Annuities - Thoughts?

[nun]

Mixing insurance and investing is usually expensive so I've never considered variable annuities with income riders etc. However, I have invested in TIAA-Traditional Deferred Annuity because it simply declares an interest rate each year and I'm guarantees a minimum of 3%. Right now it is producing 4.8% which I like as part of my fixed income allocation.

Fixed deferred annuities can work as longevity insurance, but in these times of low interest rates it's hard to make a case for annuities.

 

[Freedom56]

Hi Everyone,

Requesting thoughts on annuities. I know there is a lot of controversial info out there. Would like some advice about using them to preserve wealth vs. hoping we don't have another 2008 where investments can take a huge hit. Many thanks.

Annuities are a bad idea. Why don't you just buy a basket of investment grade preferreds, and medium term corporate notes instead and draw distributions from the income and capital.

 

[Sunset]

A DEFERRED annuity is a great tax shelter. Just don't ever annuitize the income from it.

Can you explain a bit more, I'm thinking I understand if I used $300K and bought a DEFERRED annuity that would not start until 15yrs from now, I have avoided paying taxes for 15 yrs , when maybe I'm generating lots of taxable income.

Am I right ?

And I don't get the "Just don't ever annuitize the income from it." part.

 

[mathjak107]

many longevity annuity's go away and heirs get nothing if you don't annuitize . not much sense in paying for income than not taking it .

you pay no taxes on the longevity annuity's until you start taking income .

 

[nun]

many longevity annuity's go away and heirs get nothing if you don't annuitize . not much sense in paying for income than not taking it .

you pay no taxes on the longevity annuity's until you start taking income .

The nice thing about the TIAA-Traditional deferred annuity is that you have lots of choices as to how to take income when you retire. You can buy an annuity or just take interest income, or make systematic withdrawals of some other amount and pass on the account value to your heirs or even transfer the money out over 10 years.

 

[Danmar]

spia's pay out far more cash flow than we can safely draw from ourselves unless we have only the best outcomes in our investments .

Correct and this is often ignored by those who have a bias against SPIA's. For many people in their late 60's-early 70's SPIA's pay out around 6%. 50% higher than a reasonable SWR.

I am always a little surprised that we appear to have a fairly large group of retirees who think a conservative 2-3% SWR is appropriate but also seem to be against annuities? Seems to me that this is not consistent? Although, maybe they aren't the same people?

 

[2017ish]

....

I am always a little surprised that we appear to have a fairly large group of retirees who think a conservative 2-3% SWR is appropriate but also seem to be against annuities? Seems to me that this is not consistent? Although, maybe they aren't the same people?

I am not (will not be) in either of these categories--but if one is looking at leaving a bequest, the two positions are not inconsistent.

 

[COcheesehead]

Can you explain a bit more, I'm thinking I understand if I used $300K and bought a DEFERRED annuity that would not start until 15yrs from now, I have avoided paying taxes for 15 yrs , when maybe I'm generating lots of taxable income.

Am I right ?

And I don't get the "Just don't ever annuitize the income from it." part.

Think of a deferred annuity as being almost like a IRA with no RMD's and no maximum contribution. All the money you put in grows tax deferred until you pull it out. Mine does not convert to income until I am 95.5 years old. So it now sits in a balanced fund and an S&P fund. For high earners like me and it is a nice way to continue to shelter funds.
The money in the annuity can be converted to a regular annuity paying a stream of income. That is the annuitized part of my comment. Once you do that, then it is just like any other annuity paying the low returns.
So use it as a shelter, just not for annuitized income.

Here is Fidelity's explanation of it, which I am sure is far better than mine.

https://www.fidelity.com/annuities/FPRA-variable-annuity/overview

 

[sengsational]

you cannot duplicate the diversification and consistency of an spia on your own .

A tontine would cut-out the middle-man, but I think they're illegal.

A DEFERRED annuity is a great tax shelter. Just don't ever annuitize the income from it.

Think of a deferred annuity as being almost like a IRA with no RMD's and no maximum contribution. All the money you put in grows tax deferred until you pull it out.

Too bad products like this get lumped in with the complicated "variable annuity" products. These are pretty simple, and the fees are nothing like the hard-sell "variable annuity" products. There's really no insurance aspect on these products until you annuitize, and you 'never' have to annuitize if you don't want. So basically it's a legal wrapper around a standard mutual fund.

The 'bad news', tax-wise, is that you need to remove every cent of gain before you get the tax-free jackpot at the end. So, say you had a deferred variable annuity invested in the S&P500 fund. And say you put in $100K in 1995, and now it's worth $300K. You'd pay tax on $200K, which you might need to spread-out over a couple of years to keep in a lower tax bracket, but once you "uncover the buried treasure", so to speak, you get the $100 basis tax-free. So you never have to annuitize, unless you want to...just pull out money and pay tax on the gains.

 

[nun]

Correct and this is often ignored by those who have a bias against SPIA's. For many people in their late 60's-early 70's SPIA's pay out around 6%. 50% higher than a reasonable SWR.

I am always a little surprised that we appear to have a fairly large group of retirees who think a conservative 2-3% SWR is appropriate but also seem to be against annuities? Seems to me that this is not consistent? Although, maybe they aren't the same people?

I'm not sure it's ignored by people who are dubious about annuities as they realize that the annuity with a 6% payout rate pays a constant amount and their SWR is supposed to increase with inflation.

You need to compare the SWR with the initial payout rate of an index linked or escalating annuity.

 

[nun]

Correct and this is often ignored by those who have a bias against SPIA's. For many people in their late 60's-early 70's SPIA's pay out around 6%. 50% higher than a reasonable SWR.

I am always a little surprised that we appear to have a fairly large group of retirees who think a conservative 2-3% SWR is appropriate but also seem to be against annuities? Seems to me that this is not consistent? Although, maybe they aren't the same people?

I just got some quotes for a lifetime annuity with 3% COLA for a 65 year old male and the initial payout is 3.3%.

 

[pb4uski]

I just got some quotes for a lifetime annuity with 3% COLA for a 65 year old male and the initial payout is 3.3%.

Also, when that person dies be it at age 66 or age 96 or 106 then the money is gone.

OTOH, if I run firecalc with $1,000,000 of assets, $33,000 initial spending and 3% COLA and a 60/40 portfolio I get the following:

FIRECalc looked at the 111 possible 35 year periods in the available data, starting with a portfolio of $1,000,000 and spending your specified amounts each year thereafter.

Here is how your portfolio would have fared in each of the 111 cycles. The lowest and highest portfolio balance at the end of your retirement was $-259,371 to $5,670,263, with an average at the end of $1,882,860. (Note: this is looking at all the possible periods; values are in terms of the dollars as of the beginning of the retirement period for each cycle.)

For our purposes, failure means the portfolio was depleted before the end of the 35 years. FIRECalc found that 1 cycles failed, for a success rate of 99.1%.

So the choice becomes a guaranteed benefit with a 3% COLA and a guaranteed nothing at the end (be the end is a year or 35 years or 45 years) OR a 99.1% success rate but a potential generous legacy and access to more money during my life if investment performance is favorable.

I would take the second option but some people may prefer the first.

 

[Sunset]

Think of a deferred annuity as being almost like a IRA with no RMD's and no maximum contribution. All the money you put in grows tax deferred until you pull it out. Mine does not convert to income until I am 95.5 years old. So it now sits in a balanced fund and an S&P fund. For high earners like me and it is a nice way to continue to shelter funds.
The money in the annuity can be converted to a regular annuity paying a stream of income. That is the annuitized part of my comment. Once you do that, then it is just like any other annuity paying the low returns.
So use it as a shelter, just not for annuitized income.

Here is Fidelity's explanation of it, which I am sure is far better than mine.

https://www.fidelity.com/annuities/FPRA-variable-annuity/overview

Ok so similar to putting into some investment like BRK (no divs and no captial gain declared).

But with more choice of investments, so what happens if you die at 94 ?
Do your heirs inherit it, or the cash ? The site didn't talk about death.

 

[COcheesehead]

Ok so similar to putting into some investment like BRK (no divs and no captial gain declared).

But with more choice of investments, so what happens if you die at 94 ?
Do your heirs inherit it, or the cash ? The site didn't talk about death.

It is an asset. You designate a beneficiary. The money is always yours, not the insurance company's. You can also pull the money out at anytime without penalty.
The 95.5 age is only to push the potential for income out as long as possible so you don't have to annuitize. Other than that, it is just about like an IRA.

 

[nun]

So the choice becomes a guaranteed benefit with a 3% COLA and a guaranteed nothing at the end (be the end is a year or 35 years or 45 years) OR a 99.1% success rate but a potential generous legacy and access to more money during my life if investment performance is favorable.

I would take the second option but some people may prefer the first.

Using FireCalc is a great way to compare an annuity or pension with a invested lump sum. If you do it with any of today's annuity quotes it is bound to favor the invested lump sum as that uses historical returns and the annuity rates are going to reflect today's low bond rates.

When I was given the chance to buy into my employer's defined benefit pension I did the FireCalc comparison for 30 years and the invested lump sum only had a 13% chance of beating the pension (which has a 7% payout and 3% COLA), so I bought into the pension.

 

[mathjak107]

Also, when that person dies be it at age 66 or age 96 or 106 then the money is gone.

OTOH, if I run firecalc with $1,000,000 of assets, $33,000 initial spending and 3% COLA and a 60/40 portfolio I get the following:



So the choice becomes a guaranteed benefit with a 3% COLA and a guaranteed nothing at the end (be the end is a year or 35 years or 45 years) OR a 99.1% success rate but a potential generous legacy and access to more money during my life if investment performance is favorable.

I would take the second option but some people may prefer the first.

you can't look only at the annuity by itself anymore than you can look at bonds and cash by themselves .

if you are spending down from your portfolio that bond and cash money is also likely gone and depleted over the years before being refilled .

you pull 4% inflation adjusted from the bonds and cash portion and zero is what you have left eventually.

the spia starts out 40-50% higher in cash flow , does not take a yearly drop in income like spending your own cash and bonds down would either .

the magic is in letting equity's grow longer in the beginning before they need to replace that cash and bond money spent down .


in either case the cash and bond money or annuity money will not pass to heirs . it will either be spent in the case of bonds and cash or forfeited in the case of the annuity ..

as far as balance goes the spia gives you a wider variance of outcomes because there is no sequence risk in the annuity . your own investing requires more dry powder kept unspent to allow for poor sequencing up front .

but i think the main argument that folks have is heirs get nothing from an spia but they fail to realize spending your own cash and bonds to zero can leave you with less at the end as well . in either case you are pulling that money from yourself . .

 

[nun]

the spia starts out 40-50% higher in cash flow , does not take a yearly drop in income like spending your own cash and bonds down would either .

The SPIA only starts out with 50% higher income than a classic percentage SWR from a portfolio because the income from the annuity doesn't increase each year.

the magic is in letting equity's grow longer in the beginning before they need to replace that cash and bond money spent down .

It's good to let the equities compound, so why not have equites instead of an annuity with a ridiculously low interest rate.

in either case the cash and bond money or annuity money will not pass to heirs . it will either be spent in the case of bonds and cash or forfeited in the case of the annuity ..

With an equity and bond portfolio there is a chance of leaving money to heirs, and also a chance of running out of money. With the annuity there's no chance of running out of money, but also no chance of leaving any to heirs. It's a balancing act between risk and income.

as far as balance goes the spia gives you a wider variance of outcomes because there is no sequence risk in the annuity . your own investing requires more dry powder kept unspent to allow for poor sequencing up front .

I think you mean that the portfolio gives the wider range of outcomes. I'm generally a fan of locking in some guaranteed lifetime income, but with rates so low it's hard to lock in such low income amounts from annuities. I recently bought into a defined benefit pension with $282k that pays $20k a year with a 3% COLA starting at age 55, those are good numbers. If I'd gone on the commercial market my $282k would have bought $14.5k annual income with no COLA. If you plug the commercial SPIA amounts into FireCalc you see that a 60/40 portfolio as a 98% chance of beating the annuity out to 30 years. The portfolio does use historical data and I assume the SPIA is fixed by today's low interest rates, but still I like the odds of the portfolio. If the annuity paid more it might be a different story.


If I only had access to commercial annuities I'd probably hold off and put my cash in a 5 year CD ladder to mitigate sequence of risk return rather than buying the SPIA.

 

[mathjak107]

annuity's are not a proxy for equity's . the best combo is likely the annuity instead of bonds and you still use equity's . don't forget cash and bonds have a declining balance as they are spent even though they may be getting a small amount of interest that level is dropping . each year generates less and less ..

don't forget as you spend down cash and bonds towards zero before refilling the spia still has the same base income so less equtiy's will be needed to refill .

a lot of an spia comes from the dead and your age not rates so much . an almost 6% draw rate for a 65 year old is pretty good cash flow today .

i would ladder them if i did any as a proxy for some bond and cash money . .

 

[nun]

annuity's are not a proxy for equity's . the best combo is likely the annuity instead of bonds and you still use equity's . don't forget cash and bonds have a declining balance as they are spent even though they may be getting a small amount of interest that level is dropping . each year generates less and less ..

don't forget as you spend down cash and bonds towards zero before refilling the spia still has the same base income so less equtiy's will be needed to refill .

a lot of an spia comes from the dead and your age not rates so much . an almost 6% draw rate for a 65 year old is pretty good cash flow today .

i would ladder them if i did any as a proxy for some bond and cash money . .

Sure an annuity has zero risk so can't be compared to an equity. The thing is that given the low levels of income from annuities the risk associated with an equity and bond portfolio being able to produce that level is pretty low.

I think you need to adjust that 6% cash flow to 5% for a 65 year old male today. That level of income can be sustained for 25 years from a portfolio getting 2% interest. You can get 2% from a CD ladder with no risk and it will be a better bet than the annuity for 80% of 65 year old males, 68% of females and 72% of 65 year old male and female couples. It's hard to recommend an annuity when a CD ladder is better for most people.

 

[Danmar]

I'm not sure it's ignored by people who are dubious about annuities as they realize that the annuity with a 6% payout rate pays a constant amount and their SWR is supposed to increase with inflation.

You need to compare the SWR with the initial payout rate of an index linked or escalating annuity.

Point taken.

 

[mathjak107]

Sure an annuity has zero risk so can't be compared to an equity. The thing is that given the low levels of income from annuities the risk associated with an equity and bond portfolio being able to produce that level is pretty low.

I think you need to adjust that 6% cash flow to 5% for a 65 year old male today. That level of income can be sustained for 25 years from a portfolio getting 2% interest. You can get 2% from a CD ladder with no risk and it will be a better bet than the annuity for 80% of 65 year old males, 68% of females and 72% of 65 year old male and female couples. It's hard to recommend an annuity when a CD ladder is better for most people.

as of this morning a 65 year old male is 6.19% draw . immediate annuity's.com

income sustained not for 25 years but forever unlike the cd ladder .

 

[pb4uski]

... a lot of an spia comes from the dead and your age not rates so much . an almost 6% draw rate for a 65 year old is pretty good cash flow today .

So much of what you have said in your last few posts is so wrong I'm not going to bother refuting you and nun has made many of the points that I would have made.

The main point is that if one can live with a high probability of success instead of guaranteed success then comparing the economics of today's pricing of COLAed annuities (and the 3.3% payout rate for a 65 yo) to a total return approach for a reasonably balanced portfolio then the portfolio is pretty attractive trade-off of risk and benefits in that there is a high probability of success and more financial flexibility.

What we are comparing here is a 3% COLAed annuity which has a 3.3% payout rate with a 60/40 portfolio with a 3.3% WR.

If someone wants to accept the inflation risk of a SPIA then a 6% fixed payout would be better than almost any portfolio because the high payout rate results in high sequence of withdrawals risk.

 

[mathjak107]

it may be your opinion it is wrong but there is nothing i said that has not been shown in academic study's to be true

 

[pb4uski]

That's the beauty of the first amendment...

 

[nun]

as of this morning a 65 year old male is 6.19% draw . immediate annuity's.com

income sustained not for 25 years but forever unlike the cd ladder .

Ops, sorry, you are correct......so using 6% for the 65 year old male the money in a 2% CD ladder will last for 19 years so 52% of males will be better using the CD ladder. Not such a slam dunk for the CD, but still better for most people. Of course you are buying the insurance and the mortality credits with an annuity. Still, a commercial annuity would be one of the last things I'd choose in retirement. I'd rather defer SS and set up a 5 year CD ladder if I was nervous about my equity and bond portfolio. Still a 60/40 portfolio has a 95% chance of generating that initial flat 6% for 30 years and that is going to be better than the annuity for 94% of 65 year old males.