FYI: Ben Stein's views on asset allocation.

[REWahoo]

Asked...

Originally Posted by jdw_fire

There are some that saved a large some over most of their working life, or got an inheiritance, or won the lottery and are looking for a way to retire. They may not have all the financial expertise as the main posters of this board and maybe all they need is an inflation adjusted income stream that doesn't require that expertise to maintain. I wouldn't want to tell them "sorry you can't retire, keep working", would you?

Or maybe someone wants to have a very sure minimal cash flow amount to cover their bare bones retirement needs and an annuity would work very well but without that security they are too afraid to retire. I wouldn't want to tell them "sorry you can't retire, keep working", would you?

...and answered.

Originally Posted by Nords

Does an annuity help you sleep better at night? Then go buy one. It's not a financial issue, it's an emotional issue.

[jdw_fire]

REW I don't think your reply addresses the first paragraph. In that example it is not an emotional issue it is an expertise issue.

[REWahoo]

Originally Posted by jdw_fire

REW I don't think your reply addresses the first paragraph. In that example it is not an emotional issue it is an expertise issue.

Hmmmm. If I thought maybe I had enough $ to retire but lacked the expertise to manage my portfolio and had to keep working, you bet I'd be emotional!

Yes, there are situations when an annuity or even a financial advisor (lightning will stirke me at any moment) might make sense for an individual who lacks financial expertise and/or emotional capability and lacks the ability to develop those skills. However, I think very, very few of those individuals find their way to this forum.

If such an individual does post here and if I believe they do not posess or cannot develop the expertise to manage their retirement funds or emotions, I will not hesitate to suggest they consider an annuity.

Are we done?

[Rich_in_Tampa]

In my never-ending quest for knowledge, I took Nords' suggestion and did some calculating. Interesting findings:

Take $100,000 and self-annuitize over 30 years. Presume that for this comparison you would need to stuff these funds in rock-solid investments, i.e. CDs, MMF, etc., and that all earnings are disbursed monthly, just like in the immediate annuity.

My calculation shows that in order to generate the equivalent of 7.4% annual yield (like with an age 60, male, immed annuity), you would have to see about 6.3% annual yield on that bedrock investment.

Full disclosure: I don't fully trust my own annuitization calculations all that much, but double-checked these a couple different ways. Corrections are welcome. But I think Nords' suggested approach to comparing these is great.

So, it seems that for those age 60+ who desire a no-risk, 30 year-plus, non-COLA pension-like component in their annual expense bucket:

1. If you feel you can get a rock-solid return of 6.3% for 30 years on your own in a minimal-risk cash investment, go ahead and self-annuitize, accepting that there will be some volatility.

If you die before 30 years, your heirs will have some money left. Plus you have the right to change your mind and move your money elsewhere at any time. If you live longer, go look elsewhere for the money, you'll be nibbling at their inheritance.

2. If not, get an immediate annuity for the same initial investment - you will make more money per month.

If you die before your actuarial funeral date, tough luck, no refunds. If you live longer, congratulations: the payments march on. Your inheritance will be a bit better preserved. Your income advantage comes at the price of being committed to this plan for the rest of your life.

Does this sound right?

[cute fuzzy bunny]

Ah but Rich, you automatically tie the self annuity end's arms behind its back by forcing it into a non-equity holding position.

Thats not what the insurance company does.

I think I can shed some light on the aversion.

If you're going to live longer than the insurance company thinks you will, ideally by a lot, you'll do well with an annuity. Under some circumstances, a portion of your money set in an annuity to create a small dependable income stream can have long term (and current) positive effects to your SWR and survivability.

If you dont live as long, you will lose out.

Nobody knows when they're going to die, so its incalculable.

But a certain amount invested in a balanced fund or an s&p 500/TSM type equity fund for 20 years will produce a level of return far in excess of what the annuity will pay. Just not smoothly. Or with as good a "sleep at night factor". At least thats what the history says, nobody knows what the future holds.

or whether that insurer will be around 30 years from now to pay your annuity.

So in short, the investor has to ask themselves how comfortable they are with figuring out the year of their death, and taking what will quite plausibly be a lower return, in exchange for a quite plausibly higher return from a self directed investment.

I'll take the self directed investments in that scenario. Theres more data, its broader based, and the worry factor just isnt there for me.

Others might feel differently.

Oh yeah, and according to the range of calculators I've used, I'll leave somewhere between 800k and 3M in todays dollars to my son when my wife and I pass away. I'm guessing he'll be in his 40's. The idea of passing financial independence down to my heirs at what I think will be "the right time" for them is very appealing.

[2B]

Originally Posted by Rich_in_Tampa

2B,

Your points are well taken. Interestingly, you do much better on a lifetime annuity (yield-wise) than you do on a fixed term annuity (say, 15 years) because -- I believe, the fixed annuities alway pay out in full, whereas the life annuities allow the company to spread the risk, ending payouts when you die; I double-checked and indeed a 60 year male old life-only annuity pays well over 7%.

If it paid in the 4s or 5s, I'd pass. At 7.4% it gets my attention.

Cheers.

Please understand that your return isn't 7.4%. That is the payout with the value at the end of the term zero (at your death). The rate of return is about 4.7%. Part of what you are seeing as 7.4% includes return of your initial investment.

You can do better with a ladder of 5.3% CDs except you can't assure you will die on any specific date. There is a reduction in return due to the life annuity aspect.

[Rich_in_Tampa]

Originally Posted by Cute Fuzzy Bunny

Ah but Rich, you automatically tie the self annuity end's arms behind its back by forcing it into a non-equity holding position.

Yes, I see your point. Since one of the advantages of an IA is reduced volatility, I tried to use a comparable investment on the self-annuity side. If you figure more traditional investments rather than bedrock investment, the analogy starts to unravel a bit -- apples and oranges.

This has proven helpful. I think the two are a pretty close call depending on personal preferences. If not right for everyone, I think the summary dismissals of an IA component in certain doses and circumstances are exaggerated.

Thanks for your observations. You are a lot smarter than everyone here told me you were...

[cute fuzzy bunny]

Originally Posted by Rich_in_Tampa

Thanks for your observations. You are a lot smarter than everyone here told me you were...

No i'm not. I copied off of someone elses paper

[Rich_in_Tampa]

Originally Posted by 2B

Please understand that your return isn't 7.4%. That is the payout with the value at the end of the term zero (at your death). The rate of return is about 4.7%. Part of what you are seeing as 7.4% includes return of your initial investment.

You are right, that's what I meant.

That's why I compared it to a 30-year annuitized investment (zero balance at the end) and it seems that the equivalent to a 7.4% annuity is more like a 6.3% one-time investment annuitized over 30 years.

Thanks for the clarification of my fuzzy terminology.

[jdw_fire]

OK let me try from another angle, an example.* The facts for this example are a couple (both 60 years old) wants to retire with $100,000 of assets that can be used for income production (this number is arbitrary as the numbers in this example are scalable, if its size troubles you multiply it by 10 or 100 or whatever, just remember that all the dollar values in this example need to be multiplied by the same number).* Reading an article by Henry Hebeler dated 3/8/05 entitled "An Appeal for Better Planning” we would be foolish to use less than 40 years (and this may not even be long enough) for our FIRECalc calculation.* Also, I have read several posts here that suggest planning for a long life.* With a 50/50 portfolio split, a starting W/D of $3386 gets us a success rate of 100%.* If now we go to Vanguard’s site and look at inflation protected immediate annuities we need to spend $65,424.64 to get the same starting income rate from said annuities, leaving $34575.36 for you to invest however you see fit.* (I should note I would actually propose buying 2 individual life annuities each providing half the W/D amount stated above, one for each member of the couple.* This technique actually provides the income for a smaller initial payment then a single annuity with a 50% spousal benefit.* When one of the couple dies the other will only have half of the inflation adjusted income from an annuity, but 1) it shouldn’t cost as much for a single person to live as the couple and 2) remember that there is still the $34575.36 that has been invested from the date of retirement until the first spouses death without a need for withdraw up to this point.* If additional income is needed at this point that money is then used to buy another inflation protected immediate annuity for the surviving spouse or if the surviving spouse has the capability and inclination to manage the assets for additional withdraw s/he can do so.* Please note that the longer the time between their retirement and the death of the first spouse the larger the payment stream will be on a newly purchased inflation protected immediate annuity for any given purchase price.)*

This analysis is even better for a single person since the annuity costs only $62614.65 and the $37385.45 remaining portfolio after the initial purchase of an inflation protected immediate annuity will never have to be used to make up lost income when a spouse dies.

I used here an extreme example (i.e. a very large annuity) to try and show my point as clearly as possible however as I said in an earlier post maybe a better solution is to use the annuity to provide the bare bones amount necessary for retirement and let the success of the remaining portfolio provide for discretionary expenses.

Before anyone flames me please consider some of the benefits of this approach.*
* * *- potentially less need for management/monitoring of your portfolio (just put the $34575.36 remaining portfolio into an index fund for 40 years)
* * *- using FIRECalc the residual values after 40 years are higher with the annuity ($34,575 – $1,274,044 w/ avg $416,137) than w/o ($72 – $634,124 w/ avg $181,113)
* * *- if someone really couldn’t stand working any more they could actual retire with fewer assets without giving up safety or income

If you still don’t think this a financially viable solution please explain why?* In this explanation please remember that the past performance of the stock and bond markets is no guaranty of future performance.

[2B]

Originally Posted by Rich_in_Tampa

That's why I compared it to a 30-year annuitized investment (zero balance at the end) and it seems that the equivalent to a 7.4% annuity is more like a 6.3% one-time investment annuitized over 30 years.

Here again it's tough to compare a "lifetime" annuity because of the inherent reverse life insurance. A large group of 60 year old men would all not be expected to live to 90. A few 60 year old men would and they would be getting the 6.3% return. Many would die in their 70's and subsidize the higher return for the few survivors.

[2B]

Originally Posted by jdw_fire

If you still don’t think this a financially viable solution please explain why?* In this explanation please remember that the past performance of the stock and bond markets is no guaranty of future performance.

Hey! Go for it if it makes you feel better. You can go all the way and a single person can get a 5.1% inflation adjusted payout. I didn't run the two individual annuities with 50% spousal benefits.

Key points to consider. Your money is now gone and you are a creditor of the AIG subsidiary that sold you your annuity. What's their credit rating now? What will be their credit rating be when a cure for old age is discovered and their annuitants live forever? What will their credit rating be when the stock market falls 80%? What is their inflation adjustment based on? I didn't see anything displayed too prominently.

Not my cup o' tea at this point in my life but I think it is a valid approach for a fixed income portion. I would be concerned if too much of a portfolio was committed to this. I still believe you can get a better return with your own laddered CDs and bonds. The 5.1% payout doesn't excite me expecially with all capital depleted upon your death.

When you run FireCalc, there is the "residual" that can always be used to juice the payout if there is an end of life issue. You can't do that with an annuity.

If you follow Guyton, you can withdrawl up to 6.2% inflation adjusted. Of course, there you have to be willing to adjust withdrawls with portfolio swings. I actually think our currently retired bretheren do that now even if they limit themselves to 4% or less. I wish I was their heirs (and they were a lot older).

[unclemick]

Hmmm

Ballpark 40% of spending from early SS plus non cola pension with 5% of Vanguard Target 2015 variable takeout for the rest except for 7% in Roth VG Lifestrategy mod for my old age.

13th year of ER - single, no heirs to speak of - age 62/63.

Annuity is an option for my 80's - if I need it.

heh heh heh heh heh - more than one way to skin a cat. Party on.

[cute fuzzy bunny]

Originally Posted by jdw_fire

If you still don’t think this a financially viable solution please explain why? In this explanation please remember that the past performance of the stock and bond markets is no guaranty of future performance.

There are "guarantee" problems in both approaches.

In one, you're creating doubt about the viability over a decades long period of the financial market of the greatest economy the world has ever known and hundreds of millions, perhaps billions, of investors.

In the other, the long term financial viability of a single company, and your own individual mortality.

But the good news is, with the latter one you get less money and nothing at the end for your heirs/charities. But its guaranteed. If the company is still in good shape and you're still alive.

Ask the people who worked for 25-30 years for the biggest blue chip companies of the 50's/60's/70's who are now losing their pensions and medical benefits how well that faith worked out for them.

And if you want less management/monitoring of your portfolio, just buy Target Retirement xxxx and dont look at it again. Just cash the dividend checks and when needed, sell shares to suit your spending needs.

[unclemick]

Crap! - second cup of coffee.

Pssst - Wellesley. (lest I forget).

heh heh heh heh heh heh heh heh - Annuity! We don't need no stinking annuity. Unless of course it works for your situation.

[jdw_fire]

2B, thanks for taking the time to review and comment on my example, let me now address your comments

Originally Posted by 2B

Key points to consider.* Your money is now gone and you are a creditor of the AIG subsidiary that sold you your annuity.* What's their credit rating now?* What will be their credit rating be when a cure for old age is discovered and their annuitants live forever?* What will their credit rating be when the stock market falls 80%?* What is their inflation adjustment based on?* I didn't see anything displayed too prominently.

On your key points 1) your money is not "now gone".* You have two annuities AND $34,575 invested in what ever you want to invest it in!* 2)Your question on the AIG subsidiary's credit rating now is a valid point and I suppose you could spread this risk by buying smaller annuities from multiple companies, kind of like a mutual fund.* 3) Your next credit rating question on a cure for old age is just an emotional argument not based in fact.* 4) Your next question applies as much to your ideas about a portfolio and self annuitizing as it does to my example.* 5) CPI

Originally Posted by 2B

Not my cup o' tea at this point in my life but I think it is a valid approach for a fixed income portion.* I would be concerned if too much of a portfolio was committed to this.* I still believe you can get a better return with your own laddered CDs and bonds.* The 5.1% payout doesn't excite me expecially with all capital depleted upon your death.

When you run FireCalc, there is the "residual" that can always be used to juice the payout if there is an end of life issue.* You can't do that with an annuity.

I'm glad that you are at least willing to consider that the annuity might be a valid substitute for the income portion of a portfolio, however I think that when you state that you could do better laddering CDs and Bonds you are forgetting how low interest rates were just a year or so ago.* The annuity would lock in an inflation adjusted income stream for your entire life.* I don't think your ladder will do that since it would require a different CD or bond for each year of your remaining life to be purchased now to prevent having to purchase when interest rates are lower.

There is a "residual" with the annuity also, remember the $34,575 invested in what ever you want to invest it in.* If invested in an S&P 500 index fund it would yield a larger residual than the self annuitizing plan laid out by FIRECalc.* Look back at my example "using FIRECalc the residual values after 40 years are higher with the annuity ($34,575 – $1,274,044 w/ avg $416,137) than w/o ($72 – $634,124 w/ avg $181,113)"

Originally Posted by 2B

If you follow Guyton, you can withdrawl up to 6.2% inflation adjusted.* Of course, there you have to be willing to adjust withdrawls with portfolio swings.* I actually think our currently retired bretheren do that now even if they limit themselves to 4% or less.* I wish I was their heirs (and they were a lot older).

Unlike my example, in Guyton's plan each year's W/D is not always inflation adjusted from the previous year.*

It appears that the only credible concern you express is the viability of the company issuing the annuity and to address that concern (from my comments above) "you could spread this risk by buying smaller annuities from multiple companies, kind of like a mutual fund. " or (from my post that stated the example) maybe a better solution is to use a smaller annuity to provide the bare bones amount necessary for retirement and let the success of the remaining portfolio provide for discretionary expenses.