which inflation adjustment for SPIA ?

[JohnEyles]

I have decided to do a SPIA, from Vanguard/AIG, but I haven't decided which
inflation-protection plan to opt for. Let's don't turn this into another SPIA
flame-fest - I've already made my yes/no decision, and I am planning to use
only a single-digit percentage of my egg. It seems like a nice diversification,
and the funds are currently in an after-tax annuity of which I'm not so fond.

The options are (for quarterly payments):

3% annual increase - $837
CPI-adjusted (10% annual cap) - $785
4% annual increase - $727

These represent about 4.1 - 4.7% WRs; I'm a mid-50yo male.

I'm least inclined to the 4% option and most inclined to the 3% option.
But still considering the CPI-linked option (especially after the Lord Abbott
thing).

I'd appreciate your thoughts on my decision (the one I haven't yet made).

 

[brewer12345]

The real question to as k is what do you hope to achieve by buying this thing? If the point is to help avoid running out of money when you are very elderly, then I would suggest you think long and hard about the CPI indexed version. The big risk (aside from longevity risk) is that inflation eats you alive over time. 3 or 4% you could pretty easily handle with equities, etc. It is the high inflation scenarios that you really need to hedge.

 

[JohnEyles]

It is the high inflation scenarios that you really need to hedge.

You're recommending the CPI-linked. Makes good sense, thanks.

 

[brewer12345]

You're recommending the CPI-linked. Makes good sense, thanks.

Oh yeah, and the obligatory: I can understand the impulse to buy a CPI-linked SPIA, but I wish you could find a better company to buy it from.

 

[JohnEyles]

... I wish you could find a better company to buy it from.

Only one I know of. Of course, others offer the graded X%-increasing one.

I'd be more worried if it were a bigger sum.

 

[Running_Man]

It would appear the net present value of the the 3% payout to age 85 for a 55 year old male is higher than the net present value of the 4% payouts. CPI inflation would hurt usually in burst in a relatively short span of years and there would be years less than 3%. I would take the 3% increase for this portion of a retirement portfolio

 

[FIRE'd@51]

The options are (for quarterly payments):

3% annual increase - $837
CPI-adjusted (10% annual cap) - $785
4% annual increase - $727

Interesting - if you look at the 30-yr TIPS/Treasury spread on Bloomberg, the implied inflation is something like 2.5%. Yet AIG is pricing the CPI-adjusted SPIA at well over 3% expected inflation.

 

[JohnEyles]

Interesting - if you look at the 30-yr TIPS/Treasury spread on Bloomberg, the implied inflation is something like 2.5%. Yet AIG is pricing the CPI-adjusted SPIA at well over 3% expected inflation.

Interesting indeed. The spread is actually a hair less than 2.5% it seems today.
And the CPI-linked SPIA is roughly halfway between the 3% and 4% payout.

On the other hand, I like Brewer's argument that the main reason I seem to be
doing this is as a diversification of income sources, mainly hedging against excess
longevity and hence inflation.

I'm a diversificator, as he-whose-name-cannot-be-mentioned-outside-Other_Topics
might say ...

 

[brewer12345]

Interesting - if you look at the 30-yr TIPS/Treasury spread on Bloomberg, the implied inflation is something like 2.5%. Yet AIG is pricing the CPI-adjusted SPIA at well over 3% expected inflation.

I presume that a chunk of the extra "inflation assumption" is actually a combination of profit margin and mortality assumptions. In actual fact, AIG will probably buy a bunch of bonds yielding 100BP over treasuries and swap them back to TIPS rates to hedge the annuity.

 

[FIRE'd@51]

I presume that a chunk of the extra "inflation assumption" is actually a combination of profit margin and mortality assumptions. In actual fact, AIG will probably buy a bunch of bonds yielding 100BP over treasuries and swap them back to TIPS rates to hedge the annuity.

I would think the profit margin and mortality assumptions are built into the 3% and 4% annual increase SPIA's as well, so there still seems to be an additional inflation assumption here. According to OP's numbers, if $837 per quarter equates to a 4.7% SWR, then $785 per quarter would be a 4.4% SWR, a difference of 0.3% per year.

I agree that AIG is probably hedging this with TIPS. Looks like at current rates, an "interest only" TIPS would yield a 30-yr inflation-adjusted (with no 10% cap) SWR of 4.7%

 

[JohnEyles]

According to OP's numbers, if $837 per quarter equates to a 4.7% SWR, then $785 per quarter would be a 4.4% SWR, a difference of 0.3% per year.

Correct-o-mundo.

I agree that AIG is probably hedging this with TIPS. Looks like at current rates, an "interest only" TIPS would yield a 30-yr inflation-adjusted (with no 10% cap) SWR of 4.7%

Not sure what you mean by "interest-only TIPS" ? Looks to me like you'd need
to have a return-of-principal to be able to get inflation-adjusted 4.7%.

Of course my expectancy is only 30yrs or so, but the point here is to hedge
against longevity (and high inflation).

 

[brewer12345]

I agree that AIG is probably hedging this with TIPS. Looks like at current rates, an "interest only" TIPS would yield a 30-yr inflation-adjusted (with no 10% cap) SWR of 4.7%

Doubtful. What they are probably doing is buying a portfolio of bonds, MBS, credit default swaps, and gawd knows what else. Then they swap the fixed and floating fixed income portfolio to CPI-based floaters.

 

[FIRE'd@51]

Not sure what you mean by "interest-only TIPS" ? Looks to me like you'd need
to have a return-of-principal to be able to get inflation-adjusted 4.7%.

By "interest only" TIPS, I mean our old friend, the TIPS with the maturity payment stripped off. This would have the return-of-principal built in without having to do the logistical nightmare we talked about in some other threads.

Of course my expectancy is only 30yrs or so, but the point here is to hedge
against longevity (and high inflation).

Correct, the "interest only" TIPS would not give you the longevity insurance, but it would give you (or your estate) a guaranteed 30-year inflation protected SWR of 4.7%, without an "early death penalty".

 

[JohnEyles]

Hot off the presses ... Vanguard/AIG has eliminated the 10% annual cap on
CPI-linked payment increases.

Also noticed (for their variable annuity, which isn't under discussion here, but
probably relevant) that the mortality expense charge is 0.52% and average
portfolio expense is 0.27%.

 

[JohnEyles]

Well, I did it ! Put in about 7% of my egg. (What a moron).
Went for the CPI-adjustment and will get a 4.4% initial WR.

The elimination of the 10% cap (on annual CPI increase)
was the clincher, to go for that instead of the 3%-graded
(for which initial WR woulda been 4.7%).

I feel pretty well-hedged against inflation now, with 5-6%
of remaining portfolio in TIPS (individual) and ISM.

 

[Nords]

(What a moron).

That's the financial analysis of what may also be a decision with an emotional "sleep at night" component.

Both perspectives are equally valid... as long as you can sleep at night!

 

[JohnEyles]

That's the financial analysis [I'm a moron] of what may also be a decision with an emotional "sleep at night" component.

Both perspectives are equally valid... as long as you can sleep at night!

Lot more dreams than usual last night ... hmm.

But I also feel like the small-fraction-of-egg SPIA is a good diversificator.
Since it's CPI-linked, it's an inflation hedge. Also, a living-way-too-long
hedge. And also, a markets-do-really-poorly (but not poorly enough for
AIG to go belly-up) hedge.

Anyhow, I guess we're rehashing all the pro-/con-SPIA arguments ...

 

[Cut-Throat]

Went for the CPI-adjustment and will get a 4.4% initial WR.

You must be a lot younger than age 70, I'm guessing. What made you decide on this at an early age and did you consider buying this later in life where you would have had a higher payout?

 

[JohnEyles]

You must be a lot younger than age 70, I'm guessing.

Yes, mid-50s.

What made you decide on this at an early age and did you consider buying this later in life where you would have had a higher payout?

I think actuarially, it's the same amount of money, I just get less per year but over
a longer period of time. It's actually more, because they benefit off the chance I die
young, whereas if I waited til 70yo they'd still have the risk I live way beyond life
expectancy. (And, of course, I need money now, from whereever, 'cause I'm RE'ed).

But ... the main reason I bought it now is because of the diversification factors I
outlined a couple of posts ago (hedging against inflation, really bad investment
returns, and excess longevity). And also because I don't really like where it is
now (an after-tax annuity with not-so-low expenses and very limited investment
options).