Say Goodbye to the 4% Rule - tips from the WSJ

[obgyn65]

I mentioned this under a couple of threads I think over the last few months. Did you google my username and the terms annuity and 12% ?

12%! Where do we sign up for that?

Everything I found online was more along these lines...

I certainly wouldn't buy Wellesley if I had a 'deferred annuity bought last year that will generate 12% per year from 62 until you die...'

 

[obgyn65]

I bought it when I was 47. It will generate about 12% when I turn 62.

12% must be the payout rate rather than the IRR, but even as a payout rate that sounds quite high. I'm skeptical.

 

[pb4uski]

Yeah, obgyn's sig line says he is 47 yo. He's already paid for the annuity. So the insurance co has some "free" time before he turns 62 and starts collecting, about 15 years I guess. 12% payout rate seems possible. I don't where to get an online quote for deferred annuities.

Also, I don't think the bar charts midpack posted above are mundane to the payout rates we are talking about.

Yes, it seems plausible. A SPIA for a 62 yo would have a 6.25% payout rate per immediateannuities.com If the 6.25% grew to 12% over 16 years (62 -47) the IRR over the deferral period would be 4.4%.

 

[obgyn65]

To reassure you, my posts are often very short, but always truthful my written style and grammar in English might be slightly below par, but my maths are not

I didn't realize the deferral period was that long. Given that, a 12% payout rate on the single premium doesn't sound implausible.

 

[obgyn65]

Let's assume you buy an annuity today for 30k that will "yield", or "generate", or "pay out" 3,600 per year in 15 years, what is the correct English verb ?

'Generate' is the key word. He didn't say 'return', 'IRR' or anything else. So it appears he bought it ~ age 46, can get 12% of that per year at 62, so the money is sitting idle for 16 years, and I assume that 12% has no inflation factor built in. Is that a good deal?
-ERD50

 

[youbet]

Yes, it seems plausible. A SPIA for a 62 yo would have a 6.25% payout rate per immediateannuities.com If the 6.25% grew to 12% over 16 years (62 -47) the IRR over the deferral period would be 4.4%.

I did find a site which had numbers for deferred annuities, but it was very confusing to me. For annuities which relinquished their surrender charge after 15 yrs, there were columns for base rate, current rate, bonus rate and effective rate. The effective rate was listed as 12.2%. No clue if that's what we're talking about.

In any case, I see that obgyn65 has reminded us that we've discussed this before and where to look for further information.

I too believe that the 12% figure is plausible for what it is. But I don't share Midpack's enthusiasm for buying one. The web site with the quote tables looked very complicated to understand offering these deferred annuities based on CD's, fixed and variable base investments with up front bonuses and other issues to understand. Could be a great deal, a bad deal or something inbetween. But right now I note it's almost 6:00 PM and I'm quite late for cocktails. Not a good time to start researching new investment products!

 

[MichaelB]

To reassure you, my posts are often very short, but always truthful my written style and grammar in English might be slightly below par, but my maths are not

Oby, I've spent half my life around people with "below par" English language abilities. In comparison, your English is excellent.

On second thought, better than many native English speakers I know.

 

[pb4uski]

Let's assume you buy an annuity today for 30k that will "yield", or "generate", or "pay out" 3,600 per year in 15 years, what is the correct English verb ?

Payout would be the annual annuity payments in relation to the premium paid, or 12% in your 3,600/30,000 example.

For most investments, the rate of return (aka return or or yield) would be the discount rate that applied to the cash inflows (annuity payments in this case) is equal to the cash outflows (the premium paid in this case). Since for a life contingent annuity one doesn't know how many annuity payments will be received, it is difficult to calculate a "return" until the annuitant dies or you make an assumptions as to when the annuitant will die.

Another way to think of it is that 12% is not the "return" because a bit of every annuity payment you receive is a return of the $36,000 you paid to begin with.

 

[obgyn65]

Actually, deferred annuities bought in your mid 40s may not be a good deal if you are certain to live say up to 85 when rates for SPIAs payout about 12- 15% I guess.

Is that a good deal?
-ERD50

 

[Midpack]

But I don't share Midpack's enthusiasm for buying one.

You're simply mistaken. If I ever buy an annuity, it's not likely before age 75 or thereabouts.

And I also didn't know the OP's age.

What research I have done on annuities (for plan B) has been confined to SPIAs. It was actually an honest question, as I could not find an online calculator for deferred annuities that would work on my iPad (all Flash based). But I'll have to do some homework when I get near my PC again...always learning.

 

[ERD50]

Let's assume you buy an annuity today for 30k that will "yield", or "generate", or "pay out" 3,600 per year in 15 years, what is the correct English verb ?

I probably wasn't clear, but I was defending your use of the word 'generate'. I think it is accurate in this case.

Other terms are a bit confusing/complicated, since an annuity includes return of principal. If someone purchased an annuity that 'generated' 10%, but lived 10 years, they only got their principal back, they didn't 'yield' or 'earn' anything (and gave up opportunity cost and buying power). But it did 'generate' 10% for every year they lived.

To reassure you, my posts are often very short, but always truthful my written style and grammar in English might be slightly below par, but my maths are not

Oby, I've spent half my life around people with "below par" English language abilities. In comparison, your English is excellent.

On second thought, better than many native English speakers I know.

Agreed, there is nothing in his writing style that makes me think he didn't grow up with English as a first language. As you say, probably better than most of us native speakers, including me, (I?, myself?), - arggghhhh, I hate grammar!

-ERD50

 

[Accidental Retiree]

Oby, I've spent half my life around people with "below par" English language abilities. In comparison, your English is excellent.

On second thought, better than many native English speakers I know.

+1 Indeed.

And learning financial language alone is like learning another language.

 

[Huston55]

Um, no. I once tucked away some Twinkies in the back of my desk drawer for a hunger-emergency.

After about a year, Twinkies turn green and fuzzy.

GREEN and fuzzy...YELLOW and fuzzy, is there a real difference?

 

[Stanley]

On second thought, better than many native English speakers I know.

Hey Dude! Watcha doink talking smack about my english. I speak it good! Their lieing if they say its not good. Them dont got nuthin on me. And I can spell good two!!

 

[FinancialDave]

So indirectly it is effectively inconsequential. The insurers would buy bonds with an aggregate duration approximately equal to the duration of the SPIA obligations. While insurers hold stocks that support their surplus and perhaps some longer term products (like whole life for instance) it would be almost unheard of for stocks to be included in the pool of assets supporting SPIA liabilities.

While I'm not a fan of SPIAs at all, I don't think it is a fair statement to suggest they have market risk.

Pb4, It sounds to me like what you are saying (and I agree) is that the insurance companies take the premiums and invest them in bonds to support the SPIA payouts. If this is true, what does this tell you about the real return of the SPIA's (on an aggregate level) after you take the meager bond returns and subtract out all the expenses of the insurance companies and the agents that sell these products. Does this not say you could do a heck of a lot better on your own. What you are paying for is the risk transfer that the insurance company offers -- the problem is the possibility of failure is very small so you are getting essentially nothing for your money.

In fact what is so funny about Wade's Retirement Income Frontier (Fig. 2 on his website showing SPIA / Stock frontiers,) is that if it were actually true, what it is telling you is that overall SPIA's are a money losing "frontier" as there is no combination of stocks or bonds that provides a better return.

 

[samclem]

Does this not say you could do a heck of a lot better on your own. What you are paying for is the risk transfer that the insurance company offers -- the problem is the possibility of failure is very small so you are getting essentially nothing for your money.

What the informed consumer is paying for is the transfer of longevity risk, not market risk. Nobody should buy an SPIA thinking they'll get a higher expected return than what they could get on their own from investing in the same assets in which the insurance companies invest.
If you are one of the fortunate ones to outlive the averages, the SPIA may pay out more than you would have received by investing the funds yourself, this made possible by the transfer of assets paid in by those who died ahead of schedule. SPIAs are an insurance product, not an investment product.

 

[retire2020]

But same article talks about the following analysis...minimum withdrawal rate 4.5%..what do you all think?

>>>>>>>>>>>>>>>>>>>>>>>>>>>>
His rules: If the P/E 10 is above 20, in which case he considers the market overvalued, you would withdraw 4.5% in the first year of retirement, adjusting that initial amount for inflation every year thereafter. If the benchmark falls between 12 and 20, where he considers the market fairly valued, the initial withdrawal would be 5%. If it's below 12, or undervalued, you can pull out 5.5% the first year. (If you aren't comfortable taking out that much, you might use lower percentages but incorporate the same approach.)
You can track the P/E 10, based on research by Robert Shiller, a professor at Yale University, at multpl.com/shiller-pe. The current number is 23.4, meaning a first-year withdrawal of $45,000 if you're starting retirement now with a $1 million nest egg.

 

[Texas Proud]

What the informed consumer is paying for is the transfer of longevity risk, not market risk. Nobody should buy an SPIA thinking they'll get a higher expected return than what they could get on their own from investing in the same assets in which the insurance companies invest.
If you are one of the fortunate ones to outlive the averages, the SPIA may pay out more than you would have received by investing the funds yourself, this made possible by the transfer of assets paid in by those who died ahead of schedule. SPIAs are an insurance product, not an investment product.

Also to add... with an SPIA, you are using up your principal which most investors are not willing to do if they invest themselves....

This gives a higher monthly payment to the holder without worrying about running out of money....

 

[teejayevans]

IMHO, the value of the 4% rule ...

IMOH: Its a guideline, not a rule.
TJ

 

[FinancialDave]

What the informed consumer is paying for is the transfer of longevity risk, not market risk. Nobody should buy an SPIA thinking they'll get a higher expected return than what they could get on their own from investing in the same assets in which the insurance companies invest.
If you are one of the fortunate ones to outlive the averages, the SPIA may pay out more than you would have received by investing the funds yourself, this made possible by the transfer of assets paid in by those who died ahead of schedule. SPIAs are an insurance product, not an investment product.

Certainly, insurance products are risk transfer items, but when you buy them you do so at the "loss" of market risk or gain as the case may be, so you can't neglect one for the other.

If you are the super conservative that needs insurance -- by all means buy it (in the form of a fixed annuity) -- but don't try to claim it is a GOOD investment, on pure investment terms -- except of course to the insurance companies that sell it. It is a risk transfer item, much like any other insurance product. Most know the simple fact that when you transfer the risk away from yourself, your chance of gains is much less. This is one of the most basic laws of investing.

fd

 

[FinancialDave]

IMOH: Its a guideline, not a rule.
TJ

Yes, the 4% rule is a guideline and should be treated as such.

 

[obgyn65]

Thank you for your kind compliments about my written English. They give me confidence to continue participating in these forums.

 

[FIRE'd@51]

Let's assume you buy an annuity today for 30k that will "yield", or "generate", or "pay out" 3,600 per year in 15 years, what is the correct English verb ?

According to this Actuarial Table, the life expectancy of a 47 year-old male is 31.5 years.

Using the IRR funtion in excel with an outflow of $30,000 in year 1 and inflows of 0 until year 16 followed by inflows of $3,600 in years 16-31, gives an IRR of 2.98%.

This would be the break-even point for an insurance company writing these deferred annuities for a large pool of 47 year-old men. The insurance company could hedge this liability and make a nice profit by buying 30-year Treasuries, which currently yield about 3.2%.

If one lived to be 100, the IRR would be about 5%.

These returns are in nominal $ (i.e. before inflation).

 

[mathjak107]

those life expectancys are only the 50% point so there is just as much a chance you will go on as die.

in fact the 50% point moves to 82 for a man at 65 and 85 for a woman.

the 50% point for a 65 year old couple is 87.

 

[FinancialDave]

According to this Actuarial Table, the life expectancy of a 47 year-old male is 31.5 years.

Using the IRR funtion in excel with an outflow of $30,000 in year 1 and inflows of 0 until year 16 followed by inflows of $3,600 in years 16-31, gives an IRR of 2.98%.

This would be the break-even point for an insurance company writing these deferred annuities for a large pool of 47 year-old men. The insurance company could hedge this liability and make a nice profit by buying 30-year Treasuries, which currently yield about 3.2%.

If one lived to be 100, the IRR would be about 5%.

These returns are in nominal $ (i.e. before inflation).

Fire'd,
Unfortunately, it seems you should have run the excel spreadsheet on the insurance companies 30 year Treasury, because they have to cash it in in year 20 and try to cash flow the rest of the OP's $3600 per year payment. Unfortunately, they run out of money in year 30 about $4000 short of their goal for the 31.5 yr life span. And that is before they paid any commissions or salaries to anyone.

So I am thinking the 12% payout after only 15 years is a little optimistic and probably is not guaranteed, at least if you were to buy it today.

fd