Annuities - Opinions Yay or Nay?

[Clone]

I think that this board is rather aggressive about jumping on annuities as a bad deal. For some folks, they have been a great deal!

Like for the financial advisor that sold one to my mother! It was a great deal for him!

 

[Running_Man]

I'm not a big fan of annuities and would not by one myself. However, I think they have their place for some people, often for psychological reasons. In any case, below is some Food for Thought.

Below are three old ads for annuities.

$200 from 1950
$250 from 1954
$300 from 1961

Life expectancy in 1950 for a male 65 year old was 8 years in 1950, by 1965 inflation had made the $200 needed in 1950 was $249 in 1965

 

[copyright1997reloaded]

I don't see how. It's not the investment fluctuation that's the major issue. It's that it pays out on schedule whether you die tomorrow or live to 130. How would you cover that? It's insurance, and you're pooling "risk" of longevity with others, which you can't do with a group of one unless you cover the absolute "worst" case of living long.

As I think was mentioned in this thread, a tontine would be another way to do something similar, but those aren't legal in the US anymore.

Yes, I mentioned it and even mentioned illegality (in the USA) but was surprised that no one (until you) picked up on it.

That is as you note above the big issue with a DIY annuity is the how long are you going to live question. A tontine (somewhat) "solves" this because as others die, your share of the pool is increased. And if you die, who cares that others in the pool benefit.

 

[BeachOrCity]

No single answer for everyone but for folks who long for the days of defined benefit retirement plans putting a portion of the nest egg into a SPIA might provide a nice psyc benefit.

Additionally for folks who are healthy (actually anyone buying an annuity should be above average health for their age) buying a delayed or deferred annuity that begins to pay at 75 or 80 years of age can be a nice longevity or inflation hedge

I am not at all a fan of indexed annuities (ie tied to stick market for returns).

Bottom line is annuities merge longevity risk among purchasers and that is something I have never figured out how to do with anything I can go out and buy (not incl social security and a defined benefit pension)

Again no single answer.

 

[audreyh1]

I just did my monthly check on a 15 year period certain SPIA with no COLA. 1.58% APR. That is pathetic. I'll check again next month. I love how they say the payout rate is 8.24%. While that is absolutely the truth, they certainly don't advertise the APR as 1.58%.

With an annuity I only care about the payout rate.

 

[corn18]

With an annuity I only care about the payout rate.

That may be true for a life SPIA, but for a period certain SPIA, it is not. Why get a period certain SPIA yielding 1.58% when you can get more than that in an FDIC insured savings account. Just build your own SPIA.

 

[ShokWaveRider]

That may be true for a life SPIA, but for a period certain SPIA, it is not. Why get a period certain SPIA yielding 1.58% when you can get more than that in an FDIC insured savings account. Just build your own SPIA.

Agreed, but most people need to plan for 30 years I think.

 

[pb4uski]

Agreed, but most people need to plan for 30 years I think.

It would be a little work, but you could build a 30 year bond ladder for the gap amounts between your spending and retirement income.... or a fixed amount each year.

 

[Independent]

I have a faint recollection of my company talking about such a product when I was employed by a mid-sized insurer. I think we all agreed that it would be a good product and would be attractive to retirees. The struggle was how to invest the premium in matching assets whose return would increase with inflation so we could maintain a constant spread... I think it probably could have been done, but it would have been complicated to scale it to hundreds of millions... it ultimately lost steam.

Simple answer - TIPS.

I worked for one of the first (maybe the first) company to market a CPI indexed SPIA. A couple of us promoted the product when TIPS were new. It took a few years to get management on board and the product on the market.

Looking at the WSJ TIPS yield page, I see maturities of April 2028, April 2029, and April 2032 with coupons of 3.625%, 3.875%, and 3.375%. I think those are 30 year bonds issued in 1998, 1999, and 2002. We could get decent rates with yields like that. (Yes, they did not normally back SPIAs with treasuries, but we had a sharp investment guy who was willing to work on ways to get above treasury yields through swaps or internal trading.)

When TIPS yields went down, the pricing got unattractive and they eventually dropped the product.

 

[pb4uski]

^^^^ Perhaps, but if that was the easy answer then we would see many more inflation adjusted SPIAs in the market today. Besides, the discussions that I referred to were in the early 1990s before TIPs were available... they first came out in 1997 but only 10 year maturity and I left the company in 1998.

And then there is always that scaling to hundreds of millions thing.

 

[gauss]

[-][/-]

Simple answer - TIPS.

I worked for one of the first (maybe the first) company to market a CPI indexed SPIA. A couple of us promoted the product when TIPS were new. It took a few years to get management on board and the product on the market.

Looking at the WSJ TIPS yield page, I see maturities of April 2028, April 2029, and April 2032 with coupons of 3.625%, 3.875%, and 3.375%. I think those are 30 year bonds issued in 1998, 1999, and 2002. We could get decent rates with yields like that. (Yes, they did not normally back SPIAs with treasuries, but we had a sharp investment guy who was willing to work on ways to get above treasury yields through swaps or internal trading.)

When TIPS yields went down, the pricing got unattractive and they eventually dropped the product.

Retracted
[-]I think current TIPS yields are less than 1%. There was one negative 3% yield that I noticed on the WSJ page.

For a moment, I thought it might be time to buy TIPS.[/-]

-gauss

 

[Independent]

^^^^ Perhaps, but if that was the easy answer then we would see many more inflation adjusted SPIAs in the market today. Besides, the discussions that I referred to were in the early 1990s before TIPs were available... they first came out in 1997 but only 10 year maturity and I left the company in 1998.

And then there is always that scaling to hundreds of millions thing.

For the company I was working for, it really was that easy. Inflation adjusted SPIAs were worth a test, no one knew how to invest the premiums until TIPS came along, then it became a doable idea.

I'm pretty sure I know why this company doesn't have them today
1. SPIAs of all sorts are a hard sell in a low interest environment. You're asking people to lock in today's low rates. I frequently see this reasoning in threads here.
2. The cost (lower initial monthly payout per premium dollar) of the inflation protection just "seems too high". I think that people underestimate the potential damage of inflation because it's a distant risk that depends on compounding. IMO, the gut feel isn't very accurate for inflation.

 

[brewer12345]

I have the option to buy additional pension payout for a lump sum with zero carrier risk. Things could change, but if I were 55 today I could get a second to die fully CPI indexed payout of about 3.6% of the principal. Would you do this?

 

[audreyh1]

That may be true for a life SPIA, but for a period certain SPIA, it is not. Why get a period certain SPIA yielding 1.58% when you can get more than that in an FDIC insured savings account. Just build your own SPIA.

Was talking about life.

 

[capjak]

I have the option to buy additional pension payout for a lump sum with zero carrier risk. Things could change, but if I were 55 today I could get a second to die fully CPI indexed payout of about 3.6% of the principal. Would you do this?

For immediate annuities the CPI payout rate for male/female both 55 years old by Principle is 2.88%.

So the payout is good compared to commercial annuity.

I might do it depending on what other sources of income I had and my overall portfolio and how risk/conservative I was.

 

[copyright1997reloaded]

I have the option to buy additional pension payout for a lump sum with zero carrier risk. Things could change, but if I were 55 today I could get a second to die fully CPI indexed payout of about 3.6% of the principal. Would you do this?

This seems like a pretty good rate for a SPIA fully indexed w/no carrier risk. The second to die aspect adds additional value in terms of expected longevity of two people.

I would be sorely tempted to go for this, at least up to my expected 'baseline' spending requirements. This would also let you keep a more aggressive asset allocation for the other assets outside the pension.

 

[BeachOrCity]

I have the option to buy additional pension payout for a lump sum with zero carrier risk. Things could change, but if I were 55 today I could get a second to die fully CPI indexed payout of about 3.6% of the principal. Would you do this?

If this buy is a true pension (not a commercial annuity your employer buys for you) you should check the financial heath of your plan and also check if PBGC insures the COLA aspects of it. You want to be sure the plan is rock solid or the COLA guarantee is not worth as much.

 

[gauss]

^^^ It may be a public sector pension in which case I don't think PBGC applies.

-gauss

 

[brewer12345]

Like I said, no carrier risk.

 

[BeachOrCity]

So your risk might be legislative. I don’t know a lot about this but public sector pensions are at risk of reduced cola reduced healthcare etc.
Lots of states and municipalities are sitting on unfundrd pension obligations. Yours may not be.

Since you are “buying in” you may not have any risk in this area, but I would check it out to be sure.

What you are buying with the cola is for 20-30 years down the road and a lot can change.

 

[Red Badger]

I was the recipient of a 28 year buyout that will expire in 2 years. It is for a fixed amount annually. It now has about 60% of the original buying power. The US has not experienced significant inflation in that period. Annuities (SPIA's, COLA'd, etc) may be a good investment for some folks. Me? I'll pass, thank you.

 

[Stonewalker]

I stumbled across this article about what happened to Vanguard's Wellington and Wellesley funds during the great recession:
https://seekingalpha.com/article/4207915-ride-next-market-storm-balanced-vanguard-funds

+1 This was a great read. Thanks for posting it.

 

[pb4uski]

I have the option to buy additional pension payout for a lump sum with zero carrier risk. Things could change, but if I were 55 today I could get a second to die fully CPI indexed payout of about 3.6% of the principal. Would you do this?

I dunno... I think it is pretty likely that you could invest the lump sum in a diversified portfolio and withdraw 3.6% with inflation adjustments and have a very low risk or ruin... but a much better potential upside (vs an upside of zero for the pension) since SWR's are by definition somewhat of a bad/worse case scenario.

Are you delaying SS? If not, that is a better deal to buy an inflation adjusted second-to-die annuity. IIRC the payout is about ~8.5% (depending on your interest rate assumption for the years that you are not collecting) vs your 3.6%.

 

[samclem]

I would be sorely tempted to go for this, at least up to my expected 'baseline' spending requirements. This would also let you keep a more aggressive asset allocation for the other assets outside the pension.

I'd be in this camp. It looks like a pretty good deal, and I'd use it to get to my anticipated "bare bones" baseline retirement spending requirement. If it carries the risk of legislative revision ( like SS does, etc), then the best defense against that is diversity of income sources/assets and accumulating big pile of those other assets. Run up the score with equities, etc while that opportunity exists.

 

[brewer12345]

I dunno... I think it is pretty likely that you could invest the lump sum in a diversified portfolio and withdraw 3.6% with inflation adjustments and have a very low risk or ruin... but a much better potential upside (vs an upside of zero for the pension) since SWR's are by definition somewhat of a bad/worse case scenario.

Are you delaying SS? If not, that is a better deal to buy an inflation adjusted second-to-die annuity. IIRC the payout is about ~8.5% (depending on your interest rate assumption for the years that you are not collecting) vs your 3.6%.

I will not be eligible to claim ss until about the time the trust fund will be depleted.