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What about a single payment annuity for my wife?
Old 11-29-2011, 06:09 PM   #1
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What about a single payment annuity for my wife?

She's 57, I'm 62. We have retirement savings that generate about $52,000 a year without touching principal. We have some income from an installment sale that generates about $95,000 annually through 2018.

We can live easily on the $95,000 and the $52,000. We've got some commercial property for sale that could get us anywhere from $500,000 to $700,000. I've been planning on investing it with the rest of our retirement funds, but today I was considering an annuity. If we buy an annuity and don't take it until 2018, it should generate about $42,000 from 2018 until the last of us dies. SS would be close to $50,000 for both of us if we delay until 2018.

What about taking the $52,000 we now get anyway, plus $50,000 in SS, plus $42,000 from an annuity and go our merry way? That's a bunch of money. The other alternative would be to take the $500-700,000 and get 4%, or $20,000 to $28,000, and leave more to our 3 kids. Right now, I'm kind of leaning toward more income for mom and dad and less inheritance for the kids.

Thoughts?
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Old 11-29-2011, 06:16 PM   #2
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What about taking the $52,000 we now get anyway, plus $50,000 in SS, plus $42,000 from an annuity and go our merry way? That's a bunch of money. The other alternative would be to take the $500-700,000 and get 4%, or $20,000 to $28,000, and leave more to our 3 kids. Right now, I'm kind of leaning toward more income for mom and dad and less inheritance for the kids.

Thoughts?
Just be very aware of inflation. Opinions vary all over the place, but my opinion is that it is impossible to put meaningful boundaries on how much inflation might come along, or when, or how long it will last if/when it does come.

Ha
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Old 11-29-2011, 07:29 PM   #3
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I've thought about annuities. I keep coming back to the notion that an annuity is basically longevity insurance. Like any insurance, the company collects more in premiums and investment income than it pays in benefits (somebody has to pay for marketing, administration, and risks). So the general rule is to buy insurance against a catastrophe, but not against an inconvenience. I don't know if living a long time is likely to be an economic catastrophe for you.

One analysis is to compare the annuity to a bond ladder. See how long the same amount of money can provide an income (both interest and principal) if you invest it in bonds with varying maturities.

Another thought is that, unlike life insurance, there's very little risk in waiting. Generally, the advantage of annuities over bonds doesn't get significant until you get to later ages. So it may be best to wait well past 58.

I have an annuity in may financial plan as a "bail out" option. If our assets fall to the point where thay are getting close to the premium on an SPIA for our "basic" expenses, then we'll have to consider buying the SPIA as insurance.
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Old 11-29-2011, 08:01 PM   #4
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I've thought about annuities. I keep coming back to the notion that an annuity is basically longevity insurance. Like any insurance, the company collects more in premiums and investment income than it pays in benefits (somebody has to pay for marketing, administration, and risks).
There are definitions for an annuity other than longevity insurance. An indexed annuity from a very strong company is about the safest way that one can run an asset liquidating strategy. It may be for reasons other than "insurance", like the OP's, who just wants more money to spend while he and/or his missus are alive. Just because they are inurance contracts doesn't imply the narrow definition of purpose that you cited.

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Old 11-29-2011, 08:20 PM   #5
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I think there are two things you need to consider.

The first is that the 4% should be based on the value of the investments in 2018 when you first start withdrawals rather than the amount in 2012. So the $500-700k today would grow to $685-$960k by 2018 assuming a 5% annual return so the initial withdrawals would be $27-38k and you should compare those amounts to the $42k.

Second, the way the 4% SWR works is that each year's withdrawals are increased by inflation. So if inflation is 3% annually, in 2028 your withdrawals would be $37-$52k but the annuity would still be $42k a year. In 2038 your withdrawals would be $50-$69k but the annuity would still be $42k a year.

On top on the above, when you pass the insurer gets any remainder with the annuity but with the investment portfolio your heirs get the remaining balance.
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Old 11-29-2011, 08:54 PM   #6
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I concur with Ha's comment on inflation; at 3%/yr your annual purchasing power will be cut by 45% in 20 years.

Having said that, you might consider options to build your own reliable income stream. For example, if you can generate 4%/yr, you can produce the same $42k/yr that the annuity will give you for 33 years, which is (sorry to say) past your wife's actuarial longevity. So, it's practically "lifetime" income. The advantage here is that you retain control of the principal but, it's not "guaranteed."

A simple way to generate >4%/yr on average would be something like VWINX, which is approximately half as volatile as the S&R 500 and which returned >6%/yr over the past 5 & 10 years.
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Old 11-29-2011, 09:59 PM   #7
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Right now, I'm kind of leaning toward more income for mom and dad and less inheritance for the kids.
Thoughts?
I think the kids would prefer it that way too, especially if the alternative is having to spend their money to care for you guys in your late late life.

I think it's a good idea to annuitize a portion of one's income. However the insurance companies selling anything other than a plain-vanilla SPIA have generally made it a crappy implementation of what would otherwise be a good idea.

As UncleMick would say, "Psssst... Wellesley."
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Old 11-30-2011, 07:12 AM   #8
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Just a thought on your topic, you say "What about a single payment annuity for my wife"? If you are thinking about insuring only her I would recommend that you reconsider and go with joint life. Just because she is younger doesn't mean she will outlast you.
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Old 11-30-2011, 02:44 PM   #9
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It would definitely be joint!

I generally think annuities are a bad idea because the insurance companies pretty much always win in the long run. I talked to an investment advisor we've used, and he's been getting us a pretty solid, mostly tax free return, of about 5% or a little more. We have a lot of municipal bonds from a lot of different issuers with a lot of different maturity dates-we don't trade them, we buy them for the income and hold them until they mature or are called.

He says we could probably get a similar return with a $500,000 or so lump sum. As PB points out, and the way I've always calculated it, we should be able to get 5% to 6% for the next 7 years or so until we need the income, so it would be around $700,000 by then. 4% of $700,000 is $28,000 and we could invade the principal if need be.

Inflation doesn't scare me too much. The bonds we have could be re-invested at the higher rates as they mature, or at least that's the plan. And our personal inflation rate won't be a big deal. The relatively small mortgage on the house will be gone in about 5 years and our last child will be out of a very good school with a very marketable degree in less than 3 years.

These decisions are hard, but I don't think there is a "wrong" way to go. Frankly, I don't see how we'll spend all that money in retirement anyway--after we take a few big trips, our life style is relatively simple and cheap. And we have tons and tons of equity in our main house that we can easily use if need be.

Why am I working today? Oh yeah, health insurance and carrying costs on the commercial property. Soon and very soon!
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Old 11-30-2011, 03:09 PM   #10
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The single premium immediate annuity I'm look at with USAA - when interest rates start recovering - is joint with a 20 year guarantee. If I pass, my spouse continues receiving the full monthly benefit. If we both die before the end of 20 years, the young 'un gets the remaining monies.
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Old 11-30-2011, 08:58 PM   #11
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The single premium immediate annuity I'm look at with USAA - when interest rates start recovering - is joint with a 20 year guarantee. If I pass, my spouse continues receiving the full monthly benefit. If we both die before the end of 20 years, the young 'un gets the remaining monies.
Do you find USAA's rates competitive? I've been very pleased with them as an insurer and I trust them.
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Old 11-30-2011, 09:44 PM   #12
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The only problem with SPIAs right now is that the IRR is so low on most of them due to the interest rate environment. In 3 years or so, the payments you would get right now would be much lower.

That being said, I plan on annuitizing part of my retirement income to act as a "must have" dollar amount. Heck, in many ways that's what a non-COLA pension is anyway. If my bills are $2,000 a month and I have $2000 a month coming in guaranteed, am I really worried about anything but inflation? I can always adjust my other investments to deal with inflation..........
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Old 12-01-2011, 09:05 AM   #13
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That being said, I plan on annuitizing part of my retirement income to act as a "must have" dollar amount. Heck, in many ways that's what a non-COLA pension is anyway. If my bills are $2,000 a month and I have $2000 a month coming in guaranteed, am I really worried about anything but inflation? I can always adjust my other investments to deal with inflation..........
That's the way I'm looking at it. My basic expenses are low, so SS will take care of a big chuck of it. I will only need to buy a small spia for the balance. The rest of my investments can be used on wild women an med's.
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Old 12-01-2011, 08:50 PM   #14
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Do you find USAA's rates competitive? I've been very pleased with them as an insurer and I trust them.
Yes, they are competitive in almost every line of business. The rates for the SPIAs are low right now industry wide; however, some companies with less-than-stellar ratings and reputations may be offering a "better deal". I want my money with a company that has a great reputation, has been and will continue to be around a long time, and is in good standing with the regulators, rating agencies, and their membership.

We moved our 401ks to USAA over a year ago. They're sitting in Flexible Retirement Annuities (FRAN) until the Single Premium Immediate Annuity (SPIA) rates improve. At the time we set up the FRAN we got a 2% bonus and with 4% annual earnings. And that was down from about six months earlier. Right now the FRAN is a 1% bonus and a 1.95% annual interest rate (for funds between $100k and $499k). I'm hoping the rates will start going up in 3Q12.

I personally think the stimulus packages haven't spurred the economy (people incurring more debt because it's cheap). I think it has stopped those of us with reasonably large savings and investments from spending. If the interest rates go up next year to a level I'm comfortable with, I'll move my large FRAN into a SPIA and happily spend every nickle I get every month. Right now, I'm just sitting on the money.
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Old 12-01-2011, 11:08 PM   #15
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Inflation doesn't scare me too much. The bonds we have could be re-invested at the higher rates as they mature, or at least that's the plan.
Re-investing at higher rates doesn't compensate for inflation. You need to invest a greater amount of principal.

For example, you hold a 10 year bond paying 5%. You spend all the interest but don't touch the principal. We have inflation averaging 7% over that decade but at the time the bond matures it has subsided and interest rates are back down. Prices don't back down as deflation is extremely rare. So you now have sharply higher prices and the same income.

Put another way, inflation tends to be cumulative. Interest rates aren't. History says prices will be higher in the future. Interest rates may or may not be. To be sure of off-setting inflation, you need to increase the amount of principal you're investing.
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Old 12-02-2011, 09:07 AM   #16
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Re-investing at higher rates doesn't compensate for inflation. You need to invest a greater amount of principal.

For example, you hold a 10 year bond paying 5%. You spend all the interest but don't touch the principal. We have inflation averaging 7% over that decade but at the time the bond matures it has subsided and interest rates are back down. Prices don't back down as deflation is extremely rare. So you now have sharply higher prices and the same income.

Put another way, inflation tends to be cumulative. Interest rates aren't. History says prices will be higher in the future. Interest rates may or may not be. To be sure of off-setting inflation, you need to increase the amount of principal you're investing.
I'm not sure using an isolated case like this is representative. If we want to evaluate the effectiveness of a bond investment strategy, it seems to me what's more realistic is to a see what return a bond ladder might produce, then evaluate it against inflation; of course, this would be over a period of time, not just one slice in time.

The average return on a 10 yr bond ladder 1965-2010 is 7.2% (6.8% for 5 yr ladder), which seems adequate to me if the OP decides to take that strategy. Is there some volatility - yes there is. But, I'm not sure that's the most relevant question, as there's some level of volatility in every strategy.

I think an interesting question for the OP's situation is whether a bond ladder strategy is better than an annuity. To me, that is a trade off of accepting a little volatility in order to keep the principal versus giving up the principal to eliminate the volatility. Given the OP's other income streams, I'd choose the bond ladder (or a similar investment that retains principal).
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Old 12-02-2011, 12:58 PM   #17
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The OP likes the concept of the bond ladder and has tried to accomplish that with taxable and tax deferred accounts. We have well over 100 different bonds, in varying face amounts from $5000 to $30000, with a smattering of 0 coupons maturing from 2017 to 2024. I got a little snookered on the 0 coupons that mature way out in the future and put a stop to that! I don't even count those as part of the income stream, but at some point, there is another $175,000 that will begin maturing in 5 years.

My assumption has been that if I am focused on the income and not trading the bonds, it should work out. For instance, if I have a 5%, $10,000 bond generating $500 a year. Lets say it matures in 5 years. Lets say we have inflation during those 5 years so that a market interest rate goes up with inflation to 7%. If I take the $10,000 from the matured bond and buy another bond that is now generating 7%, or $700 a year, haven't I protected against inflation? It shouldn't be a major problem unless inflation out paces rising interest rates, should it?

While I think our personal rate of inflation will be fairly low, I hope that with a large bucket of muni bonds maturing at different times, and at different rates, plus some equities, it should protect against inflation. Am I missing something major? We're not buying bonds to trade, we're buying them to create a stream of income.
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Old 12-02-2011, 01:23 PM   #18
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Along the same lines, does the 4% SWR or the actual present value of the portfolio matter so long as it is generating enough income? Again, for example, lets assume we end up at some point with $2,000,000 invested mostly in bonds, with most of them being tax free. Lets assume the rates vary enough so that we are collecting $110,000 in income from that bucket. Lets assume rates go up so that the value of the bonds go down to $1,800,000. Do I care? I'll still be getting my $110,000 (or more as bonds mature and are reinvested). If I keep the bonds until they mature, they're going to mature at $2,000,000 over the long run and in the shorter run, as each $5,000 or $10,000 or $25,000 or whatever matures, it gets put into something getting a higher interest rate. Obviously, the increase in income would trail inflation, maybe by years, but the value of the portfolio on a month to month basis would be irrelevant, wouldn't it?
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Old 12-02-2011, 01:50 PM   #19
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The OP likes the concept of the bond ladder and has tried to accomplish that with taxable and tax deferred accounts. We have well over 100 different bonds, in varying face amounts from $5000 to $30000, with a smattering of 0 coupons maturing from 2017 to 2024. I got a little snookered on the 0 coupons that mature way out in the future and put a stop to that! I don't even count those as part of the income stream, but at some point, there is another $175,000 that will begin maturing in 5 years.

My assumption has been that if I am focused on the income and not trading the bonds, it should work out. For instance, if I have a 5%, $10,000 bond generating $500 a year. Lets say it matures in 5 years. Lets say we have inflation during those 5 years so that a market interest rate goes up with inflation to 7%. If I take the $10,000 from the matured bond and buy another bond that is now generating 7%, or $700 a year, haven't I protected against inflation? It shouldn't be a major problem unless inflation out paces rising interest rates, should it?

While I think our personal rate of inflation will be fairly low, I hope that with a large bucket of muni bonds maturing at different times, and at different rates, plus some equities, it should protect against inflation. Am I missing something major? We're not buying bonds to trade, we're buying them to create a stream of income.

That will only work a few cycles at most, and only so long as interest rates are rising. If inflation is rising an average of 3% a year, you will need your bond in 20 years to have an interest rate of 5%*1.03^20 = 9%. That's really not too bad, but no way can you count on rates to climb like that. The main problem is that rates may follow inflation each year, but not cumulatively across many years.
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Old 12-02-2011, 01:54 PM   #20
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That will only work a few cycles at most, and only so long as interest rates are rising. If inflation is rising an average of 3% a year, you will need your bond in 20 years to have an interest rate of 5%*1.03^20 = 9%. That's really not too bad, but no way can you count on rates to climb like that. The main problem is that rates may follow inflation each year, but not cumulatively across many years.
For a good example, think of all the folks who locked in 5% plus CDs in 2006 or so. Now they can lock in 5 years at 2-2.5% or so. SO, their income is cut in half while their food costs are up 25-30% and gas is up 50%.

So, despite the govt saying there is no real inflation out there, that's a lie............... In other words, there's only inflation if the "govt says so based on numbers that can't be independently verified".......
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