What is mean by the "Annuitization Hurdle"?

[HadEnuff]

a simple explanation would be great.

thanks,

 

[pb4uski]

Do you mean that Figure 9 wasn't simple enough for you?

http://www.schulmerichandassoc.com/Modern_Portfolio_Decumulation.pdf

I can't answer your question as I'm still digesting it myself.

 

[samclem]

Did you see the link at the bottom of this post? It has an explanation (near the end). The term was new to me, too. It is roughly analogous to Jim Otar's "Grey zone" and"Red Zone"--you can find more on that, too.

In an (oversimplified) nutshell, if a person is spending down their retirement savings, and if their real balance is going down, at some point it may become advantageous to buy an annuity with all that they have. If they wait longer than this and their nest egg continues to decline, they won't have enough money to buy an annuity that will provide a monthly check that meets their needs.

In my opinion the concept is a useful one, but I always remember that many folks providing information on annuities do it because they make a lot of money selling them. And the money they make comes from the pockets of those who buy them.

Opps--I cross-posted with pb4uski.

 

[HadEnuff]

Do you mean that Figure 9 wasn't simple enough for you?

http://www.schulmerichandassoc.com/Modern_Portfolio_Decumulation.pdf

I can't answer your question as I'm still digesting it myself.

I'm glad I wasn't the only one who thought that graph might be a bit confusing.

 

[FireBug]

Seems just to complicated enough that you best let them handle it for you....hmmm

 

[LARS]

I would answer it as follows:

Assume you "need" $10,000 a month. (For simplification assume no other sources of income like pension or SS).

What amount of $s are needed to secure an SPIA for that income. Let's assume that is $2.5 million (given your age, etc).

So what that says to me is if your assets are depleting, AND are approaching the $2.5 million level your are approaching the "annuitization hurdle". In other words, you should consider swapping assets for the "secure" income stream of an SPIA.

Additionally, to my mind, this serves as a quick and dirty as to whether your portfolio is holding up with regard to your needs.


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[pb4uski]

But... the SPIA would need to be an inflation adjusted benefit (like SS benefits are), and those SPIAs are very hard to come by... there are some out there, but not many.

 

[Danmar]

I would answer it as follows:

Assume you "need" $10,000 a month. (For simplification assume no other sources of income like pension or SS).

What amount of $s are needed to secure an SPIA for that income. Let's assume that is $2.5 million (given your age, etc).

So what that says to me is if your assets are depleting, AND are approaching the $2.5 million level your are approaching the "annuitization hurdle". In other words, you should consider swapping assets for the "secure" income stream of an SPIA.

Additionally, to my mind, this serves as a quick and dirty as to whether your portfolio is holding up with regard to your needs.


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Yes, agree on your explanation. In my case if I need 4% from my portfolio to support my desired spending and if an annuity pays out 6% at my age, my portfolio can fall by 1/3 (.06-.04/.06) before I need to worry or make a decision on buying an annuity. Ignoring inflation as mentioned by pb.

 

[RunningBum]

I'd be really worried about dumping my whole nest egg into an SPIA. If I need, for example, $50K a year, it's probably not going to be right around $50K every year. I might need $50K one year, $40K the next, and $60K the year after that due to uneven major expenses, repairs, and replacements. What if that $60K comes before the $40K and puts me behind? I have to go into debt?

Might be good to use as a guide. I may annuitize at some point, but not 100% unless it still leaves me with a nice nest egg.

 

[Chuckanut]

But... the SPIA would need to be an inflation adjusted benefit (like SS benefits are), and those SPIAs are very hard to come by... there are some out there, but not many.

+1

And several article I have read indicated that the inflation adjusted annuities are often so much more expensive than an ordinary SPIA that they rarely pan out unless the adjustment is uncapped and the inflation rate is very high for a long time.

For that reason, my inflation adjusted annuity is called 'taking SS at 70'. Not to start a debate on that issue again, but for me, it seems to be all the insurance I reasonably need and can afford.

 

[LARS]

Might be good to use as a guide. I may annuitize at some point, but not 100% unless it still leaves me with a nice nest egg.

To me the clear benefit of this analysis is to have a real world check on the health of my spending relative to my portfolio. Honestly, until the thread suggesting this framework came up, I had never thought of this as a way to gauge that relationship.

As to actually buying an SPIA, personally long before I approach the "hurdle" I trust I would have changed my outflows as I am not a big fan of turning over assets at least at this age (maybe in late 70’s I will feel differently).

A big thank you to whomever posted the first reference to "annuitization hurdle".


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[big-papa]

I would answer it as follows:

Assume you "need" $10,000 a month. (For simplification assume no other sources of income like pension or SS).

What amount of $s are needed to secure an SPIA for that income. Let's assume that is $2.5 million (given your age, etc).

So what that says to me is if your assets are depleting, AND are approaching the $2.5 million level your are approaching the "annuitization hurdle". In other words, you should consider swapping assets for the "secure" income stream of an SPIA.

Additionally, to my mind, this serves as a quick and dirty as to whether your portfolio is holding up with regard to your needs.


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Good explanation. Then there are the gamblers who just know it's going to turn back around.

 

[samclem]

And several article I have read indicated that the inflation adjusted annuities are often so much more expensive than an ordinary SPIA that they rarely pan out unless the adjustment is uncapped and the inflation rate is very high for a long time.

I agree, but this will be worth re-checking occasionally. With interest rates so low right now, there is a paucity of ultra-safe assets insurance companies can use to generate returns. Once the Fed gets their thumb off the scale and interest rates on govt and investment grade bonds start to go up, maybe annuities will pay more. And if they think there's a good chance their investments will stay ahead of inflation (or if they can cheaply insure against the risk that they don't), maybe inflation-protected annuities will become more available, too.

For that reason, my inflation adjusted annuity is called 'taking SS at 70'. Not to start a debate on that issue again, but for me, it seems to be all the insurance I reasonably need and can afford.

That's our plan as well.

 

[big-papa]

I'd be really worried about dumping my whole nest egg into an SPIA. If I need, for example, $50K a year, it's probably not going to be right around $50K every year. I might need $50K one year, $40K the next, and $60K the year after that due to uneven major expenses, repairs, and replacements. What if that $60K comes before the $40K and puts me behind? I have to go into debt?

Might be good to use as a guide. I may annuitize at some point, but not 100% unless it still leaves me with a nice nest egg.

I think that's why some folks suggest only annuitizing the 'fixed' portion of your spending (again, unrealistically ignoring inflation), but to keep other funds immediately available for the lumpy spending requirements like new roof, appliance replacements, medical deductable, etc....

 

[RunningBum]

I think that's why some folks suggest only annuitizing the 'fixed' portion of your spending (again, unrealistically ignoring inflation), but to keep other funds immediately available for the lumpy spending requirements like new roof, appliance replacements, medical deductable, etc....

OK, that makes sense.

 

[big-papa]

I would answer it as follows:

Assume you "need" $10,000 a month. (For simplification assume no other sources of income like pension or SS).

What amount of $s are needed to secure an SPIA for that income. Let's assume that is $2.5 million (given your age, etc).

So what that says to me is if your assets are depleting, AND are approaching the $2.5 million level your are approaching the "annuitization hurdle". In other words, you should consider swapping assets for the "secure" income stream of an SPIA.

Additionally, to my mind, this serves as a quick and dirty as to whether your portfolio is holding up with regard to your needs.


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I haven't read the entire article through yet, but it would seem to me that the annuitization hurdle would vary over time. If you're following a 4% rule type of withdrawal methodology, on year 2 you'd want to replace the $10K/month with something a little larger because of inflation. At the same time, however, you have earned a year's worth of mortality credits for the SPIA. And, of course, interest rates might have changed affecting the SPIA payout rate as well. So recalculating the annuitization hurdle each year would probably be a good idea.

 

[LARS]

What is mean by the "Annuitization Hurdle"?

I haven't read the entire article through yet, but it would seem to me that the annuitization hurdle would vary over time. If you're following a 4% rule type of withdrawal methodology, on year 2 you'd want to replace the $10K/month with something a little larger because of inflation. At the same time, however, you have earned a year's worth of mortality credits for the SPIA. And, of course, interest rates might have changed affecting the SPIA payout rate as well. So recalculating the annuitization hurdle each year would probably be a good idea.

Clearly it is a moving target overtime. Hence, from time to time (annual check up not a bad plan) it makes perfect sense to check annuity investment amounts for a given monthly cash payment to see how you're doing.


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[Midpack]

A big thank you to whomever posted the first reference to "annuitization hurdle".

You're welcome. It's not a litmus test/definitive call to act, just something it seems wise to be conscious of. I update/review investments/net worth quarterly - getting a new SPIA quote to plot against net worth adds about 20 seconds to my review. Seems like 20 seconds well spent.

I haven't read the entire article through yet, but it would seem to me that the annuitization hurdle would vary over time. So recalculating the annuitization hurdle each year would probably be a good idea.

Yes it would. It's easy to increase the payout assumption by inflation each year for the annuity quote.

 

[audreyh1]

This is a good reminder, and I'm going to start doing this annually. Thanks!

 

[donheff]

But... the SPIA would need to be an inflation adjusted benefit (like SS benefits are), and those SPIAs are very hard to come by... there are some out there, but not many.

+1

I noticed yesterday that the outfit that Vanguard uses for generating their SPIA quotes includes a few with inflation adjusted annuities. You do pay a significant premium. Using me (67) and DW (63) a representative income (AIG) for $1M with a 20 year guaranteed payout and 100% survivor was: $4605.40/mth with no inflation adjustment; $3,609.41mth with 2% annual increase; $3,289.66/mth CPI-U adjusted. So, at our age a 28% reduction in starting income for the full inflation protection. That hit should decrease with age. Also, if you found yourself panicking and turning to an SPIA late in life it could be safer to select a fixed annuity. I went with 20 years guaranteed and a joint annuity to reflect my biases. Going joint life only would add $67.47/mth to starting CPI protected income at our age.

Interestingly, that inflation adjusted annuity is right about equivalent to a starting 4%/yr SWR. For a lot of people, that annuity hurdle will start looming with any significant downturn.

Note: you need to sign on to Vanguard to use the quote generator.

 

[samclem]

Interestingly, that inflation adjusted annuity is right about equivalent to a starting 4%/yr SWR. For a lot of people, that annuity hurdle will start looming with any significant downturn.

Yes. I'll probably calculate my annuitization hurdle based on a fairly Spartan monthly spend rate. If someone is retiring with a 4% WR and they are already at that very bare-bones spending level, then there's no room for a downturn.

 

[Midpack]

+1

I noticed yesterday that the outfit that Vanguard uses for generating their SPIA quotes includes a few with inflation adjusted annuities. You do pay a significant premium. Using me (67) and DW (63) a representative income (AIG) for $1M with a 20 year guaranteed payout and 100% survivor was: $4605.40/mth with no inflation adjustment; $3,609.41mth with 2% annual increase; $3,289.66/mth CPI-U adjusted. So, at our age a 28% reduction in starting income for the full inflation protection. That hit should decrease with age. Also, if you found yourself panicking and turning to an SPIA late in life it could be safer to select a fixed annuity. I went with 20 years guaranteed and a joint annuity to reflect my biases. Going joint life only would add $67.47/mth to starting CPI protected income at our age.

Interestingly, that inflation adjusted annuity is right about equivalent to a starting 4%/yr SWR. For a lot of people, that annuity hurdle will start looming with any significant downturn.

Note: you need to sign on to Vanguard to use the quote generator.

Great post.

Doesn't surprise me. That's why I'm advocating keeping track - it literally takes me 20 seconds/quarter to get a quote (plot automatically updated) while I am already reviewing my investments/net worth quarterly. How that's like work is [-]absurd[/-] beyond me. Not sure what the downside is, even if you think you're immune (a few seem to).

 

[HadEnuff]

+1

I noticed yesterday that the outfit that Vanguard uses for generating their SPIA quotes includes a few with inflation adjusted annuities. You do pay a significant premium. Using me (67) and DW (63) a representative income (AIG) for $1M with a 20 year guaranteed payout and 100% survivor was: $4605.40/mth with no inflation adjustment; $3,609.41mth with 2% annual increase; $3,289.66/mth CPI-U adjusted. So, at our age a 28% reduction in starting income for the full inflation protection. That hit should decrease with age. Also, if you found yourself panicking and turning to an SPIA late in life it could be safer to select a fixed annuity. I went with 20 years guaranteed and a joint annuity to reflect my biases. Going joint life only would add $67.47/mth to starting CPI protected income at our age.

Interestingly, that inflation adjusted annuity is right about equivalent to a starting 4%/yr SWR. For a lot of people, that annuity hurdle will start looming with any significant downturn.

Note: you need to sign on to Vanguard to use the quote generator.

Help clarify this for me please.
Does this mean that if you paid a single premium of $1 Million, in return you and your wife would $4605.40/ month with no inflation adjustment, for 20 years? IF either one of you were to die, the survivor would continue to receive that pay-out until s/he died, but at the end of 20 years it stops, no matter what?

The lesser amounts would work the same way, except would increase with inflation adjustments?

 

[donheff]

Help clarify this for me please.
Does this mean that if you paid a single premium of $1 Million, in return you and your wife would $4605.40/ month with no inflation adjustment, for 20 years? IF either one of you were to die, the survivor would continue to receive that pay-out until s/he died, but at the end of 20 years it stops, no matter what?

The lesser amounts would work the same way, except would increase with inflation adjustments?

We would get $4605.40/mth for as long as either of us lived (potentially 30+ years). If we both died in less than 20 years, the payments would continue to our heirs for the 20 year guaranteed period.

You can choose to guarantee for longer (e.g. 30 years) or shorter (e.g. 10 years) periods or for life only and the annuity amount will be adjusted to account for that. Life only got us an additional $69/mth IIRC.