annuities?

[cyclone6]

Does anyone who is er'd or close to er use annuities? I see that Vanguard has some that are quite cheap - at least compared to the average costs.

I guess I have a problem seeing what gap they could fill in a well diversified portfolio. What advantages, if any, do they provide over bonds or CDs?

How are any of you, if anyone has one, using them?

Thanks...

 

[Brat]

Brewer is the go-to guy on fixed income.

I haven't purchased any immediate annuities but I think they work for many. IMHO if the immediate annuity is to run more than 5-10 years you need to consider one with the inflation feature (usually 5% compounded/yr).

 

[Rich_by_the_Bay]

Does anyone who is er'd or close to er use annuities? I see that Vanguard has some that are quite cheap - at least compared to the average costs.

I guess I have a problem seeing what gap they could fill in a well diversified portfolio. What advantages, if any, do they provide over bonds or CDs?
How are any of you, if anyone has one, using them?

Search the forum here for "Immediate annuities" or such. This is a controversial topic which arises every month or so. You should find what you need.

Short version: some feel it provides valuable longevity and volatility insurance when used carefully and selectively. Others feel you can always do better by self-annuitizing if you have the discipline, since the insurance company fees can be avoided. Both agree that variable (as opposed to immediate) annuities are worthless. Both agree that if you do this, use only a relatively small portion of your nest egg for it, like 20-25% max. There are cogent arguments on both sides.

 

[brewer12345]

Further to Rich's post: in a nutshell, payout and fixed annuities equal fixed income (bonds, CDs, etc.). Pretty much an equal substitute, IMO. As with fixed income, the biggest problem with annuities is inflation eating up the value of the payouts ver time. I think payout annuities work best for older people, so you won't see many 40-something retirees buying them.

 

[Rich_by_the_Bay]

Further to Rich's post: in a nutshell, payout and fixed annuities equal fixed income (bonds, CDs, etc.). Pretty much an equal substitute, IMO. As with fixed income, the biggest problem with annuities is inflation eating up the value of the payouts ver time. I think payout annuities work best for older people, so you won't see many 40-something retirees buying them.

Payout v. Immediate annuities? Is Payout a special type or are you using the word generically?

Also, anyone know of a good calculator for setting up a self-annuitization acct schedule (e.g. enter duration, APY, compounding periods, starting principle and come out with monthly payments)? I guessed that mortgage calculators essentially do that (pretending that you are the bank) but the numbers don't match those on the calculators at Vg, BH, etc. Of course the problem in any case is that when you do it yourself, you can never lock in an APY for 25+ years.

 

[brewer12345]

Payout v. Immediate annuities? Is Payout a special type or are you using the word generically?

Also, anyone know of a good calculator for setting up a self-annuitization acct schedule (e.g. enter duration, APY, compounding periods, starting principle and come out with monthly payments)? I guessed that mortgage calculators essentially do that (pretending that you are the bank) but the numbers don't match those on the calculators at Vg, BH, etc. Of course the problem in any case is that when you do it yourself, you can never lock in an APY for 25+ years.

Payout = Immediate. Just generic terms.

A mortgage calculator should get you close enough. You are basically talking about an amortization schedule, so any mortgage calculator can do it. The problem comes in selecting the appropriate term. Life insurers can calculate this via the law of large numbers (write enough policies and everyone averages out - in aggregate, people die on schedule). Just make your best guess based on your expected longevity.

 

[Dawg52]

Further to Rich's post: in a nutshell, payout and fixed annuities equal fixed income (bonds, CDs, etc.).  Pretty much an equal substitute, IMO.  As with fixed income, the biggest problem with annuities is inflation eating up the value of the payouts ver time.  I think payout annuities work best for older people, so you won't see many 40-something retirees buying them.

I totally agree. I don't plan on buying one anytime soon but I could see myself buying one when I get older. I think a lot of people when they get old just want to put it on autopilot and an annunity will help do that. Social Security + a small annuity =  monthly cash flow needs. Keep the rest invested in a balance mix of investments. 

 

[brewer12345]

I totally agree. I don't plan on buying one anytime soon but I could see myself buying one when I get older. I think a lot of people when they get old just want to put it on autopilot and an annunity will help do that. Social Security + a small annuity =  monthly cash flow needs. Keep the rest invested in a balance mix of investments. 

Sounds reasonable. Just make sure that the rest of the portfolio is able to make up for teh inevitable erosion of purchasing power caused by the annuity. I have also heard of people buying a series of annuities period certain for 5 or 10 years. So you buy such an annuity, it pays out for 5 or 10 years regardless of whether you live or die, and then you buy another one.

 

[New Thinking]

Although I am biased, I respectfully disagree that they are essentially fixed income..They may be backed by the purchase of fixed income assets, but they pool longevity risk, so if you live longer than average, you receive a higher income lifetime return than other individual fixed income investments. They also provide an asset/liability match so that you don't have to do it yourself (i.e. laddering bonds or CDs since you need income each month)

If you adopt a SWR with a bond fund component, you must lower your monthly income (and enjoyment of retirement) because you face market risk due to the fluctuation of interest rates. For example, The Wall Street Journal reported yesterday "... the average U.S. Treasury bond fund returned a negative 2.8% for the year ended June 20, and the average TIPS fund returned a negative 2.1%, according to Lipper."

Many people don't understand that bond values go down when interest rates rise and fewer recognize that a big component of bond mutual fund returns over the last 20+ years was driven by decreasing interest rates and thus price appreciation.

I respect that many board members wish to self-insure and they most likely do a great job of it..It just shouldn't be for everybody IMO.

 

[MasterBlaster]

Some people on this board have avocated an income mutual fund (like Vanguard Wellesley) as a substitute for an immediate annuity or a strict bond-only approach. This fund currently has an income yield of just over 4.5 percent and that income is likely to increase with inflation.

You could probably spend all of the income in that fund and still keep up with inflation. Then you can either pass the fund balance on to your estate when you die or alternately dip into the principal as you get older. Annuities pay about the same as the Wellesly fund, usually have no inflation protection, and keep the principal when you die. There is some market risk with an income mutual fund however some beleive that they beat the pants off of an immediate annuity.

 

[GMueller]

I know little about annunities and have a question. Can I purchase an annunity with a payment period for a fixed number of years? For example, can I purchase an annunity that will provide income for up to 20 years and after 20 years all payments would cease? It seems to me that such an annuity might furnish income greater than I could achieve with other fixed income vehicles because of the effects of risk pooling (i.e., some annuitants will die early and won't collect for the full 20 years). Of course, I'm gambling that I will live at least 20 years so as to enjoy the benefits. I don't need income for life, just a little extra while I am young enough to really enjoy it.

 

[brewer12345]

I know little about annunities and have a question.  Can I purchase an annunity with a payment period for a fixed number of years?  For example, can I purchase an annunity that will provide income for up to 20 years and after 20 years all payments would cease?  It seems to me that such an annuity might furnish income greater than I could achieve with other fixed income vehicles because of the effects of risk pooling (i.e., some annuitants will die early and won't collect for the full 20 years).  Of course, I'm gambling that I will live at least 20 years so as to enjoy the benefits.  I don't need income for life, just a little extra while I am young enough to really enjoy it. 

Sort of. What you have in mind is known as an annuity period certain or an annuity certain. With this type of payout annuity, payments continue for the specified number of years regardless of whether you are still alive for the full period. If you drop dead before the end of the specified time period, payments are made to your estate/alternate beneficiaries. I don't know of any annuities certain that stop payment if you die.

 

[Nords]

Although I am biased, I respectfully disagree that they are essentially fixed income..They may be backed by the purchase of fixed income assets, but they pool longevity risk, so if you live longer than average, you receive a higher income lifetime return than other individual fixed income investments.

I'm biased too, but let me make sure I understand this math.

Fixed income assets will presumably stay with an investor for the rest of their life too. So if one lives longer than average, their fixed income assets will still stay with them for longer than average, giving them a higher lifetime income than the other average guys.

From my perspective, having fixed income assets for the rest of my life appears to be the same as having an annuity that lasts for the rest of my life, except for two things-- an annuity means that I'll be paying someone else to take care of my assets for me, and I won't have anything left in the estate when I die.

So explain that "you receive a higher income lifetime return than other individual fixed income investments" again?

 

[brewer12345]

Although I am biased, I respectfully disagree that they are essentially fixed income..They may be backed by the purchase of fixed income assets, but they pool longevity risk, so if you live longer than average, you receive a higher income lifetime return than other individual fixed income investments. They also provide an asset/liability match so that you don't have to do it yourself (i.e. laddering bonds or CDs since you need income each month)

If you adopt a SWR with a bond fund component, you must lower your monthly income (and enjoyment of retirement) because you face market risk due to the fluctuation of interest rates.  For example, The Wall Street Journal reported yesterday "... the average U.S. Treasury bond fund returned a negative 2.8% for the year ended June 20, and the average TIPS fund returned a negative 2.1%, according to Lipper."

Many people don't understand that bond values go down when interest rates rise and fewer recognize that a big component of bond mutual fund returns over the last 20+ years was driven by decreasing interest rates and thus price appreciation.

I respect that many board members wish to self-insure and they most likely do a great job of it..It just shouldn't be for everybody IMO.

I hate to break this to you, but the things that change the the value of the bonds and TIPS you are excited about also change the market value of a fixed payout annuity. Just because you don't see the annuity marked to market every day doesn't mean that you didn't gain or lose based on interest rate movements and the passage of time.

 

[Rich_by_the_Bay]

Fixed income assets will presumably stay with an investor for the rest of their life too. So if one lives longer than average, their fixed income assets will still stay with them for longer than average, giving them a higher lifetime income than the other average guys.

I think the analogy is to self-annuitizing, not just sitting on fixed investments. In that case, the annuitized fixed income assets will run out at some point, unless you choose a very long payout period which reduces payments, of course.

It's interesting: annuities calculated at 5.xx% generally pay out at over 7% of principle each year. Conservative fixed income assets which are not annuitized pay the usual 4-5% per year.

For me, the insurance company and inflation erosion pieces are a tradeoff against fixed income yields fluctuating when I can least afford it, running out of money if I self-annuitize for too short a time, or lower-than-optimal payments if I self-annuitize over too long a period. Still on the table for when I get to be 65 or older; too far off to decide right now (age 57).

 

[Nords]

It's interesting: annuities calculated at 5.xx% generally pay out at over 7% of principle each year. Conservative fixed income assets which are not annuitized pay the usual 4-5% per year.

I wonder if the difference between 5.xx% and 7% is the cost of the annuity and just a return of your principal...

 

[brewer12345]

Hmmm, let's see. Life expectancy for a 65YO is what, 83? So 17 years of life expectancy. The annuity gives you an extra, say, 1.75% payout a year. So 1.75% times (83-65) equals 31.5% of your principal paid back to you.

Its a little sloppy since they wouldn't have the entire principal amount to collect interest on the whle tme, but ~70% of your principal to work with is a pretty big cushion/profit margin.

 

[Rich_by_the_Bay]

I wonder if the difference between 5.xx% and 7% is the cost of the annuity and just a return of your principal...

No, real dollars net of expenses (the expenses are why it's, say, 7.3% rather than 7.5% or such). It's return of principle - as such that portion is not taxable.

 

[New Thinking]

So explain that "you receive a higher income lifetime return than other individual fixed income investments" again?

Dr. Brown at U of Ill-Champaign put in best when discussing immediate annuities and the risk-pooling of longevity..."Equally important, a life annuity has the potential to provide a higherlevel of sustainable income than can be achieved with other financial assets.This is because a life annuity is an insurance product that pools resources across a large number of annuity buyers, essentially using the resourcesof those who die earlier than expected to pay higher benefits to those who live longer than expected. The “cost” of this approach is that assets that are converted into a life annuity stream are no longer available to leave as a bequest. In exchange, however, the life annuity provides surviving individuals with a higher rate of return than the individual
could get on an otherwise similar, but unannuitized, portfolio.
The extra rate of return that a life annuity can pay is sometimes called a
“mortality premium” because it is essentially an extra rate of return that
annuitants can earn in return for giving up their claim on their assets at
death. To illustrate this concept in a simple, hypothetical example, suppose
that at the beginning of the year 100 people each invest $1 in bonds
earning 5 percent interest, and that 95 of them are still alive at the end
of the year. Each of the 95 survivors would have $1.05 to consume,
while the five decedents would leave $1.05 to each of their estates. If
instead, each of these 100 individuals had pooled his or her money
through an annuity contract, each of the 95 survivors would receive
$105/95 = $1.10 to consume. Thus, the annuity contract provides an
extra 5 percent rate of return – the mortality premium – in exchange for
reducing the resources available for a bequest."

 

[unclemick]

I have the evil left handed version - trad IRA and the boys at IRS with their RMD. I notice I'm allowed to croak at 84.6 instead of 84.3 like the old days(circa 1993).

Apparently their 'fees' are called income tax so that's ok - I guess.

heh heh heh

 

[cute fuzzy bunny]

Dr. Brown at U of Ill-Champaign

A fake name if I ever heard one...



So does the wellesley funds payout of 10.6% annually over the last 36 years, with an income component almost always exceeding 4.5% not a contender because its not a pure 'fixed income fund'?

 

[Rich_by_the_Bay]

So does the wellesley funds payout of 10.6% annually over the last 36 years, with an income component almost always exceeding 4.5% not a contender because its not a pure 'fixed income fund'?

With 35-40% in stocks I'd say probably more like a conservative blended fund. Pretty good one at that, but the volatility, while low compared to standard index funds, isn't like treasuries which is what I think the original analogy implied (hypothetical straight 5% per year).

It has ranged from 4.79 to 8.67% on 1 and 10 year returns, probably more on year-to-year numbers (too lazy to find them).

 

[spideyrdpd]

Hi
It still confuses me why one wants an annuity . My sister that is able to retire on friday at 55 is putting a small portion of her funds in one. Now that you guys menion it the description was the same as a bond. I dont think I got an answer why its better than a cd since the rates arent that much better and your locking yourself into a fixed rate. She will be able to get her money back out. I believe that she has to wait 5 yrs or there is some penalties.
I did consider it to be a compromise since she is putting more money into the family real estate business and a good portion of the money will go into equities.

 

[brewer12345]

Hi
   It still confuses me why one wants an annuity . My sister that is able to retire on friday at 55 is putting a small portion of her funds in one. Now that you guys menion it the description was the same as a bond. I dont think I got an answer why its better than a cd since the rates arent that much better and your locking yourself into a fixed rate. She will be able to get her money back out. I believe that she has to wait 5 yrs or there is some penalties.
I did consider it to be a compromise since she is putting more money into the family real estate business and a good portion of the money will go into equities.

Um, I think you have signals crossed. Most of the posts on this thread are referring to a payout annuity. Payout annuities involve the buyer giving the insurer a pile of cash in exchange for a stream of payments that can go for a specified time period or life. Once you buy a payout annuity, you are locked in and you cannot get your money out.

It sounds like your sister purchased what is known as a deferred annuity, which is a bit of a misnomer. A deferred annuity works like a CD: you put money in, and in the future you get the money plus a return back. It is still considered an annuity because you technically have the right to annuitize the value of your annuity, but almost nobody does so. The deferred fixed annuity your sister bought is essentially a tax advantaged CD with high fees.

 

[donheff]

Hi
It still confuses me why one wants an annuity .

It is all about certainty. People worry about a "black swann event," something extremelly unusual that blows all the bets away. An annuity, for example, could address circumstances that result in a collapse that continues unabated for twenty years right after you retired. That is why some people put everything in CDs and Treasuries - they want risk to be a close to zero as possible.

Of course, if the ice fields melt and seas rise twenty feet in 10 years instead of 100, and the gulf stream shuts down, nothing will work