annuities?

[2B]

Anti-Annuity Troll here -- I am not familiar with the TSP options. The key is to look at their effective interest rate. Don't get seduced with "income for life." In 15 or 20 years what looks like a good amount of cash will be a pittance due to inflation.

Compare whatever is offered against current CD/bond rates. The annuity competition is a laddered CD/bond "self-annuity" that goes on forever and always has an available cash value. Put your money into an income-stream annuity and it all goes away when you die and you can never get your principle back.

 

[Rich_by_the_Bay]

Compare whatever is offered against current CD/bond rates. The annuity competition is a laddered CD/bond "self-annuity" that goes on forever and always has an available cash value. Put your money into an income-stream annuity and it all goes away when you die and you can never get your principle back.

This is an oft-repeated topic here, and you are right about the competing strategy. At least in the context of an immediate annuity, usually the annuity wins as far as monthly cash flow (offset by kissing your money goodbye the day you open the annuity).

The reason is that insurance carriers can do this prudently by anchoring it to your expected survival since group volumes will follow that path very closely (i.e. longevity mean). For every one who lives longer, there are those who die prematurely.

Comparing it to a bond ladder, you have to count on doing the ladder for your maximum expected age, say 95 or older. You don't have the luxury of playing for the mean. Long time to tie up 10% money in a 5% investment. Annuities after age 65 or so might pay the equivalent of a 7% return or more per annum.

None of this says whether an IMMEDIATE annuity is right or wrong -- that depends on your circumstances. But for those who want increased cash flow and longevity insurance in return for taking a sizable chunk off the table for your heirs, it is a viable option. Most would agree that you should not tie up your whole portfolio in annuities, but 20% or so is OK for some folks who understand the trade-offs.

 

[2B]

Long time to tie up 10% money in a 5% investment. Annuities after age 65 or so might pay the equivalent of a 7% return or more per annum.

Current annuities may payout 7% of the initial investment but that is a long way from the calculated rate of return (IRR). The 7% is simply a calculated cash flow calculated on the initial payment. The actual IRR is probably about 3%.

Of course, living to be 100 changes everything. Then you'll get 7%.

 

[mathjak107]

the nice thing about immeadiate annuties is they allow a larger monthly withdrawl than a bond ladder does....putting 100,000 into a bond ladder may provide someone with about 2.000 a year to withdraw for life figuring 5% and 3% inflation....an immeadiate annuity at 7% allows the same person a 3,000 a year income for life ..a 50% increase for life......by removing the uncertainty of making the money last it allows someone who may be struggling to pay bills a greater income

 

[Gearhead Jim]

I just went to the advanced FIRECALC and plugged in:

40 yrs expected retirement life
$1,000,000 invested
.5% expense ratio
50/50 mix of stocks/5 yr treasuries
95% success ratio allows $35,107 per year, increasing with CPI

Then I went to the Vanguard annuity website and plugged in:
Same $1,000,000 invested in their inflation-indexed annuity
Man 61/Woman 59 yrs old, 100% survivor option
Annual payout $41,520 per year, increasing with CPI

Please feel free to run these numbers for yourself and see if i made any errors.

There are things you can do to make the FIRECALC results better, like beating down the expense ratio and tweaking the investment choices. On the other hand, you could make some bad investments and come out much worse.

For those who have the desire, knowledge and emotional control to "do it yerself", individual investing makes sense. For the rest of the herd...

 

[MasterBlaster]

Just a comment on the annuity/Firecalc thing.

The 61 year old man and 59 year old woman have a life expectancy of maybe 25 years.

Using a 25 year expectancy and your numbers I get a Firecalc suggested withdrawl of $42k.

That alone will really tilt the odds in favoring the annuity to favoring investments.

Also, keep in mind that should the markets do better than horrible over that timeframe that an increased withdrawal in the later years would probably be in the cards. With an annuity you get what you signed up for.

 

[REWahoo]

For those who have the desire, knowledge and emotional control to "do it yerself", individual investing makes sense.

Yep. I suspect 90+% of those reading this fall into the do-it-yourself category or have the desire to do so. That's a key reason this forum is so darned successful and continues to have over 250 posts per day.

For the rest of the herd...

Yep, an annuity is always an option. Of course the question usually rolls around to "Unless I figure out how to invest, how the heck am I going to get my hands on $1,000,000 to buy that big old annuity?"

 

[Gearhead Jim]

Just a comment on the annuity/Firecalc thing.

The 61 year old man and 59 year old woman have a life expectancy of maybe 25 years.

***On the average, yes.  But there is something like a 25% chance that at least one of them will live to 97.  A little too old to start a new career.

Using a 25 year expectancy and your numbers I get a Firecalc suggested withdrawl of $42k.

That alone will really tilt the odds in favoring the annuity to favoring investments.

***That's only about $500/year more than the annuity.

Also, keep in mind that should the markets do better than horrible over that timeframe that an increased withdrawal in the later years would probably be in the cards. With an annuity you get what you signed up for.

***The markets could also do worse than FIRECALC factors in. 

We need more research and unemotional discussion, but at first glance the Vanguard inflation annuity appears to move annuities from "What was he thinking?" to "We need to think about that."

 

[Nords]

We need more research and unemotional discussion, but at first glance the Vanguard inflation annuity appears to move annuities from "What was he thinking?" to "We need to think about that."

Keep in mind that the Vanguard annuity inflation COLA is capped at 10%.

I wonder what the tax rate is on an annuity vs investment dividends/cap gains.

 

[haha]

Just a comment on the annuity/Firecalc thing.

The 61 year old man and 59 year old woman have a life expectancy of maybe 25 years.

Using 1983 annuity tables, joint life expectancy for a 61 year old and a 59 year opld is 29.7 years.

Ha

 

[gummy]

There's a fun spreadsheet described here:
http://www.gummy-stuff.org/annuity-yes-no.htm

 

[brewer12345]

Keep in mind that the Vanguard annuity inflation COLA is capped at 10%.

I wonder what the tax rate is on an annuity vs investment dividends/cap gains.

Annuity payments are taxed partially as return of principal and partially as interest income.

 

[donheff]

I wonder what the tax rate is on an annuity vs investment dividends/cap gains.

OK, here is one for you math wizzes (I have to leave for my volunteer job or I would spend some time figuring this out myself ) If you put tax deferred money into an annuity the income stream is taxed as ordinary income. IRA RMD's the same. So, if you calculate 20 years of RMD's based on some conservative assumed growth rate of your IRA portfolio and dump that lump sum into a Vanguard inflation protected annuity (with starting age calculated as 70) what is the resulting cash flow versus the RMD?

 

[Brat]

There's a fun spreadsheet described here:
http://www.gummy-stuff.org/annuity-yes-no.htm

Gummy, you are loved!!! 

It is a wonderful to see a person who can communicate the fun of math to all who quaked before a chalk-board.  Congratulations on your retirement.  We are all blessed that you share your skills in a web-wide classroom... and your grandchildren are blessed by your time.

 

[MasterBlaster]

Also, keep in mind that should the markets do better than horrible over that timeframe that an increased withdrawal in the later years would probably be in the cards. With an annuity you get what you signed up for.

***The markets could also do worse than FIRECALC factors in. 

GearheadJim:

Firecalc pretty much does factor in the worst case scenarios. The odds at around 20:1 (using historical data) suggest that someone could indeed do better using investments than getting an annuity.

So, I stand by my comments that should the markets do better than horrible over that timeframe that an increased withdrawal in the later years would probably be in the cards.

If on the other hand the markets go to zip then your annuity is likely in trouble also. The annuity does not really offer any security in the event of a financial meltdown.

 

[donheff]

OK, here is one for you math wizzes (I have to leave for my volunteer job or I would spend some time figuring this out myself ) If you put tax deferred money into an annuity the income stream is taxed as ordinary income. IRA RMD's the same. So, if you calculate 20 years of RMD's based on some conservative assumed growth rate of your IRA portfolio and dump that lump sum into a Vanguard inflation protected annuity (with starting age calculated as 70) what is the resulting cash flow versus the RMD?

I am back and I withdraw this question. As I think about it I realize it doesn't make sense unless someone goes so far as to calculate a theoretical set of RMDs under some assumed growth rate and then calculate back the present value of those withdrawals to calculate what the current lump sum for the annuity would be. Better to play with Gummies excel sheet.

 

[2B]

Annuity payments are taxed partially as return of principal and partially as interest income.

The ones my FIL and father had were first taxed as interest income and then, after all interest had been drained, as return of principal.

 

[2B]

Anti-Annuity Troll here -- I am not familiar with the TSP options.  The key is to look at their effective interest rate.  Don't get seduced with "income for life."  In 15 or 20 years what looks like a good amount of cash will be a pittance due to inflation.

Compare whatever is offered against current CD/bond rates.  The annuity competition is a laddered CD/bond "self-annuity" that goes on forever and always has an available cash value.  Put your money into an income-stream annuity and it all goes away when you die and you can never get your principal back.

A pure repeat of my earlier post. It still applies. I have never seen an annuity that matches the interest rate you can achieve with your own fixed income investments.

Insurance companies, like casinos, did not build all of their big buildings and fill them with people so that you could make more money than you could investing on your own. They are selling "convenience" and the consumer pays for it.

 

[mathjak107]

investing yourself and an immeadiate annuity are very different and for different purposes...under certain circumstances they can complement each other......as i explained earlier ....putting 100,000 into a bond ladder may provide someone with about 2.000 a year to withdraw for life figuring 5% and 3% inflation....an immeadiate annuity at 7% allows the same person a 3,000 a year income for life ..a 50% increase for life......by removing the uncertainty of making the money last it allows someone who may be struggling to pay bills a greater income .....the other thing an immeadiate annuity can do for some is allow you to invest more aggressivly than you might otherwise do because you have a steady stream of income for life.....

 

[Rich_by_the_Bay]

I think a better analogy for an immediate annuity is a self-investment treated almost like a mortgage loan over a term virtually certain to cover your lifespan. You draw it down yearly in equal amounts, keep it invested in a fixed rate, ultra-safe investment (if only you could nail that down for such a long duration), and end up with little or nothing at the end, depending on how long you live.

In my own calculations, the self investment certainly ends up better for your heirs. But if you are willing to take the money off the inheritance table, the IA usually results in larger monthly payments. You have to figure on the longest life span you might ever reach, whereas they only need to know the mean for the population at large so can afford to pay more on average.

 

[2B]

But if you are willing to take the money off the inheritance table, the IA usually results in larger monthly payments. You have to figure on the longest life span you might ever reach, whereas they only need to know the mean for the population at large so can afford to pay more on average.

Screw the heirs, annuities suck.  Their return is always lower than what you can get in the "real world."

 

[Rich_by_the_Bay]

Screw the heirs, anuities suck. Their return is always lower than what you can get in the "real world."

Nicely supported argument.

 

[donheff]

A pure repeat of my earlier post. It still applies. I have never seen an annuity that matches the interest rate you can achieve with your own fixed income investments.

I don't see that you have supported your argument that fixed income investments beat annuities. As mathjack shows (below) you can take out a perpetual income stream of about 2% if today's rates continue as is leaving the principle (un-inflated) intact for heirs. No inflation protection on the income stream and not much help if you need a 4% stream. Over at Vanguard a mid/late 50s couple can pick up a joint annuity that pays out about 4%, inflation protected (to 10%) and give up the pass-on to the heirs.

as i explained earlier ....putting 100,000 into a bond ladder may provide someone with about 2.000 a year to withdraw for life figuring 5% and 3% inflation.

 

[Gearhead Jim]

we've got a ton of threads about determining your SWR and the importance of not exceeding it. The example I posted above, with conditions that are typical for many people, gave a 3.5% SWR. The inflation annuity gave 4.1% and people say it's junk.

Yes, some people under some circumstances, will do better than the inflation annuity. But some people will do worse.

Again, I'll say that the product is too new for us to understand all of the ramifications. Time, experience, and careful thought will help us understand it's place in some people's portfolios. BTW, while in retirement I would NEVER put a high percentage of my portfolio in any one type of investment (including inflation annuities) no matter how good it looked.

 

[2B]

I don't see that you have supported your argument that fixed income investments beat annuities.  As mathjack shows (below) you can take out a perpetual income stream of about 2% if today's rates continue as is  leaving the principle (un-inflated) intact for heirs.  No inflation protection on the income stream and not much help if you need a 4% stream.  Over at Vanguard a mid/late 50s couple can pick up a joint annuity that pays out about 4%, inflation protected (to 10%) and give up the pass-on to the heirs.

I don't know what you pro-annuity people are smoking but it must be real good stuff......

If you look at the actual interest rate used to calculate fixed annuities you will find it is 3% or less. The insurance company then throws in a longevity hedge since they are pretty sure people with terminal cancer don't buy lifetime annuities which lowers this. If you buy an inflation indexed annuity, that is hedged too in the form of a lower starting interest rate. The annuity is then calculated to payout over a recipient's actuarial lifetime. Since you rocket scientists all assume you will live forever, it looks like a great deal. You get all excited about a 7% payout and don't bother to consider that you are getting a bunch of your principal back and, on average, you'll be dead in your 80's.

If you start with CD's, you can get over 5%. These are also insured by FDIC so it's really likely you'll get your principal back should the financial institution collapse which is a whole lot better than if its the insurance company that sold you your annuity. They have been known to go under. That's a technical financial term that means they stop paying.

You can get CD's out 10 years and probably longer. There are US bonds that go out as long as 30 years if you are really focused on doing it once and forgetting about it. Personally, we are in the midst of historically low interest rates so I don't think that now is the time to go real long.

You can actually take principal out of your laddered CD's!!! What a concept!!!!! You can get the same wonderful 7% withdrawl rate the annuity offerred!!!!!!

If you run the numbers, which I have, you will find that you will need to live about 15 years past your normal, predicted life expectancy to break even! That is if your insurance company doesn't go broke paying their management their big bonus they all deserve.

Annuities have high fees and commissions to support the sales staff. Annuities invest in the same financial instruments available to us mere mortals. You aren't going to "game the system" and get free money.

I am still cleaning up the annuity mess my FIL got into. He put most of his available cash into annuities (fixed and variable) about the same time I saw his Alzheimer's symptoms appear. When he talks about his "investments," he is adament about the great returns he's getting. They were 2.7% last year.

If you people have bought annuities and are trying to defend your mistake, get over it. If you haven't bought them yet, don't. The longer you wait the more the payout will be for your "investment." Do like my FIL did and wait until Alzheimer's sets in. Then you'll have an excuse.