Annuity question and How do Amerprise agents sleep at night

[RockOn]

You are under the persistent mistaken impression that a person who invests 25x their annual budget with a 60/40 portfolio runs out of money after 30 years.

Ok, but my only point is this. If you did make 6% annualized with your 60/40 and withdrew the same amounts, at the same frequency, for the same number of year, as my 6% IRR annuity, your account would be $0 after 30 years, 100% of the time. That is all.

I'm not saying the annuity is better or even a reasonable choice for many, only that if I lived 30 years after annuitizing, my outcome would be the same as the one described above. It might not be enough of a return for you, it might be good enough for me.

P.S. on your points about miscalculation, I still think my calcs are fine. Maybe someone can clear that up. We don't agree there. My inputs and assumptions seem perfectly fine to me.

Lastly I really don't see why you think an insurance company would not pay an IRR of 6%. An annuity is just a very, very, long term bond, there are 6%, 30 year bonds out there today. A state pension plan that I am aware of currently assumes a ~8.5% annualized investment return, they could easily pay 6% if they had to. Why couldn't insurance companies do the same?

 

[RockOn]

RockOn, you are failing to distinguish between annuities (which are appropriate for some investors) and the salesmen that harangue this board on behalf of a high-commission product. They're an extremely vocal crowd of shills and they've given the product a bad name.


I've been 12-15% APY for the last five years and I've racked up an overall record of 11% APY since 1982 (that includes money market funds and everything) so I'm happily convinced that I can make at least 6% on the compounded remains for the rest of my life.

And I'm totally convinced that I can beat any returns an insurance company hopes to achieve, since I won't be paying their expenses and subject to their regulatory requirements.

Annuities are appropriate for those who want insurance or total financial management or some form of liability shelter, but they're not appropriate for those who are seeking a market return.

I agree 100%.

My point is that I do not need a market return, reducing risk of an unsatisfactory outcome is important to me. You will do much better than I with the track record you have shown, I'm not trying to take that from you. But, if I can make a "safe (questionable of course)" 6% IRR, my life is good, my kids are pretty well off after I am gone. Some of us value things differently. I don't see why some think this is wong. Whether annuities get me to the safe 6%, that's the question I want to explore. If nothing else we could look at annuities as a worse case bottom line "safe?" outcome. It is nice to have that, especially if that return is in the 6% range for many of us.

I'll add that I wil not jump in on this anymore, sorry for altering the OP. I have been given a lot of good info and any decisions I make on annuities will be mine to make. I'm comfortable with my calculations, if anyone thinks I'm missing something major, I'd like to hear about it. I'd like to see the general annuity bashing stop since I do not think I am alone in seeing annuities as a viable retirement option. IMO why not just see them for what they are...fairly safe....moderate to low rate of return (similar to fixed income) investments.....with their own issues? Not wonderful, not all trash, just another investment option. Bash the sales tactics, that's fine; bash specific products, that's fine; but not annuities overall as some products are decent investments for conservative people.

 

[cute fuzzy bunny]

Ok, but my only point is this. If you did make 6% annualized with your 60/40 and withdrew the same amounts, at the same frequency, for the same number of year, as my 6% IRR annuity, your account would be $0 after 30 years, 100% of the time. That is all.

Except that I wouldnt make a mere 6%, I wouldnt take 6% out of the portfolio because thats unsustainable, and you wouldnt make 6% on your annuity. Unless you lived longer than 95% of the rest of the population and didnt mind the erosion of buying power when you're too old to get a job.

So other than every assumption being incorrect or unlikely, yep...you're good.

P.S. on your points about miscalculation, I still think my calcs are fine. Maybe someone can clear that up. We don't agree there.

I'm not arguing your calcs. I'm saying your assumptions are wrong, your inputs are wrong, and your preferred algorithm is wrong.

Other than that, again...you're fine.

 

[RockOn]

Except that I wouldnt make a mere 6%, I wouldnt take 6% out of the portfolio because thats unsustainable, and you wouldnt make 6% on your annuity. Unless you lived longer than 95% of the rest of the population and didnt mind the erosion of buying power when you're too old to get a job.

So other than every assumption being incorrect or unlikely, yep...you're good.



I'm not arguing your calcs. I'm saying your assumptions are wrong, your inputs are wrong, and your preferred algorithm is wrong.

Other than that, again...you're fine.

Ok, whatever.

 

[Marquette]

I'm probably a nerd, but the only thing I can think of is a well-worn physics joke.

The punchline is "first, assume a spherical chicken"

 

[cute fuzzy bunny]

Ok, whatever.

And I need a double secret probation ignore list that doesnt give me the option of pressing the shiny, pretty red button.

Have you noticed that when expressing your thoughts about various topics, when the discussion rotates back to actual facts and data you become reclusive and respond with helpful posts like "Ok, whatever" ?

You will do what you want to do. Your justifications for feeling the government is loaded with inflation black helicopters offset by your insurance company's efforts to keep you solvent are well taken.

Just dont confuse people along the way.

If you're in your 60's or 70's, are in very good health, are concerned about running out of money in your 90's and are okay with annuity payouts, buy one.

But as an early retiree in your 40's or 50's, dont think you'll make a free lunch forever 6% return by buying one based on the results of a poorly accepted formula for capital equipment projects that doesnt apply one iota to comparisons of annuities vs other investment products.

 

[cute fuzzy bunny]

The punchline is "first, assume a spherical chicken"

DING DING DING!

And as an aside, I like your computer.

 

[Marquette]

And as an aside, I like your computer.

Thanks. I gotta say, I do too

 

[RockOn]

Have you noticed that when expressing your thoughts about various topics, when the discussion rotates back to actual facts and data you become reclusive and respond with helpful posts like "Ok, whatever" ?

Sorry, I cannot have a discussion with someone who is sure they know they are right but offer little in logic, fail to address the points, and are rude. Others can see it for what it is.

If my assumptions don't fit your reality you become closed minded. Sorry, but true.

Ok, let's go with your reality. Most die before the tables say; the 60/40 portfolio will be up 14% a year forever; your portfolio is guaranteed to be inflation protected; annuities have an IRR of 4%; IRR's are only valid for capital equipment purchases and have never been used correctly for comparing investments; nobody would even consider investing for a 6% yeld. Annuities really do suck, what was I thinking!

My way out there assumptions were:
I might live to 86 and choose to base my payouts on that age
My current age is 53
The payouts on Vanguard are real
IRR is a valid way to compare fairly simple investment returns
My calculator works and the 3 people who confirmed my IRR calcs know what they were doing

What else? It's about that simple. But my "inputs, assumptions, and modeling" are just unbelieveable.


One of your bold quotes:
"I'm not arguing your calcs. I'm saying your assumptions are wrong, your inputs are wrong, and your preferred algorithm is wrong."

The only things you could argue are my life expectancy and using IRR. When I gave my view on using 86 as my life expectancy, you didn't comment. On IRR, I could be proven wrong, but you surely didn't prove it. Not accepting a cash flow calculation to determine IRR as a valid way to compare these two pretty simple investments seems pretty far out there to me, haven't heard that one before.

 

[2B]

Rockon,

If you really want to examine your IRR assumptions, run your financial plan through FIRECalc both with a substantial percentage of your assets annuitized (use Vanguard numbers) and without. I suggest you don't use the "inflation adjusted" annuity numbers because they are full of exception and limitations. When you do the runs you will find (1) the success rate or 95% "safe" withdrawl will be higher in the annuitized portfolio and (2) the non-annuitized portfolio will have many, many runs that overwhelm the asset growth of the annuitized portfolio.

The bottom line is just what you said. Very conservative investors have a higher success rate but have very limited upside. You expose yourself to higher credit risk (unsecured creditor of the insurance company), no or limited inflation protection, illiquidity and undermarket return on your assets.

CFB and Nords are correct in that their portfolios over the long term will perform better than the nominal 6% you find so attractive. They will have more flexibility with their assets for future needs and achieving "expected" rather than "minimum" returns will allow them options unavailable if their assets are annuitized.

I'll come back to a suggestion I made earlier. If you accept the credit risk of an annuity, you are an unsecured creditor of the insurance company. You can spread your money between several companies but you are still not very diversified. Rather than annuitize, buy preferred stocks in a range of companies with "good" credit ratings. In a default they aren't as high as a bond but they will get money long before the unsecured annuity holder does. These high grade preferreds are paying 6 to 8% and can be spread accross dozens of companies. It significantly beats your IRR no matter how you calculate it. It is more secure than an annuity. The real kicker is you still have access to your principle.

Now I consider this suggestion to totally negate any benefit of an annuity unless you are in the sales force.

 

[RockOn]

Rockon,

If you really want to examine your IRR assumptions, run your financial plan through FIRECalc both with a substantial percentage of your assets annuitized (use Vanguard numbers) and without. I suggest you don't use the "inflation adjusted" annuity numbers because they are full of exception and limitations. When you do the runs you will find (1) the success rate or 95% "safe" withdrawl will be higher in the annuitized portfolio and (2) the non-annuitized portfolio will have many, many runs that overwhelm the asset growth of the annuitized portfolio.

The bottom line is just what you said. Very conservative investors have a higher success rate but have very limited upside. You expose yourself to higher credit risk (unsecured creditor of the insurance company), no or limited inflation protection, illiquidity and undermarket return on your assets.

CFB and Nords are correct in that their portfolios over the long term will perform better than the nominal 6% you find so attractive. They will have more flexibility with their assets for future needs and achieving "expected" rather than "minimum" returns will allow them options unavailable if their assets are annuitized.

I'll come back to a suggestion I made earlier. If you accept the credit risk of an annuity, you are an unsecured creditor of the insurance company. You can spread your money between several companies but you are still not very diversified. Rather than annuitize, buy preferred stocks in a range of companies with "good" credit ratings. In a default they aren't as high as a bond but they will get money long before the unsecured annuity holder does. These high grade preferreds are paying 6 to 8% and can be spread accross dozens of companies. It significantly beats your IRR no matter how you calculate it. It is more secure than an annuity. The real kicker is you still have access to your principle.

Now I consider this suggestion to totally negate any benefit of an annuity unless you are in the sales force.

I'll go with that. Pretty well put. The 1) point above is my point also. I also agree 100% with 2). I don't necessarily agree with the last sentence.

IMO what the 3 of you are missing is that many people are afraid to invest in your ideal porfolios because of risk. There is a lot of money in cd's and mm funds. For people with that risk tolerance, a 6% rate of return on an annuity might make sense as the return is likely higher than a cd ladder or MM funds. Even if they only put 1/2 of their money in the annuity, with that steady income as a backstop to cover many of their living expenses they might be able to put 1/2 in a riskier portfolio. In that case the annuity can be very valuable. (In my case 1/2 in an annuity would cover the entire 2.5 to 3% SWR I was assuming from my assets, if I put 1/2 in an annuity I could handle lots of risk with the other 1/2. If the risky invested funds did crap out; for whatever reason, look at Japan stock market as an example of how things could go wrong; I'd still be ok.)

On the preferred stock option, I own 2 closed end preferred funds just for your reasoning. Both of them were down 40% from their highs in the last year. (I bought them a few months ago and I should have bought a lot more the way it looks.) However, to me that investment is almost as risky as 100% stocks, and the 60/40 portfolio; down 40% in one year is huge. I like the yields but the volatility is not low.

Any other ideas on how to get a long term 6% return? I am looking for options with "little or no volatility". Annuities are about it as I see it, at least right now. A bond ladder might come close if one was able to buy individual issues and stay away from treasuries. The bond funds yield less and have for quite a few years now. I'm always looking, I was surprised to see that SPIA annuities can provide that type of return with fairly low risk and no volatility. I haven't bought any, but still might in a few years. It is a viable option.

I think the big disagreement here has been whether the ~6% IRR from SPIA's is correct. I believe it is and believe you agree from what you have said. I don't know why we can't just accept that. Arguing whether IRR is a correct way to calculate yield, or is a rigged method to benefit the insurance companies saleforce, seems futile. Just because it is close to 6% for a mid-80's lifespan doesn't mean anyone should buy annuity, that is up to them.

I should add that with the state guarantees and the fact regulators step in during an insurance default, I believe annuities are significantly safer than individual bonds and preferred stocks. Maybe I am wrong there but I think that has been backed up a few times now.

 

[cute fuzzy bunny]

Maybe I am wrong.

Finally a little accuracy.

 

[Nords]

Any other ideas on how to get a long term 6% return? I am looking for options with "little or no volatility". Annuities are about it as I see it, at least right now. A bond ladder might come close if one was able to buy individual issues and stay away from treasuries. The bond funds yield less and have for quite a few years now. I'm always looking, I was surprised to see that SPIA annuities can provide that type of return with fairly low risk and no volatility. I haven't bought any, but still might in a few years. It is a viable option.

No, as you raise the return you're going to raise the volatility.

Your attempt to eliminate the volatility raises a whole 'nother crop of problems. If you feel that annuities will solve your volatility problem then that's what you should do.

I think we're done here.

 

[Notmuchlonger]

Its the whole risk / reward thing. Crap I slipped up and got into this thread again

 

[Gumby]

If you accept the credit risk of an annuity, you are an unsecured creditor of the insurance company. You can spread your money between several companies but you are still not very diversified. Rather than annuitize, buy preferred stocks in a range of companies with "good" credit ratings. In a default they aren't as high as a bond but they will get money long before the unsecured annuity holder does.

If I may interject, this is not really true. In a bankruptcy, preferred stockholders are lower in priority than all creditors -- secured or unsecured. Preferreds rank ahead of common stockholders, but that is all.

 

[RockOn]

Finally a little accuracy.

Ok, whatever.

 

[RockOn]

If I may interject, this is not really true. In a bankruptcy, preferred stockholders are lower in priority than all creditors -- secured or unsecured. Preferreds rank ahead of common stockholders, but that is all.

Thanks for a little sanity.

 

[2B]

No, as you raise the return you're going to raise the volatility.

Your attempt to eliminate the volatility raises a whole 'nother crop of problems. If you feel that annuities will solve your volatility problem then that's what you should do.

I think we're done here.

RockOn,

I'll take Nords' lead and leave you to your annuity. Buying one will certainly eliminate any volatility. The second you sign on the dotted line the resale value of your annuity becomes zero and remains there. Buyers regret is common from my experience.

We all buy our own ticket and take our chances. Go with your plan. It's clear you are fully committed.

 

[cute fuzzy bunny]

Shhh...dont tell him but the black helicopter down the street just picked up his transmission and will increase their fudging of the CPI by another two percent the minute he buys the annuity.

 

[2B]

If I may interject, this is not really true. In a bankruptcy, preferred stockholders are lower in priority than all creditors -- secured or unsecured. Preferreds rank ahead of common stockholders, but that is all.

What you say is technically true. What I didn't repeat from a previous post to RockOn was the observation that insurance companies always (at least the ones I've seen) issue their annuities through a subsidiary. That means the sub will almost certainly go belly up before the parent company. If both go down together, there is a legal separation between them that will probably keep the unsecured debt of the bankrupt annuity holding company from being considered before the preferreds of the parent. I might be wrong but I would suspect that in a total collapse it wouldn't matter. Everyone would get zip.

The other illusion of security is the "state insurance." I'm not an expert on the individual states' plans but I've heard they were seriously underfunded in the event of a serious or a series of failures.

Another risk is the possibility that mega-prime annuity company sells the contract to a "slightly" lower rated company. Actually, the original annuity company would pay the other company to take on the financial responsibility but then they are free of the obligation. These are contracts so unless there is a "no transfer" clause (which I've never seen) in the contract they are simply finacial assets. I don't know how common this is but I suspect that it does happen. I mentioned to RockOn in a prior post that I've had my term life policy sold twice in the last 9 years. Amazingly, the new company has always been just a little lower in their credit rating.

RockOn has jumped in or started several threads trumpeting the benefits of annuities. Since the same subject is being beaten to death repeatedly, I've not made my posts as detailed as I probably should. My prior post will be my last direct comment back to him on the subject.

 

[2B]

Shhh...dont tell him but the black helicopter down the street just picked up his transmission and will increase their fudging of the CPI by another two percent the minute he buys the annuity.

Actually, to calculate the NPV of an annuity or it's equivalent IRR, you'd need to tie the calcs into the annuity table. There is a finite chance that a person will die in any given year between the day the annuity is purchased and infinitity. The tables used by the annuity companies are almost certainly broken down by the month.

The NPV would be what the sum of all of those possibilities are at a specified interest rate. You could even use different interest rates for the different periods but that's really getting messy. There may be a 2% chance that a 60 year old will die in the following year (purely hypothetical because I'm too lazy to look it up). The NPV to the insurance company would be massive but the probability is low. There my also be a 2% chance that a 60 year old will live to be 100. This gives a terrible NPV to the insurance company but, again, the probability is low. Add up all the possibilities, throw in your deduct for the agent's commission and the annuity has been priced!

The equivalent pseudo-IRR would turn it around and ask what interest rate would I need to have to obtain a NPV equal to the annuity cost.

This linkage to the actuarial tables is why the payout on a minimum guaranteed term annuity falls.

 

[cute fuzzy bunny]

NPV is a better tool, certainly more useful than IRR.

You need to have a couple of other factors to produce a reasonably accurate figure for either one. Death data, bankruptcy rate, and adherence of the annuitants personal rate of inflation over 20-40 years to the CPI (in the case of a CPI adjusted annuity) are all, unfortunately, unknowable and cant even be guessed at.

Guessing at future rates of return of various investment asset classes based on 30-100+ years of past performance or guessing at 3 things...two of which have no reasonable historic data or basis for a good guess...?

Tough call...

 

[brewer12345]

What you say is technically true. What I didn't repeat from a previous post to RockOn was the observation that insurance companies always (at least the ones I've seen) issue their annuities through a subsidiary. That means the sub will almost certainly go belly up before the parent company. If both go down together, there is a legal separation between them that will probably keep the unsecured debt of the bankrupt annuity holding company from being considered before the preferreds of the parent. I might be wrong but I would suspect that in a total collapse it wouldn't matter. Everyone would get zip.

Bzzzt! Wrong.

Usually, the way insurance companies are set up is that a holding company (with little in the way of actual assets) owns one or more insurance operating company subsidiaries. The holding company issues debt, preferred, common equity, etc. and uses the proceeds to capitalize the insurance subsidiary, pay dividends, interest, buy other companies, etc. Over time, the holding company meets its obligations by taking dividends from the regulated insurance operating subsidiary.

Most of the time, when you buy a bond or preferred issued by an insurer you are buying an obligation of the holding company. Aside from owning the operaing company, the holdco usually has little in the way of assets. If the operating subsidiary starts getting in trouble, the regulator steps in and takes over the operating subsidiary where all the cash, assets, capital, etc. are. The regulator then decides what to do, possibly including liquidating the operating company and distributing the proceeds to the policyholders. Under that scenario, creditors of the holding company are left buck naked with their balls blowing in the breeze, since they get zip unless and until all the obligations of the operating subsidiary are taken care of. Usually, there is little or nothing left by the time the regulators are done, but the policyholders are usually made whole.

 

[2B]

Bzzzt! Wrong.

Thanks for the correction.

 

[brewer12345]

Thanks for the correction.

Yeah, but keep up the good work beating back the hordes of sleazy annuity promoters.

RockOn, if you want an annuity, buy one. Don't waste your time trying to convince the rest of us its a good idea.