Wade Pfau- How are annuities better (different) from bonds?

[mathjak107]

i saw that too and wondered about the update .

he did sy it beat it 67% of the time , not 100% and i can see that , especially if sequence risk and market risk are not the greatest .

but we still want to see those updated numbers .

 

[Independent]

Maybe I have enough to self-insure.

.
This may be the key. Many people here have enough money that they don't see any meaningful longevity risk. No reason to pay an insurer to assume an uncertainty that's not significant to me.

Of course, that's not true about everyone.

 

[mathjak107]

i agree however planning for my wife is another story.

eventually we will migrate to some insurance products.

she wants the security if i am not here of a pay check at least covering essentials.

she was a widow once already so she does not want a complex pile of investments dropped in her lap .

many wives feel that way . while the husband is into investing and index's and allocations they are not.

they have the proverbial image of a homeless bag lady in their head who has out lived her money.

while 80% of all married men die married , 80% of all married women die alone as well as live longer.

so while most of us men feel we don't need no stinkin insurance products you really have to consider the wife factor in the equation too.

locking in non descretionary spending in to a pay check and then using simple investments like wellesley for inflation protection and the wants may be a very comfortable idea to her .

it can also be the reverse in some relationships but the longer longevity of women usually creates additional issues .

i just retired last week so for now i do all the investing but i can see in a decade or so migrating some money over .

 

[Hermit]

pfau is a researcher he sells nothing.

Phau works for The American College. It is supported by and provides courses for the finance industry. It is "accredited" by The Middle States Commission on Higher Education. This is not to be confused with the Middle States Association of Colleges and Schools which is one of 6 regional accrediting organizations for colleges. I think it would more clear to say he is a researcher in support the financial community that certainly does sell financial goods and services.

 

[mathjak107]

but many times he goes against various types of products they sell as well .

to quote pfau on variable annuity's

"But after examining historical data, Pfau found that these products don’t provide guarantees of any real value. One, the withdrawals decrease on an inflation-adjusted basis.

“Prospective retirees may be overvaluing the guarantees in their mind because they are not properly considering how inflation will erode their real value over time,” he wrote in his paper. “In behavioral economics, this bias is known as money illusion. People can logically understand the effects of inflation, but their emotional responses and decisions remain attached to nominal values.”

two: retirees could do better using a plain-vanilla systematic withdrawal plan. "

 

[Texas Proud]

Former researcher here.

As far as I know public funding does not determine outcomes, but it does influence what gets investigated.

Frequently it ends up being a game: You repackage what you want to research or already are researching into the "fad of the grant year".

For example in ICT, suddenly distributed computing becomes "cloud computing", and wireless low power networks becomes "the internet of things". Grant bodies are happy, research institution merrily goes on doing what they already were doing.

I have never seen anyone steering or adjusting results though because it went against the (perceived) agenda (political or otherwise) of the granting entity.

No idea how that transfers to private funding - but we all remember tobacco funded research 'proving' no link with lung cancer. So in that case we all could rightfully be suspicious.

Not to defend the tobacco companies... but they were using artful words like some politicians....

I think they were saying that no causal proof to lung cancer... there was plenty of circumstantial evidence to prove it, but no 'smoking gun'.... (pun intended)... I have not looked, but wonder if this still holds up or not...

 

[Chuckanut]

f I have $1M in bonds, why should I give it over to an insurance company, pay them a fee and a sales commission and allow them to take the remaining money and invest it in bonds to pay me money, when I can just invest in bonds myself.

Are insurance companies limited to just investing SPIA $$'s in bonds?

I was under the impression that insurance companies invest in many things: bonds, stocks, commercial real estate, commodities, etc. Am I wrong?

 

[Chuckanut]

<snip>
she was a widow once already so she does not want a complex pile of investments dropped in her lap .
<snip>
i just retired last week so for now i do all the investing but i can see in a decade or so migrating some money over .

Good points.

And may I add that any man or woman who lives long enough may suddenly realize that he/she no longer can manage the investment very well. For most of us our cognitive powers and energy decline with age. A simple investment strategy with a comfortable guaranteed floor and somebody else balancing things for additional income would be very desirable.

Also, FWIW, it's hard to swindle an older person out of money that's been annuitized.

 

[fritz]

i agree however planning for my wife is another story.

eventually we will migrate to some insurance products.

she wants the security if i am not here of a pay check at least covering essentials.

she was a widow once already so she does not want a complex pile of investments dropped in her lap .

many wives feel that way . while the husband is into investing and index's and allocations they are not.

they have the proverbial image of a homeless bag lady in their head who has out lived her money.

while 80% of all married men die married , 80% of all married women die alone as well as live longer.

so while most of us men feel we don't need no stinkin insurance products you really have to consider the wife factor in the equation too.

locking in non descretionary spending in to a pay check and then using simple investments like wellesley for inflation protection and the wants may be a very comfortable idea to her .

it can also be the reverse in some relationships but the longer longevity of women usually creates additional issues .

i just retired last week so for now i do all the investing but i can see in a decade or so migrating some money over .

Retirement is as unique as the individual himself. Much too much information about retirement is placed into generalities, and probably causes more confusion than clarity. Keeps places like Yahoo finance profitable with daily articles. Also keeps people in the industry like Wade Pfau happily employed.

Not all the information put out for perusing is completely accurate. Some is meant to intentionally drive those light in financial expertise, straight into the arms of those willing to help them (and possibly help themselves as well). There are many good people out there, but there are some who do not always act in your best interest.

We retired at 58/56 and have been retired for +5 years now. We are fortunate to have saved/invested well, and live comfortably off them in retirement (no pensions or annuities). Don't see us buying any annuities, but not opposed to SPIAs - which get inflicted with the same bad press as the other no-so-great types of annuities.

I am the financial person in our marriage, and yes, my wife has zero interest in managing our finances. It's not that she can't (she was a banker), she just leaves it to me. This is troubling and I have had to figure out a way to insure that things will roll along as they are now for the rest of her life. This applies to me as well, as I'm pretty sure that somewhere along the way, I'll lose my financial edge and won't know it.

I have our investments set @ 52/48 stock/bond for growth and to automatically rebalance and pay out a nice stream of income for the both of us until it's no longer needed (Balanced Funds - the most underrated retirement investment vehicle IMHO). It should last for the rest of our lives and then automatically be passed along to our daughters. Our agreement is that when we notice we're no longer as sharp with our finances, our daughters will take over for us. When one of us passes, our daughters will be advised of our financials and to take over when necessary. There is also a written "what to do when" document for my wife/them when the time comes. Works for us, but as I said upfront - retirement is as unique as the individual himself.

 

[Independent]

Are insurance companies limited to just investing SPIA $$'s in bonds?

I was under the impression that insurance companies invest in many things: bonds, stocks, commercial real estate, commodities, etc. Am I wrong?

Life insurers can invest in a lot of things, but the economics push them into things with stable values.

States require some "surplus", which is just the excess of assets over liabilities.

How much surplus depends on how much risk the company is absorbing.
For the investment risk, the statutory "Risk Based Capital" formula uses a much higher multiple for stocks than for bonds. IIRC, the base is 30% for stocks and 1-2% for investment grade bonds. Furthermore, the company needs to maintain that assets minus liabilities cushion at the end of every accounting period (at least annually, but maybe quarterly). So, if you're holding lots of stocks, and stocks went down recently, the "assets" side is down, but you still need the same cushion.

Generally, stockholders don't want to tie up all that capital. If the company is calculating some return on capital to demonstrate good performance, surplus is a drag. Bonds reduce your capital requirements and allow a better ratio of profits to capital.

 

[clifp]

This is as the best answer I have yet seen...not entirely satisfactory, but closer to convincing me. My main question was that if I have $1M in bonds, why should I give it over to an insurance company, pay them a fee and a sales commission and allow them to take the remaining money and invest it in bonds to pay me money, when I can just invest in bonds myself.

The reasons I remain skeptical of paying the middle man to take the sequence of returns risk is that a bad sequence of returns CAN wipe out insurance companies, too. Also as Pfau's buddy and some time co-author, Michael Kitces, recently pointed out, bond fund holders of shorter duration bonds can be just fine even in the supposedly terrible forthcoming rising-rate environment,

https://www.kitces.com/blog/how-bon...ve-help-defend-against-rising-interest-rates/

so the boogie man of an economic storm wiping out my money before I die just seems either unlikelier or at least a similar threat to the annuity companies as it is to me.

I agree. The benefit of annuities vs bonds is all the dead bodies (nice phrase mathjack ). One of the reasons that annuities aren't too interesting to this crowd, is that the dead bodies don't really start to pile up until people hit their 70s.

I also have the same fear you do in in an economic storm taking out insurance companies.

It seems to me that one of most likely bubble we are going to have in the next decade is a bond bubble. The massive amount of liquidity injected into the world economy is certainly a key ingredient. Moreover the massive debt pile up by the developed economies gives government a strong incentive to increase inflation. Now obviously I and many other have been wrong about this for years, but I don't think the economic fundamentals have changed.

The big holders of bonds are insurance companies.
One of thing that struck me reading lots of books about the financial crisis is the pretty low sophistication of life insurance companies.

Michael Lewis and Aaron Sorkin were both pretty harsh on them. Consequently they got stuck holding lots of AA and AAA rated CDO, CDO^'2 CMO an all the other crazy products. Companies like Goldman Sach held very little before the prices collapsed and a few hedge funds made money (The Big Short). About the only group of investors that were less sophisticated than insurance companies were city and county treasurers. What saved insurance companies was their lack of leverage and the rise in the value of treasury and high grade corporate.

My other area of concern is that insurance are regulated at the state level. With 50 points of failure this really increases the risk of incompetence or bribery.

 

[RetireBy90]

An SPIA's cost is determined by a pooled "average" lifespan, so if you live extra long, you get extra value. With portfolio withdrawals you have to allow for the possibility of an extra long lifetime, reducing your income from what you could have spent if you knew you would live to the average lifespan. And most likely leaving some of your portfolio to your estate instead of spending it all.

The benefit of a SPIA is that you get the pooled coverage. If I didn't have pension income to cover required expenses, I would think harder about one. I would have to buy direct from the company, to cut out commissions.

On the other hand some of our posters bought rental real estate to get a monthly check, and I also have the same. You get the check as long as you need, and have the house left when ever you need the cash or to your estate. It is better to have 3 or 4 and to pay someone to manage but you I get a check each month without the guarantee.

Just my view.

 

[mathjak107]

except as a landlord i can tell you :

you don't have to evict an annuity and get no rent and have legal fees .

an annuity does not complain the toilet is stuffed at 1:00am

the annuity check keeps coming even as you are out looking for a tenant

you don't have to renovate or repair damage to an annuity.


they are clearly not even close to being an equal.

you may as well consider a part time job the equivalent because that is what real estate is .

 

[Dawg52]

Good points.

And may I add that any man or woman who lives long enough may suddenly realize that he/she no longer can manage the investment very well. For most of us our cognitive powers and energy decline with age. A simple investment strategy with a comfortable guaranteed floor and somebody else balancing things for additional income would be very desirable.

Also, FWIW, it's hard to swindle an older person out of money that's been annuitized.

This is the main reason I might consider buying an spia one day. The parents of a good friend of mind blew their entire savings at a casino over the last few years. I knew his parents, his dad was an engineer and his mom appeared as level headed as they come. But when they reached their 80's, they became bored and headed to the slot machines. My friend thought they were just going for the food and playing nickle slots. Turns out they were playing $5 slots.

I'm sure most here can't imagine that happening, but you just never know. I'm not planning to turn a high percentage of my savings over to an insurance company, just enough to supplement SS to meet essential expenses.

 

[mathjak107]

usually one spouse is the investor and the other goes along for the ride.

what the bogleheads of the world forget is most folks have no interest in investing as a hobby .

many , especially our wives would rather have that pay check in their account then have their income solely based on the market gods jut because their husbands felt they could get an extra point or two .

just something i am focused on since my wife lost 1/2 her savings before i met her because she trusted the broker at her bank to put her in the right investments.

he threw her in tech and dot coms .

 

[mathjak107]

I agree. The benefit of annuities vs bonds is all the dead bodies (nice phrase mathjack ). One of the reasons that annuities aren't too interesting to this crowd, is that the dead bodies don't really start to pile up until people hit their 70s.

I also have the same fear you do in in an economic storm taking out insurance companies.

It seems to me that one of most likely bubble we are going to have in the next decade is a bond bubble. The massive amount of liquidity injected into the world economy is certainly a key ingredient. Moreover the massive debt pile up by the developed economies gives government a strong incentive to increase inflation. Now obviously I and many other have been wrong about this for years, but I don't think the economic fundamentals have changed.

The big holders of bonds are insurance companies.
One of thing that struck me reading lots of books about the financial crisis is the pretty low sophistication of life insurance companies.

Michael Lewis and Aaron Sorkin were both pretty harsh on them. Consequently they got stuck holding lots of AA and AAA rated CDO, CDO^'2 CMO an all the other crazy products. Companies like Goldman Sach held very little before the prices collapsed and a few hedge funds made money (The Big Short). About the only group of investors that were less sophisticated than insurance companies were city and county treasurers. What saved insurance companies was their lack of leverage and the rise in the value of treasury and high grade corporate.

My other area of concern is that insurance are regulated at the state level. With 50 points of failure this really increases the risk of incompetence or bribery.

the annuity's give you the mortality credits up front where they count .

when you think about the thread where we discussed kitces's method of increasing withdrawals basically it is opposite of what you want.

you do not want to take higher withdrawals down the road if markets do well . the reality is most of us want the opposite , we want that money early on in retirement .

that is also an spia strong point . you can have more cash flow earlier instead of first having to see if your investing can support that much years later.

there is a lot to be said for the use of spia's and your own investing . .

 

[Huston55]

I believe the graph in post #2 is just saying that you can spend more safely with an annuity. He's talking a single payment immediate annuity or deferred income version, which are not terrible choices. The portfolio, or bonds, can run out or not generate enough income in time. The annuity is guaranteed income for life, and about the only way to "safely" spend your last dime before you die. An SPIA's cost is determined by a pooled "average" lifespan, so if you live extra long, you get extra value. With portfolio withdrawals you have to allow for the possibility of an extra long lifetime, reducing your income from what you could have spent if you knew you would live to the average lifespan. And most likely leaving some of your portfolio to your estate instead of spending it all.

I suspect that Dr. Pfau is not including real-world fees in his annuity costs. He is an academic after all, not an annuity salesman. I haven't seen fees and annuity lifetime adjustments discussed in his papers. To that extent he may be somewhat optimistic. But I think he's got some good ideas here.

A few of us on this forum have discussed our "Plan B" (or higher) of buying an SPIA if our portfolio value drops to the point where our retirement is in danger but we can still afford an SPIA that covers our expenses. That ensures no portfolio remainder for the estate, but also that you will have sufficient income for as long as you live. It's a good way to safely maximize your income while you are living. I probably won't be buying any annuities before then (other than Social Security at age 70), but I'm not a bond guy either.

+1

I am one of those. I will use Fullmer's "annuitization hurdle" concept or Otar's "zone" concept to guide any annuity purchase(s). You can find more info on these approaches in other E-R threads.

 

[Huston55]

i agree however planning for my wife is another story.

eventually we will migrate to some insurance products.

she wants the security if i am not here of a pay check at least covering essentials.

she was a widow once already so she does not want a complex pile of investments dropped in her lap .

many wives feel that way . while the husband is into investing and index's and allocations they are not.

they have the proverbial image of a homeless bag lady in their head who has out lived her money.

while 80% of all married men die married , 80% of all married women die alone as well as live longer.

so while most of us men feel we don't need no stinkin insurance products you really have to consider the wife factor in the equation too.

locking in non descretionary spending in to a pay check and then using simple investments like wellesley for inflation protection and the wants may be a very comfortable idea to her .

it can also be the reverse in some relationships but the longer longevity of women usually creates additional issues .

i just retired last week so for now i do all the investing but i can see in a decade or so migrating some money over .

+1

IMO this reflects a well thought out strategy for 'couples.' It's typically the husband who's the financial lead but, not always. In either case, I believe it's wise to accommodate the financial aptitude and attitude of both people in a couple, as 'mathjak' suggests. Even it if means giving up a bit of control, and even a small bit of return, it can accomplish a greater goal.

PS: Congrats on your recent FIRE!

 

[bmcgonig]

+1



I am one of those. I will use Fullmer's "annuitization hurdle" concept or Otar's "zone" concept to guide any annuity purchase(s). You can find more info on these approaches in other E-R threads.

The timing of when to buy that annuity always gave me trouble. The chances are that you may hit that hurdle deep in a bear market for stocks. Then do u sell everything and buy the annuity? Or wait ?


Sent from my iPad using Early Retirement Forum

 

[daylatedollarshort]

I have not done a comparison lately but the times I checked in the past a TIPS ladder came out favorably for us compared to an annuity, at least at our ages - government backed, inflation adjusted, no fees, liquid and the balance if we die early goes into the estate.

 

[pb4uski]

Are insurance companies limited to just investing SPIA $$'s in bonds?

I was under the impression that insurance companies invest in many things: bonds, stocks, commercial real estate, commodities, etc. Am I wrong?

Generally speaking, insurers will invest assets backing reserves for payout annuities (which would include SPIAs) in bonds. Assets backing surplus supporting liabilities might be invested in other asset classes.

 

[Ticker]

This is as the best answer I have yet seen...not entirely satisfactory, but closer to convincing me. My main question was that if I have $1M in bonds, why should I give it over to an insurance company, pay them a fee and a sales commission and allow them to take the remaining money and invest it in bonds to pay me money, when I can just invest in bonds myself.

The reasons I remain skeptical of paying the middle man to take the sequence of returns risk is that a bad sequence of returns CAN wipe out insurance companies, too. Also as Pfau's buddy and some time co-author, Michael Kitces, recently pointed out, bond fund holders of shorter duration bonds can be just fine even in the supposedly terrible forthcoming rising-rate environment,

https://www.kitces.com/blog/how-bon...ve-help-defend-against-rising-interest-rates/

so the boogie man of an economic storm wiping out my money before I die just seems either unlikelier or at least a similar threat to the annuity companies as it is to me.

Maybe I have enough to self-insure.


Thanks for the link. I had never considered the premise of rolling down the yield curve, makes a lot of sense and gives me reason to reconsider medium term bond funds.

 

[Ed_The_Gypsy]

If interest rates were higher today, annuities would make more sense to me.

I am not completely averse to them now that I am in decumulation phase, but I would not like to be locked into a law interest rate vehicle just now.

But all here know of my poor judgement.

Sent from my SM-G900V using Early Retirement Forum mobile app

 

[Running_Man]

Thanks for the link. I had never considered the premise of rolling down the yield curve, makes a lot of sense and gives me reason to reconsider medium term bond funds.

For all the nice theory about gaining value by selling with an upward sloping yield curve truth is the 3-7 US treasury bond fund by I shares has returned a average of 2.59% over the last 5 years or about the same as you could have bought a 5 year treasury for in 2010, on the other hand 5 year treasuries also sold for a yield of 1.11 in 2010 so you have to be pretty well lucky on when you are "rolling" your yield curve. Probably why for last 3 years the fund has only averaged a return of 0.98%.

And that low return is what Pfau is pointing out would make investing in the annuity preferable as the standard 4 percent withdrawal would mean upon rebalancing that you would be covering for the 3% drop in your bond value from the withdrawal from your stocks.

Simple example from last full 3 years 2012 -2014:
1000K Portfolio 480 K bonds(I Shares 3-7 Treas) 480K stocks (VTI) 40 MM
withdraw 40 K
Year 2012 : Start 480 Bonds 480 VTI END 490 Bond 558.96 VTI
Withdraw 40.84K for MM and rebalance inflation 2.1 %
Year 2013: Start 504.06 Bonds 504.06VTI END 494.23 Bonds 672.67 VTI
Withdraw 41.45K for MM and rebalance Inflation 1.5%
Year 2014 Start 562.73 Bonds 562.73 VTI END 580.39 Bonds 633.30 VTI
Withdraw 42.03 Inflation 1.4%
Start 585.83 Bonds 583.83 VTI

Now if instead you use Wade's 5.37% for Joint and Survivor annuity in place of the 500K bonds (and I believe it was closer to 6.24 % back in 2012 but anyway) you get $26,850 per year payout meaning you need $13,150 in MM start of year:
Start 2012 13.15MM 486.85 VTI End: 566.94 VTI
Withdraw 13.99 (40.84 - 26.85 Annuity)
Start 2013 552.95 VTI End: 737.91 VTI
Withdraw 14.60 (41.45 - 26.85)
Start 2014 723.31 VTI End: 814.01 VTI
Withdraw 15.18 (42.03 - 26.85)
Start 2015 798.83 VTI

And you can see in just 3 years even though you bought the annuity with the bond portion of your portfolio, the lower withdrawal rate and lack of needing to replenish a bond fund that with present yields will underperform the withdrawal rate you have 35% more invested in stocks by the start of 2015 than in the standard 50/50 portfolio. And you have 68.03% of the value of the standard portfolio.

http://www.etfreplay.com/etf/vti.aspx
https://www.ishares.com/us/products/239455/ishares-37-year-treasury-bond-etf

 

[mathjak107]

yep , it is the delaying of selling equities because the annuity has a higher draw rate that gives it the income edge.

a good portion of what you get in an spia is mortality credits from the dead bodies and while rates matter ,your age and mortality credit make changes in rates not all that big of a deal.

you can ladder the annuity's , that way at this stage you stand a chance of catching the higher rate , the mortality credit and the age increases.

i think around 70 is the sweet spot to start looking in to this for my final structure . i am 62 now .