Vanguard SPIA's....IRR=?

[RockOn]

When I calculate the IRR of a quote for a Vanguard Lifetime Income annuity based on retiring at about 53 and living to 86, the IRR is about 6%?

I would have thought it was only 4%.

It also shows a CPI-U adjusted withdrawal rate of a little over 5% based on a single life. That's better than the SWR of 4% always talked about. I realize the risks are different and the upside is gone, but that return is actually not that bad. I suppose that's been discussed many times. What has been concluded?

And that's at todays lower interest rates.

For someone conservative and not concerned with losing the upside, are SPIA's actually reasonably competitive with the 60/40....4% SWR, or am I missing something?

[cute fuzzy bunny]

I think you have to throw in the loss of principal at the end in your SPIA IRR calcs...that gums up the works a bit. I think you'll find that you're getting something closer to 2.5-3.5% depending on the age and health once you throw that part in.

I could have a 7%-8% "SWR" if I was calculating a zero portfolio at age 86.

[RockOn]

Quote:

Originally Posted by cute fuzzy bunny I think you have to throw in the loss of principal at the end in your SPIA IRR calcs...that gums up the works a bit. I think you'll find that you're getting something closer to 2.5-3.5% depending on the age and health once you throw that part in. I could have a 7%-8% "SWR" if I was calculating a zero portfolio at age 86.

I did use a zero for principal at the end, it still came up with 6%. I am surprised at that.

As far as your SWR, I'm pretty sure they use zero at the end (maybe a little after 86) for the norml 4% SWR calculation also.

Maybe annuities are not that bad.

[Rich_in_Tampa]

Yeah, I'd bet you're counting the whole distribution payment which, in fact, includes a component of principle in addition to returns.

[RockOn]

Quote:

Originally Posted by Rich_in_Tampa Yeah, I'd bet you're counting the whole distribution payment which, in fact, includes a component of principle in addition to returns.

That is correct that I am including principle return. But looking at it in investment terms, it calculates to a 6% IRR unless I'm messing it up somehow.

[cute fuzzy bunny]

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Originally Posted by RockOn unless I'm messing it up somehow.

You are.

[RockOn]

Quote:

Originally Posted by cute fuzzy bunny You are.

Help me then. I didn't save it but I remember assuming that I started by buying a $1,000,000 annuity which had a yearly income of $52k CPI-U adjusted (I think I used 2.8%) for 33 years with nothing left. The IRR was 6% on handy HP calculator.

I should redo it so I have the exact numbers before someone jumps me on being precise, but I did get a 6% IRR.

Sorry....hold that thought, the $52k isn't right let me get my number correct, I'll be back.

[Rich_in_Tampa]

Quote:

Originally Posted by RockOn Help me then. I didn't save it but I remember assuming that I started by buying a $1,000,000 annuity which had a yearly income of $52k CPI-U adjusted (I think I used 2.8%) for 33 years with nothing left. The IRR was 6% on handy HP calculator. I should redo it so I have the exact numbers before someone jumps me on being precise, but I did get a 6% IRR.

Using your numbers and the spreadsheet formula cited above, I get an IRR of 3.7%.

Sorry, but I don't think you've hit the mother lode.

[Rich_in_Tampa]

Quote:

Originally Posted by RockOn That is correct that I am including principle return. But looking at it in investment terms, it calculates to a 6% IRR unless I'm messing it up somehow.

Try this formula in your own spreadsheet to double check (gives annual payment amount if paid at the beginning of each year:

=PMT(ReturnRate, numberOfPeriods, InitialInvestment, 0, 1)

Your presumed IRR in an annuity for a youngish person would amaze me. For example, $100,000 at 3.7% for 33 years gives payments of $5108 at the beginning of each year. That's an interest of 3.7%, not $5108.

Hope that helps.

[2B]

As you make another positive SPIA comment I must start questioning whether you are trolling. However, back to your question.....

Your comment about "beating" the SWR rate of 4% neglects to mention that when using the 4% SWR you end up with a substantial portfolio left at the end for either you increasing your spending somewhere along the line or leaving money for LTC or your heirs. With the SPIA, the money coming in is fixed in all cases and when you die the final balance is zero. The payout assumes capital is depleted. No residual is available to fund LTC in the couple years prior to death.

The IRR calculation is based on when you expecti to die. You picked 86 which is reasonably conservative for most people. I don't know what the mortaility table would say for a 53 year old but that seems reasonable if you are in excellent health and longevity genes run in your family. I haven't bothered to check your calculations but I suspect the return is high. Again, any annuity drives the payout to return capital over the life of the annuity. The SWR of 4% will possibly go below zero or quadruple.

All of your comments compare a "certainty" to a long term historical return with some cases lower and some cases significantly higher. Tou are comparing apples to oranges.

[RockOn]

Quote:

Originally Posted by 2B As you make another positive SPIA comment I must start questioning whether you are trolling. However, back to your question..... Your comment about "beating" the SWR rate of 4% neglects to mention that when using the 4% SWR you end up with a substantial portfolio left at the end for either you increasing your spending somewhere along the line or leaving money for LTC or your heirs. With the SPIA, the money coming in is fixed in all cases and when you die the final balance is zero. The payout assumes capital is depleted. No residual is available to fund LTC in the couple years prior to death. The IRR calculation is based on when you expecti to die. You picked 86 which is reasonably conservative for most people. I don't know what the mortaility table would say for a 53 year old but that seems reasonable if you are in excellent health and longevity genes run in your family. I haven't bothered to check your calculations but I suspect the return is high. Again, any annuity drives the payout to return capital over the life of the annuity. The SWR of 4% will possibly go below zero or quadruple. All of your comments compare a "certainty" to a long term historical return with some cases lower and some cases significantly higher. Tou are comparing apples to oranges.

Not trolling, quite serious. I was surprised the IRR on the annuity is that high.

I'm not really trying to start the 4% SWR arguement. But the annuity does seem better than I would have thought. With the 4% SWR things could blow up, the annuity has it's own risks.

[Texas Proud]

Quote:

Originally Posted by RockOn Not trolling, quite serious. I was surprised the IRR on the annuity is that high. I'm not really trying to start the 4% SWR arguement. But the annuity does seem better than I would have thought. With the 4% SWR things could blow up, the annuity has it's own risks.

I am not doubting your calculations... but it is comparing apples to oranges...

If you do a monte carlo on the exact same investment and even did a SWR of 6%... there will be a good number of portfolios that your final balance will be many times more than you started... so your IRR is much higher than 6%...

But, with the worst case to cover the 4% SWR is conservative...

SOOO, you can take your 6% and have nothing OR take the 4% and unless something bad happens you will have much more than you started with to leave to whomever you wish...

This is the big problem with talking to people about annuities and the other thread where they were using life insurance and cash value etc.... these REQUIRE you to have ZERO when you die... I much prefer to have something to leave...

[RockOn]

Quote:

Originally Posted by Texas Proud I am not doubting your calculations... but it is comparing apples to oranges... If you do a monte carlo on the exact same investment and even did a SWR of 6%... there will be a good number of portfolios that your final balance will be many times more than you started... so your IRR is much higher than 6%... But, with the worst case to cover the 4% SWR is conservative... SOOO, you can take your 6% and have nothing OR take the 4% and unless something bad happens you will have much more than you started with to leave to whomever you wish... This is the big problem with talking to people about annuities and the other thread where they were using life insurance and cash value etc.... these REQUIRE you to have ZERO when you die... I much prefer to have something to leave...

I am not going to say that the SPIA is better. I am only saying that for someone conservative, it's not a terrible option. I know it is apples and oranges, but they both are ways for one to invest.

Guys like Bogle say stocks might only return 8%, bonds might only return 4%, for the next period. At a 60/40 split that's not much more than the 6% a SPIA offers, even at today's low rates. (Again, unless I am wrong in the 6% calc.) The insurance Company could blow up, that is a risk. My feeling is the the SPIA is pretty secure, the 60/40...4% SWR is not as secure in my opinion. The SWR does have upside the SPIA does not.

Note that I'm not running out to buy a SPIA tomorrow, but it is interesting. I might someday. (If I did, it would be primarily to lock in the long term rate. I would take some of the income and fund my kids inheritance out of that. Maybe by matching their 401ks, Roths, or ideas like that.) A SPIA would also simplify my spouses management of money at a late age (last to die annuity) which scares me (the annuity salesmen might find the spouse anyway)(and for my kids sake) if I go first. Trusts are pretty expensive options, I might avoid those costs with a SPIA.

[2B]

Quote:

Originally Posted by Texas Proud SOOO, you can take your 6% and have nothing OR take the 4% and unless something bad happens you will have much more than you started with to leave to whomever you wish... This is the big problem with talking to people about annuities and the other thread where they were using life insurance and cash value etc.... these REQUIRE you to have ZERO when you die... I much prefer to have something to leave...

I'm more worried about have a reserve fund for LTC or other emergencies during my remaining life. A SPIA pays a fixed amount and no more. There are "inflation indexed" annuities but they have significant limitations on payment growth. I'd hate to put a couple of hundred thousand into a SPIA and then find myself in a Medicaid nursing home because the SPIA amount wasn't enough for a "decent" (and I use the term lightly) place. The government would take my payment and I'd be in the same place as if I was totally broke.

If I'm lucky and die quickly/cleanly, I prefer my kids to get my money instead of an insurance company.

[ats5g]

If i were comparing an inflation adjusted SPIA to a 4% SWR, I'd just look at the payout %, which apparently is 5% in your example, single life only. This is because the SWR is supposed to last until you die, and the SPIA definitely lasts until you die. Though I think the 4% rule-thingee was supposed to be over 30 years [right?] [86-53 = 33 years].

The extra "umph" in the SPIA comes from the people who die early subsidizing the people who die late. If you don't care about leaving any money to heirs, are risk averse, and don't have a spouse/partner [hence single life only], then it might not be a bad idea.

As you get older the extra "umph" from the SPIA will get larger each year. That's why Milevsky has shown [in a number of papers] that it's usually better to wait until your later 60's to annuitize. However, this is assuming your alternative is a portfolio of something like 60%stocks/40%bonds, and there is a realized equity risk premium. If you're just going to be investing in long term bonds/TIPS, are pretty risk averse, and don't care [or don't have the knowledge] to manage your own portfolio, one could make an argument for purchasing an SPIA in your 50's. Of course, the trade-off is that when you "pass on", nothing is left to your heirs.

One strategy that Milevsky has put forth [IIRC], is to instead of buying a large SPIA at once, purchase say 1/5 of the amount each year for 5 years. This spreads out the likelihood of buying annuity when interest rates are the worst, and your payout is the lowest. Kind of like laddering CDs.

- Alec

[2B]

mathjak, I think you missed my point. You might be able to get a "better" IRR now over high quality corporates (think 20 year bonds) at the same credit quality the insurance company is. The interest rates will fluxuate and right now we are near the lowest levels of most of our lifetimes. Now is not the time to sink it all into an annuity.

ats5g, inflation adjusted SPIA's have significant limitations to how much their payment will increase due to inflation. The 4% SWR has no such restrictions. I agree with your comment about waiting until at least age 60 but I'd put it even later when you have clearly demonstrated the longevity genes. The payout is even higher then. Buying one at age 53 seems absurd because of the many longevity risks that haven't even been tested.

The common attribute I've seen in anyone that "likes" annuities is their belief that all the other people will die first so they can get a great interest rate. I don't have much of a chance of having the longevity genes based on my family history. I'm also very aware of many reasons why someone that seems heathy at age 68 can be attending their own funeral 6 weeks later.

[73ss454]

I'll never get this annuity thing. Last year I bought 2 cd's from Pen Fed. One at 6% and one at 6 1/4% and at the end of 7 years I get my 200K back. Why would I want to get the same or less return and have nothing when I die.

[RockOn]

Quote:

Originally Posted by 73ss454 I'll never get this annuity thing. Last year I bought 2 cd's from Pen Fed. One at 6% and one at 6 1/4% and at the end of 7 years I get my 200K back. Why would I want to get the same or less return and have nothing when I die.

I'm not saying it's best for you. It's really not as simple as you are getting nothing when you die, you are getting paid more than you could get safely (long term, your CD's only lock in a few years) while you are alive. If you wanted to you could funnel it into a kids Roth or something. Just a side thought, not a plan.

[73ss454]

Quote:

Originally Posted by RockOn I'm not saying it's best for you. It's really not as simple as you are getting nothing when you die, you are getting paid more than you could get safely anywhere else while you are alive. If you wanted to you could funnel it into a kids Roth or something. Just a side thought.

Well, if your getting 6% and I'm getting 6 to 6 1/4 how do you figure I'd be getting paid more with the annuity?

I must be slow because I just can't put my brain around these annuities.

[RockOn]

Quote:

Originally Posted by 73ss454 Well, if your getting 6% and I'm getting 6 to 6 1/4 how do you figure I'd be getting paid more with the annuity? I must be slow because I just can't put my brain around these annuities.

You could lock in 6% for 33 years (as in my example), your CD might only get you 4% the next time it rolls. The point is you have interest rate risk, the annuity doesn't have that.