Poll:At what discount rate would you buy SPIA?

[Totoro]

So would anyone turn down a single life annuity with a 7% internal rate of return given a 3% COLA?

I'd take it, but not for my full portfolio. (up to 1/3rd or so).

 

[clifp]

Exactly. Even with a COLA the underlying interest rate to support the annual inflation adjustment can be calculated, it's just an increasing annuity. So as my employer's pension has a COLA it bumps up the internal interest rate to 7% assuming a 3% annual COLA which is what it was last year. If I was to use 1970s inflation numbers like 10% for the COLA the interest rate would have to be 15%.

So would anyone turn down a single life annuity with a 7% internal rate of return given a 3% COLA?

I voted for 6%, I am 55 so my life expectancy is 25 years which means I should be getting back ~4% just based on life expectancy. Another 6% interest rate means I'd be getting $10K a year for life on 100K investment.
Today I can only get $5550 from an annuity so there is very big gap.

I'd go lower if there was some type of COLA provision.

 

[karluk]

If OP is interested in pursuing it, the fact that lottery winners generally have a choice between annuitized annual payments and a lump sum allows one to construct another poll that would approach this issue from another angle. We could narrow down the point where most people consider a lump sum to be less valuable than a future income stream. That would give an implied interest rate that could be easily calculated, instead of forcing poll respondents to estimate how changes in the interest rate affect future cash flows. The poll would be something like

You have won a $400 million lottery prize, consisting of 20 annual payments of $20 million each. How small would the lump sum option have to be in order for you to opt for $20 million per year over 20 years instead of the lump sum?

$300 million lump sum
$200 million lump sum
$100 million lump sum
$50 million lump sum
$25 million lump sum
$10 million lump sum
$5 million lump sum
$1 million lump sum
less than $1 million lump sum

 

[nun]

I'd take it, but not for my full portfolio. (up to 1/3rd or so).

I can only use my employer's DC plan to buy in and that's about 20% of my portfolio. The pension, along with rental income, will cover my annual expenses.

 

[eta2020]

That depends on your age...I am talking about Fixed immediate annuity.

At 20 I will take 5% hands down and at 90 they will pay me maybe 20% I would not care about it.

Needless to say in current low rate environment I would not buy annuity.

 

[longinvest]

longinvest I would assume is referring to 'SPIAs realistically available'.

Yes.

Since a main function of a SPIA is to offer protection against longevity risk a non-COLA one loses much of its appeal: By the time the longevity materializes cumulative inflation could have gone virtually anywhere.

That's exactly it! If I was to pay for peace of mind in regards to longevity risk, I want to have peace of mind that the income will be sufficient and keeping up with inflation, in my old days.

A nominal SPIA protects the insurer against inflation, instead of the retiree. It's the wrong product for the retiree.

 

[nun]

I voted for 6%, I am 55 so my life expectancy is 25 years......

You should look at the latest life expectancy tables.....you have at least 3 years longer to live.

 

[clifp]

You should look at the latest life expectancy tables.....you have at least 3 years longer to live.

Really I used social securities Actuarial table. Is there a better source?

 

[nun]

Really I used social securities Actuarial table. Is there a better source?

Yes, since 2010 life expectancy has improved. The SSA has a calculator

Retirement & Survivors Benefits: Life Expectancy Calculator

 

[gauss]

Ok - I will vote for 5% based on the following back of the envelope calculations

- Totoro's link above shows an analysis where the IRR for delaying SS by one year for a male age 62 to 63 is 2.9% assuming life expectancy of 82 years.

- The 2.9% above would be a real rate of return due to SS being adjusted for inflation. I will adjust for an assumed inflation rate of 2% to get a nominal IRR of 4.9%

- The problem in this scenario is that I have not transferred the risk of much higher inflation to the annuity provider as I have with the SS alternative. I can somewhat offset this risk by remembering that I may not receive what I have currently accrued under SS due to changes (reductions) in future law.

Agreed that the ability to purchase truly inflation adjusted annuities is what is really needed for the individual.

-gauss

 

[karluk]

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.

 

[Chuckanut]

The few inflation adjusted annuities I looked at years ago seemed very expensive.

 

[nun]

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.

 

[Huston55]

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.

 

[nun]

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%.

 

[Independent]

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.

 

[Huston55]

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.

 

[karluk]

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.

 

[nun]

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.

 

[nun]

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......

 

[Huston55]

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.

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.

 

[nun]

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/calculators/cal_main.jsp?sub_item=ppa06_lumpsum_cal

 

[mickeyd]

Don't believe that I will ever have a need for an annuity, no matter what the rate offered. No place to vote.

 

[nun]

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?

 

[aja8888]

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,