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

[Independent]

Quote:

Originally Posted by rayvt 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.

Once again, let's write the numbers down:

Plan X: Both start today. Assume both are 66, husband has the high income, wife gets 50% at age 66.

Total while they are both living = $30,400 + $15,200 + $40,000 = $85,600
Total after the first death = $30,400 + $40,000 = $70,400

Plan Y: Start wife's benefit today, defer husband's to age 70, move $160,000 into short term assets to provide bridge income.

Total for first 4 years = $15,200 + $40,000 + $33,600 = $88,800
Total between 4 years and first death = $15,200 + $40,200 + $33,600 = $89,000
Total after first death = $40,200 + $33,600 = $73,800

So, over three periods (first four years - then till first death - after first death) the totals are:

Plan X: $85,600 - $85,600 - $70,400
Plan Y: $88,800 - $89,000 - $73,800

Deferring provides more income in every period.

[Animorph]

Quote:

Originally Posted by Independent Once again, let's write the numbers down: Plan X: Both start today. Assume both are 66, husband has the high income, wife gets 50% at age 66. Total while they are both living = $30,400 + $15,200 + $40,000 = $85,600 Total after the first death = $30,400 + $40,000 = $70,400 Plan Y: Start wife's benefit today, defer husband's to age 70, move $160,000 into short term assets to provide bridge income. Total for first 4 years = $15,200 + $40,000 + $33,600 = $88,800 Total between 4 years and first death = $15,200 + $40,200 + $33,600 = $89,000 Total after first death = $40,200 + $33,600 = $73,800 So, over three periods (first four years, then till first death, after first death) the totals are: Plan X: $85,600 - $85,600 - $70,400 Plan Y: $88,800 - $89,000 - $73,800 Deferring provides more income in every period.

Great for income, and I'm expecting to delay one or both of us to age 70, but you're out the $160k in capital until the extra income makes it up. Could be good or bad depending on how long you expect to live and what kind of investment gains you assume.

[Independent]

Quote:

Originally Posted by Animorph Great for income, and I'm expecting to delay one or both of us to age 70, but you're out the $160k in capital until the extra income makes it up. Could be good or bad depending on how long you expect to live and what kind of investment gains you assume.

Yes, that's the tradeoff.

Using the spending differential I've given, I don't see that the couple who defers ever makes up the difference. They would eventually if they had the same spending as the couple that started early, but I'm proposing that they spend more.

It seems to me that if investment returns are good and the $1.0 million portfolio doubles to $2.0 million, the $840,000 portfolio will also double, but only to $1.68 million. Similarly, if they're bad and the $1.0 million shrinks to $500,000, the $840,000 will shrink to $420,000.

OTOH, they are no more likely to spend their assets all the way to zero than the couple that starts earlier. And, if they should do that, deferring gives a higher safety net.

[rayvt]

It gets really complicated really fast, doesn't it.

First thought: $85.6K and $88.8K are pretty close. And, of course, that's for a person who is getting the max SS benefit. I don't know how many people hit the cap, but the average benefit is more like $1300/mo than $3300. I don't know what the distribution is, though.

Ah-ha! Google to the rescue. The distribution is highly skewed. Almost everybody (46%) is between $800 and $1600. Only 9% are above $1900. Only 2% are above $2300. Above $3100: 0.1%.

Retired worker beneficiaries distributed by benefit level

Aside from all that, I suspect that these 2 scenarios come out to be very close or perhaps even flip-flop when you take investment growth into account. The difference between $89,000 and $85,600 is $3,200.

Assuming 8% total return...
Plan X: First year asset base is 96% of $1M. Gain is $76,800

Plan Y: First year asset base is 84% of $1M. Gain is $67,200.
That difference right there is $9,600.
A naive comparison says that you'd be 3 times better off by *not* pulling 4 years of cash out.

Eh, whatever.... the numbers are so close that there is no practical difference. There's nothing you can do with $89K that you can't do with $86K.

[Kimo]

I have purchased three annuities and the best way to buy them is NOT through a salesmen. Go to Vanguard or there is another company that caters to military that has four letters, I just can't remember it at this time, you will get a much better product for your money. Also, you don't have to be in the military or ever been it to apply for the annuity.
Kimo

[MichaelB]

Quote:

Originally Posted by Kimo I have purchased three annuities and the best way to buy them is NOT through a salesmen. Go to Vanguard or there is another company that caters to military that has four letters, I just can't remember it at this time, you will get a much better product for your money. Also, you don't have to be in the military or ever been it to apply for the annuity. Kimo

USAA?

[Kimo]

Yes, USAA is correct and thank you......it was late last night and the brain just wasn't working......

[Independent]

Quote:

Originally Posted by rayvt It gets really complicated really fast, doesn't it. ... .

Yes, all the pros and cons of taking SS now or later can get pretty complicated.

I wasn't trying to cover everything, just make two simple points.

1. People who defer SS are not planning on a two-tier, low-high spending program. They have the same roughly level spending plans as people who start SS immediately.

2. People who defer SS are not planning to spend less, either sooner or later. Some of them plan to spend just as much as if they started SS immediately, others plan to spend slightly more.

I saw your post "But it's only 14% increase in your total income -- and to get it you have to take $2533 LESS income for 4 years." and thought that you weren't getting #1, and probably not #2. I might have misread your meaning.

[rayvt]

Yeah, I kinda got it and kinda discounted it.
When you are comparing different options, you have to compare like to like which means that you need to compute the NPV of the different alternatives.
When people say things like "you will get $X more money if you defer", they are implicitly assuming that $1 in 4 years (or 8 years in the case of deferring from 62 to 70) is the same as $1 today.
You can change the shape of the distribution -- taking less today and more tomorrow, or more today and less tomorrow -- but these all have the same NPV.

[Independent]

Quote:

Originally Posted by rayvt Yeah, I kinda got it and kinda discounted it. When you are comparing different options, you have to compare like to like which means that you need to compute the NPV of the different alternatives. When people say things like "you will get $X more money if you defer", they are implicitly assuming that $1 in 4 years (or 8 years in the case of deferring from 62 to 70) is the same as $1 today. You can change the shape of the distribution -- taking less today and more tomorrow, or more today and less tomorrow -- but these all have the same NPV.

Good, at least we're talking about the same numbers.

Somehow the math in FireCalc or using the 4% SWR slightly favors deferring, even though the SS actuaries say the factors are "roughly" actuarially equivalent.

The issue is that calculating the PV of a life contingent annuity requires assuming a discount rate and a mortality table. The assumptions that produce the same PV for two SS choices are not the same assumptions that most people using FireCalc or 4% SWR are making when they calculate maximum "safe" spending.

I'm NOT suggesting that you or anyone else use any specific approach. I'm just saying that I think I can see how to reconcile this anomaly.

[Gearhead Jim]

Quote:

Originally Posted by haha Almost the entire investing history of people investing today has been spent with falling interest rates and low inflation. This makes it more or less impossible for us to really imagine the ravages of moderate to high inflation. Annuities are an extremely poor long term bet. I would not touch one with a stick, other than the inflation indexed one that we all will get some of. Ha

Geez, I'm only 68 and wasn't a kid during the inflation of the 70's. I remember the stagflation discussions quite well.

For an older person who is considering a SPIA, their expected life span and current low inflation, make the prospect of future inflation less alarming than for a person who was 55 in the early-70's.

I do not have any annuities, but reserve judgment about them for now.

[thanp73]

Quote:

A typical payout rate on a SPIA for a 65 year-old male is about 6.2%. The Vanguard LT Investment Grade Fund (VWETX) currently has a yield of 4.8%. In order for the annuity to achieve a 4.8% IRR, the annuitant would have to live until age 97.

This is one of the things I hate in the annuity business- the confusion of payout rate vs IRR. Payout rate is really meaningless yet too many people fixate on it. The poster above has it right- IRR is what you're looking for to compare apples to apples.

The problem is, unless you know the exact day you're going to die and spend your last dollar that day, you can't compute your IRR, and you are always carrying your longevity risk. You can't spend principal peacefully if you risk outliving that principal....

The key thing to remember with annuities is that they are INSURANCE products and the insurance you buy with most contracts that are tied to your lifespan offloads that longevity risk to the carrier. You can spend principal prudently because the company holds the risk of you spending down to $0.

True,the yield is not as good as you hope to get in your vanguard fund, but for most types of annuities, you gain a benefit in exchange for the lower yield.

Anyway, back to the point about IRR, if you're looking for a good safe annuity with a known, definite IRR based yield, there are fixed annuities with guarantees, or Secondary Market Annuities that are nothing more than discounted payment streams. they're sold priced based on their yield- the effective rate = IRR. Pretty transparent, and not a bad yield considering there is no volatility risk.

[haha]

Quote:

Originally Posted by thanp73 Secondary Market Annuities that are nothing more than discounted payment streams. they're sold priced based on their yield- the effective rate = IRR. Pretty transparent, and not a bad yield considering there is no volatility risk.

Could you give a link to a reputable broker of these things? I know they must exist, because my free UHF TV channels always feature ads offering to take those pesky annuities or structured settlements off people's hands.

BTW, I think annuities have a giant elephant in the room risk that rarely gets deeply considered. A person does not have to be crazy to expect a humdinger inflation at some point near or far in our future.

Ha

[rescueme]

Quote:

Originally Posted by thanp73 The problem is, unless you know the exact day you're going to die and spend your last dollar that day, you can't compute your IRR, and you are always carrying your longevity risk. You can't spend principal peacefully if you risk outliving that principal....

Not necessarily true.

We have a joint/life guaranteed term SPIA and it was very easy to calculate the base IRR. Simply plug in the premium, the total annual payments, and the number of term/years (cells) on a spreadsheet.

We know the minimum return, since our guaranteed term (either we get paid, or our estate does) establishes a minimum period of payments.

And if either/or live beyond the minimum term (calculated at 28 years for us)? The calculated return actual rises.

We can't outlive our SPIA; however if our SPIA "outlives" us, there is residual value that goes to our estate.

As far as IRR vs. payment? You are correct; IRR must be computed for any SPIA product in order to make correct comparisions. Also, folks forget that an SPIA is an income product, not an investment product. It's not there to make you money but rather an instrument in your retirement toolbox to provide you with distribution of investment proceeds over a period of time. That's why our current SPIA was purchased with only 10% of our then current joint portfolio value at retirement (early 2007). The remaining 90% of our portfolio stays invested (relative to our AA) and does the heavy lifting for the future.

[ERhoosier]

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Originally Posted by haha BTW, I think annuities have a giant elephant in the room risk that rarely gets deeply considered. A person does not have to be crazy to expect a humdinger inflation at some point near or far in our future. Ha

+1. But that risk exists with long bonds (& funds) as well. Locking in to a ~4-5% yield, even assuming holding safe indiv long bonds to maturity, risks a huge loss of purchasing power over time if inflation goes back to double-digits (as too many of us can recall ).

[Kimo]

I am quite happy with my Vanguard annuities. They operate quite differently and might be worth a look...

[haha]

Quote:

Originally Posted by ERhoosier +1. But that risk exists with long bonds (& funds) as well. Locking in to a ~4-5% yield, even assuming holding safe indiv long bonds to maturity, risks a huge loss of purchasing power over time if inflation goes back to double-digits (as too many of us can recall ).

You are certainly correct, and I agree. But a big difference is if you get suspicious getting rid of the bond funds is a keystroke and a small commission away. For this reason I think a commitment like a SPIA is categorically different, and inferior, to other fixed income possibilities. In any case, a 5 year duration would be a long time for me. I've had some intermediate term bond funds with effective durations mostly between 3 and 4. I bought them at higher quotes than today, but even with weak price action over the last 6-8 months I am still well ahead of any cash type investment.

Ha

[brewer12345]

TIAA CREF offers a SPIA that I need to really dig into when I have time. It is a payout annuity that gives you the option of having the underlying assets in either the insurer's fixed account (general account) or several variable account options (including equity indicies). I am guessing that the product separates the investment risk fro the longevity risk, with the longevity risk born by the insurer and the investment risk born by the policyholder. I need to poke at this thing to really understand the mechanics of it and no doubt it is expensive, but it might offer an option for a SPIA that fives some options to allay inflation risk.

[thanp73]

Quote:

Could you give a link to a reputable broker of these things? I know they must exist, because my free UHF TV channels always feature ads offering to take those pesky annuities or structured settlements off people's hands. BTW, I think annuities have a giant elephant in the room risk that rarely gets deeply considered. A person does not have to be crazy to expect a humdinger inflation at some point near or far in our future. Ha

Link sent via PM

RE inflation- agreed 100%. inflation is a concern that must be addressed, and an annuity is not going to solve it. neither are bonds, or stocks in a general sense, or any broad answers. certain stocks, yes... certain right pieces of real estate with resilient tenants, yes... certain metals, maybe...
there is no broad brush answer we can have today for all the multitude of things that MIGHT happen tomorrow. nor is what MIGHT happen tomorrow a reason for not doing something right today. Just be prudent.

[thanp73]

Quote:

Originally Posted by rescueme Not necessarily true. We have a joint/life guaranteed term SPIA and it was very easy to calculate the base IRR. Simply plug in the premium, the total annual payments, and the number of term/years (cells) on a spreadsheet. We know the minimum return, since our guaranteed term (either we get paid, or our estate does) establishes a minimum period of payments. And if either/or live beyond the minimum term (calculated at 28 years for us)? The calculated return actual rises. We can't outlive our SPIA; however if our SPIA "outlives" us, there is residual value that goes to our estate. As far as IRR vs. payment? You are correct; IRR must be computed for any SPIA product in order to make correct comparisions. Also, folks forget that an SPIA is an income product, not an investment product. It's not there to make you money but rather an instrument in your retirement toolbox to provide you with distribution of investment proceeds over a period of time. That's why our current SPIA was purchased with only 10% of our then current joint portfolio value at retirement (early 2007). The remaining 90% of our portfolio stays invested (relative to our AA) and does the heavy lifting for the future.

I think you got my point, that the ending final IRR of your SPIA can only be calculated after it's done paying. hopefully that's well more than 28 years.

The guaranteed IRR, depending on when you bought it, was most likely in the 1.5 to 2.5% range, which is not really a very competitive return.

As with most annuities, they really should not be considered 'investment' products because they are truly 'insurance'. You're buying some level of insurance with the premium, which ALSO happens to have some (restricted) returns. In the case of your SPIA, the insurance comes into play in yours after 20 years, and the first 20 year guarantee is simply a protection of your assets for your heirs.