Why Don't Retirees Buy Annuities? They Get Something Most Economists Don't

[Independent]

I believe the paper has shown up on another thread. This article provides a nice summary:

Quote:

Another way to look at it is this: less affluent retirees already have most of their retirement “wealth” in an annuity–Social Security–and need to keep their other retirement savings liquid to pay for extraordinary healthcare costs and other emergencies.

This makes sense as a general statement.

[mickeyd]

Nice get Independent.

SS, especially SS@70, is a beautiful base for the wealthy as well as the not-so-wealthy. So is a COLAd pension or two. With guaranteed income streams flowing each month it is quite easy to avoid spending financial assets that have been thoughtfully stashed away for later use.

These are the kind of problems that we all wish for.

[Midpack]

Quote:

Originally Posted by Mike Piper It's a fully automated online system, so I don't think you're wasting anybody's time, per se.

Well I didn't realize that, thanks! I didn't want to be contacted by an advisor along with the quote, but I just assumed...

[pb4uski]

Quote:

Originally Posted by Grammymissy No worries, did not realize that only certain questions can be asked, I won't bother you again.

GM, its not that certain questions can't be asked. It is just that there is oodles of materials on that subject in various threads and VAs are controversial and are likely to derail this thread. If after looking at other threads that discuss VAs you still have questions, please feel free to start a new thread.

[Running_Man]

As I was on my way in to work this morning, my mind starting working on the question - "What is the impact to my retiree @ 65 with 300K of assets if he were to take Ha's advice and wait until age 70 to claim social security instead of utilizing 16.67% of his portfolio in an annuity?"

So to set the stage I needed to have SS figures so I am using mine:

His income @ 65 as I detailed before would have been $11,583 from the portfolio and $24,990 from Social Security for a total income of $36,573. This would mean our retiree is dependent on Social Security for 68.3% of his net income, for a potential frugal but liveable retirement. Recall the investments would have been:

50K annuity
50K 30 Year Treasuries
100K Short Term Bonds
100K Stock Market

Now our retiree sees by deferring to age 70 the Social Security will become $35,814 @ age 70, an increase of $10,824 per year and decides to purchase that annuity instead of the fixed annuity. The retiree would like to know how to establish a portfolio that will provide an increased income for life utilizing this. My suggestion is:

Will need $35,814 per year for 5 years to represent the Social Security you will claim, this results in a need for $179,365 which I am going to round to 180K for portfolio purposes and allow our retiree a dipped ice cream cone from Mc Donalds 3 times a week for the next five years.

I would then use the following from the previous portfolio to pay for the Social Security deferreal :

Short Term Cash: 100K
Annuity 50K
Long term bonds 15K
Stock Market 15K

This leaves the retiree with a portfolio of 35K short term bonds and 85K stock market, but as the remainder of his money is invested in the security of short term payouts for the next 5 years followed by social security I think this is the best hope of an improving retirement. The income generated by these will be:

Bonds: $1,680
Stocks $2,337
--------------------
Total $4,017 Together with the Social security of $35,814 total retirement income will be $39,831 an increase of $3,258 or a 9 percent increase in this case. This is a significant increase to this retiree, and virtually all of this I think will be tax free if this is the total income of our retiree. So I totally understand the benefit social security deferral affords. And if there is a spouse or if there is more money in the portfolio, this only makes more and more sense. The downsides are:

1) If the retiree dies before age 95 his legacy portfolio will be smaller.
2) Percentage of income relying on social security has now increased to 90%, however this is where those percentages of reliance on social security are deceiving. But there is surely a risk here, as the previous portfolio of about 12K per year is a very meager life but still possible to eek out on if SS were drastically curtailed.
3) Rebalancing of the stock/bond portfolio is going to be problematic but still possible, this could change results in a deflationary enviroment where Social Security would be effected as well. This is a small risk.

But overall I think this is a good demonstration of the results Ha is talking about when he says deferring social security is a no-brainer. In general I believe the more money you have the more it makes sense to defer but perhaps the risks are worth taking for an intermediate wealth retiree as well.

[rayvt]

Really? As I see it, the more money you have the less sense it is to defer.
The absolute max for a 70 yo (2013) is $3350/mo. For a 66 yo, $2533.

If yo have $1M and take 4% SWR, that's $3333/mo, so the total would be $5866 if you don't defer or $6683 if you defer. But in order to get that $6683 you'd have to take 4 years of only $3333. Where's the sense in that?

[teejayevans]

Quote:

Originally Posted by rayvt Really? As I see it, the more money you have the less sense it is to defer. The absolute max for a 70 yo (2013) is $3350/mo. For a 66 yo, $2533. If yo have $1M and take 4% SWR, that's $3333/mo, so the total would be $5866 if you don't defer or $6683 if you defer. But in order to get that $6683 you'd have to take 4 years of only $3333. Where's the sense in that?

Depends...how long you going to live??
Also, delaying SS allows you to spend down your pretax accounts, lowering your RMDs, by selectively moving money from pretax to tax accounts you can minimize tax bite.
TJ

[pb4uski]

+ assuming that DW outlives me which is statistically likely then she will have more financial security having a higher cola-adjusted "pension" in higher SS. It seem to me that delaying SS is just a call option to buy a cola-adjusted joint life annuity at a very favorable cost. Crazy not to do it in my situation where DW was a SAHM and my SS earnings were much higher than hers.

[rayvt]

Obviously it all depends on how one emotionally views it. The SSA itself says that whether you take at 62 or 66 or 70, it's actuarially identical. Therefore there is no *financial* reason to prefer one age to another.

I think that people tend to get hung up over the percentage differences and ignore the absolute dollar difference. If the bulk of your income comes from SS, then you need the extra money --- but you can't get it because you can't defer because you need the money to live on.

If you have $1M-$2M or more, then the additional money you get from SS is pretty small. In the above example, by deferring from 66 to 70 you'll get an additional $817/mo from SS. Sure, that's 33% more -- but 33% more from the SS portion of your income. But it's only 14% increase in your total income -- and to get it you have to take $2533 LESS income for 4 years.

I think focussing on the RMD tax aspect is an error, it's letting the tail wag the dog. Not to mention that -- with all the news of the financial issues that the goverment is having -- that spending your own money first and hoping to grab a larger SS payout in the future seems a high risk plan.

[Independent]

Quote:

Originally Posted by rayvt Really? As I see it, the more money you have the less sense it is to defer. The absolute max for a 70 yo (2013) is $3350/mo. For a 66 yo, $2533. If yo have $1M and take 4% SWR, that's $3333/mo, so the total would be $5866 if you don't defer or $6683 if you defer. But in order to get that $6683 you'd have to take 4 years of only $3333. Where's the sense in that?

I think you missed part of running_man's plan. Did you notice the $180,000?

I'll convert your numbers to annual and do a little rounding because it's easier for me to see what's happening.

You say the choice is:

A. Take SS today.
Starting now, $30,400 from SS + $40,000 from 4% SWR = $70,400 total, indefinitely.

B. Defer SS for four years. Your plan is has two income levels.
First four years, $0 from SS + $40,000 from 4% SWR = $40,000
After that, $40,200 from SS + $40,000 from 4% SWR = $80,200

Given the choice between A and B, you'd take A. I suppose most of us would.

But, rm has a different plan. Again using your numbers:

A. Take SS today.
Starting now, $30,400 from SS + $40,000 from 4% SWR = $70,400 total, indefinitely.

C. Defer SS for four years
Move $160,000 from my $1 million portfolio into short assets (CD's, short TIPS), leaving $840,000 invested in stocks etc.
First four years, $0 from SS + $40,000 from ST + $33,600 from 4% SWR = $73,600 total.
After that, $40,200 from SS + $0 from ST + $33,600 from 4% SWR = $73,800 total

Notice that Plan C allows me to spend more money in the first four years, and spend more money in the remaining years then Plan A. I prefer Plan C over both Plan A and Plan B. (Note that if I'm a more conservative 3% SWR person, the advantage of C is even larger.)

In fact, that's what we did. When I retired, we had a laddered portfolio of CDs and I-Bonds that was designed to fill the gap between retirement date and SS start date. We've mostly spent that portfolio down.

[ejman]

Quote:

Originally Posted by Independent I think you missed part of running_man's plan. Did you notice the $180,000? I'll convert your numbers to annual and do a little rounding because it's easier for me to see what's happening. You say the choice is: A. Take SS today. Starting now, $30,400 from SS + $40,000 from 4% SWR = $70,400 total, indefinitely. B. Defer SS for four years. Your plan is has two income levels. First four years, $0 from SS + $40,000 from 4% SWR = $40,000 After that, $40,200 from SS + $40,000 from 4% SWR = $80,200 Given the choice between A and B, you'd take A. I suppose most of us would. But, rm has a different plan. Again using your numbers: A. Take SS today. Starting now, $30,400 from SS + $40,000 from 4% SWR = $70,400 total, indefinitely. C. Defer SS for four years Move $160,000 from my $1 million portfolio into short assets (CD's, short TIPS), leaving $840,000 invested in stocks etc. First four years, $0 from SS + $40,000 from ST + $33,600 from 4% SWR = $73,600 total. After that, $40,200 from SS + $0 from ST + $33,600 from 4% SWR = $73,800 total Notice that Plan C allows me to spend more money in the first four years, and spend more money in the remaining years then Plan A. I prefer Plan C over both Plan A and Plan B. (Note that if I'm a more conservative 3% SWR person, the advantage of C is even larger.) In fact, that's what we did. When I retired, we had a laddered portfolio of CDs and I-Bonds that was designed to fill the gap between retirement date and SS start date. We've mostly spent that portfolio down.

Modified Plan C. As the SSA has been mentioning for years, benefits are reduced by 25% starting in 2033 (perhaps earlier) due to the trust fund running out and general economic malaise. Then, payments become $30,150 from SS + $33,600 from the reduced kitty for a total of $63,750.

[Independent]

Quote:

Originally Posted by ejman Modified Plan C. As the SSA has been mentioning for years, benefits are reduced by 25% starting in 2033 (perhaps earlier) due to the trust fund running out and general economic malaise. Then, payments become $30,150 from SS + $33,600 from the reduced kitty for a total of $63,750.

Yes, there are lot of variables to consider in the deferral issue. The potentially unequal treatment of people who started earlier vs. those who started later is certainly high on many lists.

I was just trying to point out that people who defer usually do not have a two tier spending plan. Instead, they plan to make extra withdrawals in the early years to fill the income gap. For them "deferring SS" is not the same as "spending less in the early years".

Getting to your numbers, note the total for plan A after 2033:
(75% of $30,400) + $40,000 = $22,800 + $40,000 = $62,800

It turns out that Plan C is still better in this particular case. But, I haven't given any thought to whether that is typical.

[pb4uski]

Quote:

Originally Posted by rayvt Obviously it all depends on how one emotionally views it. The SSA itself says that whether you take at 62 or 66 or 70, it's actuarially identical. Therefore there is no *financial* reason to prefer one age to another......

For someone who is single, I would agree that it doesn't matter since the benefits for any one person are designed to be actuarially equivalent. Ditto for a couple where each person has worked and their respective SS benefits are about the same.

But for a couple where the benefits are unequal, especially where the person with the lower benefit is female, there is a world of difference because of joint mortality and the fact that the lower earning spouse gets the higher earning spouse's benefit when the higher earning spouse dies. And if the lower earning spouse is female and also much younger, then the preference to wait to 70 is even greater.

[rayvt]

Quote:

Originally Posted by pb4uski But for a couple where the benefits are unequal, especially where the person with the lower benefit is female, there is a world of difference because of joint mortality and the fact that the lower earning spouse gets the higher earning spouse's benefit when the higher earning spouse dies. And if the lower earning spouse is female and also much younger, then the preference to wait to 70 is even greater.

If they are highly dependent on the SS benefit, arguably yes. Well, arguably perhaps.

The surviving spouse gets 50% of the deceased spouse's benefit, not 100%. So the max amount she'd get from SS would be $1675 (70) vs. $1266 (66), or $409/mo more.
Note that she'd still get the full 4% SWR of the (assumed) $1M portfolio, so her total income would be $5008 (70) vs. $4599 (66). That's only 8.9% more, so the benefit of deferring is even smaller than before.

I would submit that there's no significant difference in lifestyle for a (newly) single person between $4600 and $5000. And, again, in order to get that $409/mo for rest of her life, they had to give up $2533/mo for 4 years.
Using just back-of-envelope math: $2533 * 48 = $121,584. $124,584 / $409 = 297 months. It'll take her 25 years to get to break-even.

It's really difficult for some people to realize in their gut that actuarially identical indeed means ACTUARIALLY IDENTICAL. There's no magic way to wiggle around and get one outcome to be better than another.

[samclem]

Quote:

Originally Posted by rayvt The surviving spouse gets 50% of the deceased spouse's benefit, not 100%. So the max amount she'd get from SS would be $1675 (70) vs. $1266 (66), or $409/mo more.

The surviving spouse gets 100% of the deceased spouse's benefit, not 50%. So, she'll get $818/mo more if the now-deceased spouse has waited to 70 to start collecting SS. I think that amount of additional "I can count on this every month" money would make a significant difference in quality of life for many people.
When the surviving spouse starts collecting the full benefit of the deceased spouse, she must stop collecting any spousal benefit she got before or any benefits she was collecting based on her own work record.

Quote:

Originally Posted by rayvt It's really difficult for some people to realize in their gut that actuarially identical indeed means ACTUARIALLY IDENTICAL. There's no magic way to wiggle around and get one outcome to be better than another.

If a person's only COLA'd income stream is from SS, then "ACTUARIALLY IDENTICAL" may be a long way from IDENTICAL IN PRACTICE. As people tend to decrease their equities in later years and increase their percentage of fixed income holdings, deferring SS to get a higher monthly payout which will be COLA'd can make sense as a means to help preserve spending power in case these fixed income holdings don't keep pace with inflation. There's no cheaper inflation-protected annuity than that provided by delaying SS.

That said, I'm not entirely comfortable in depending on that government promise, and understand the appeal of taking the SS earlier to reduce draw from the portfolio in those early years, and keeping that "extra money" in more volatile assets that may also have a better chance to keep up with inflation (i.e. self-insuring against inflation rather than depending on an unchanging govt promise). I'm not sure what I'll do myself.

[obgyn65]

+1 . My FIRE spreadsheet includes small SPIAs after age 70, and already includes a couple of deferred annuities bought a few months ago. Three of my grandparents passed after the age of 90.

Quote:

Originally Posted by W2R Personally I am thinking of buying a small SPIA if/when I reach age 80-85. It should be cheaper then than it would be at an earlier age. Inflation would not be as much of a concern at that age as it would be for a younger person. The point of the annuity would be to provide steady income that I could rely upon (along with SS and my tiny pension) for basic expenses, in case I turn out to be one of the few who survive until extreme old age.

[Animorph]

Quote:

Originally Posted by rayvt It's really difficult for some people to realize in their gut that actuarially identical indeed means ACTUARIALLY IDENTICAL. There's no magic way to wiggle around and get one outcome to be better than another.

Oh, heck. Some individuals are dying of cancer at 62 and are definitely not actuarially identical. That's on average from SS's point of view, not any one individual. Given that it's on average, any little difference might throw your best option to either side of the average.

Anyway, I believe this SS stuff got started by a comment that if anyone was going to buy an SPIA they should be delaying SS until 70. I think that still stands. I assume rayvt won't be buying an SPIA any time soon.

[Mike Piper]

Social Security is only actuarially neutral for an unusual set of circumstances -- that is, for an unmarried individual with an average life expectancy, when current real interest rates match the rates baked into the Social Security calculations.

For most people, if choosing between claiming as early as possible or waiting until 70, there is an answer that is preferable (that is, an answer that has a better than 50% chance of working out well).

[Running_Man]

Quote:

Originally Posted by rayvt Obviously it all depends on how one emotionally views it. The SSA itself says that whether you take at 62 or 66 or 70, it's actuarially identical. Therefore there is no *financial* reason to prefer one age to another.

I think the idea that this is actuarially identical is a false concept. This cannot be when interest rates are not figured in the payout decision nor is the sex of the recipient, nor are payouts adjusted for changes in life expectancy. However I do think under current market conditions it is an advantage to wait if one can afford to do so.

[pb4uski]

Actually you make a good point that I forgot RM. Even though the payouts are actuarially equivalent for a single, that is based on unisex mortality, so the decision would also vary based on the recipient's gender since females tend to outlive males.