my portfolio to SPIA's and I now have less to worry about in managing the other 75%. To each his own.
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Old 11-26-2014, 09:29 PM   #78
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Funny how we differ. I have been quite comfortable turning over a considerable wad of cash in the very high six figures to secure SPIA's approaching 10% for the rest of my life. It's insurance, not an investment, and if it turns out to be unprofitable because of my premature death, I'll have had the security of that income my entire life. I didn't commit over 25% of my portfolio to SPIA's and I now have less to worry about in managing the other 75%. To each his own.
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But how much insurance do you need? I suppose that depends on your income and toleration for risk. Is SS enough of a COLAed annuity for you? If you ER maybe a 5, 10 or 15 year SPIA is a good play to bridge the gap to when SS starts. But what proportion of your annual income should an annuity/pension/SS cover....25%, 50% or more? Going on the idea that you might only want to annuitize a max of 25% of your portfolio you'd get a quarter of your income from it and maybe when you get to SS age that might add another 25%, taking the pressure of the rest of your portfolio.
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Old 11-27-2014, 10:55 AM   #79
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But how much insurance do you need? I suppose that depends on your income and toleration for risk. Is SS enough of a COLAed annuity for you? ...But what proportion of your annual income should an annuity/pension/SS cover....25%, 50% or more? Going on the idea that you might only want to annuitize a max of 25% of your portfolio you'd get a quarter of your income from it and maybe when you get to SS age that might add another 25%, taking the pressure of the rest of your portfolio.
Before purchasing SPIA's my pension and SS provided only about 1/3 of my required income. I put enough in SPIA's so that, when combined with my pension and SS, it gave me guaranteed income providing about 65% of my need. The remaining 35% comes from a 3% withdrawal from my net portfolio (assets less any debt). I feel I have plenty of inflation protection from SS and from the common stocks, TIPS and I-Bonds held in my portfolio. I sleep much better at night knowing I am not dependent on my portfolio to provide a large portion of my cash needs.
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Old 11-27-2014, 11:09 AM   #80
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As an early retiree I think there's just too much risk buying an annuity that's not cola adjusted.

At this point, I don't even think it's worth it for me to do the calculations for determining an annuity price -- the way I see it, the offerer of the annuity is going to give you some return that's less then the expected from market investments + mortality credits - administrative costs. However at my age mortality credits are probably close to 0.

Given that I'm not a borderline case (volatility in equities won't sink me) I see no reason to go for an annuity.
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