immediate annuity (again)

[JohnEyles]

Folks, I apologize, but I cannot let this one rest. Sorry. In my 'critique
my plan' thread, many of you expressed disapproval of SPIA, and pointed
me to some papers which analyze why they don't make sense, at least
for a 53yo. But, leaving aside the academic issues like "mortality credits"
and such, the bottom line for me is as follows ...

AIG (via Vanguard) will sell me a SPIA with initial payout equal to 4.4% of
my principal, and which is adjusted every year by the CPI. This sounds a
LOT like the criterion for a SWR with "constant spending power".
Given the conventional wisdom of a 4% "safe withdrawal rate" (SWR),
this seems pretty good to me. Especially given that my median life expectancy
is about 30yrs (the number for which the 4% SWR is usually specified) - but of
course my 90-percentile expectancy is more like 36 yrs. And this 4.4% is not
THOUGHT to be safe by a historical analysis. No. It IS safe. It's guaranteed - at
least unless AIG becomes insolvent (but of course, if I invest the money in other
fixed-income, besides Treasury, insolvency is still a risk).

Yes, I realize nothing will be left over. But given I will still have my house,
plus the remains of the other 75% of my portfolio, to be bequeathed to as
yet undefined survivors, I'm comfortable with that. It seems like a fair
exchange for a GUARANTEED inflation-adjusted 4.4% SWR !

Please don't humor me just to make me shut up , but doesn't this make
sense ?

Thanks, John

 

[Nords]

AIG (via Vanguard) will sell me a SPIA with initial payout equal to 4.4% of my principal, and which is adjusted every year by the CPI.

Would that CPI adjustment be for every CPI, or would it by any chance be capped at a figure like 10%?

I wonder how that kind of SPIA went over during the '70s & '80s. But of course this time it's different...

 

[JohnEyles]

Would that CPI adjustment be for every CPI, or would it by any chance be capped at a figure like 10%?

You would be correct, sir.

And I guess a CPI exceeding 10% is not out of the question.

 

[haha]

Even if it is capped at 10%, the typical investment mixes favored by retirement gurus could well do worse.

He is keeping 75% of his invested assets out; if he begins to fear runaway inflation or hyperinflation, he could invest in gold or whatever he might hope would work in that environment. Truth is, not much would, at least not without massive volatility.

It might be better to buy it when interest rates are higher, but I guess this CPI annuity is priced off of TIPS anyway, and currently they seem priced about in the middle of their time-weighted range since coming to market.

Ha

 

[Delawaredave]

And this 4.4% is not THOUGHT to be safe by a historical analysis.  No.  It IS safe.  It's guaranteed...

Believe you're trading "guaranteed" for the probable situation of large monies left over after 30 years being forefitted.

If you run FireCalc and look at the distribution of final portfolio values, the vast majority of years have large positive final balances.   The 4% (ish) SWR is designed to cover the worst case historical sequences (with high, but not absolutely guaranteed, confidence).

If you multiplied the probability times each positive final portfolio balance  - and then summed these - you'd have an estimate on "money left over" that you're giving up for the certainty.

I think this would be a very large number (wish I had time to run a sample simulation) - and, for me, not worth "paying" this for the certainty.

 

[unclemick]

Hmmmm

In a way - I sort of have two annuities at age 63 - one fixed(small non cola pension) and one adjusted(early SS) which in a hunkered down frugal mode still can cover my recurring budget expenses at around 27k/yr. So to agrue against annuities is a tad disingenious on my part.

heh heh heh heh heh - obviously wild and free with VG Target Retirement 2015 for the flexible part. When I decide to act my age - may switch to 2005 or even Income Series.

 

[Mysto]

Overall you will find that the majority of the people on this board are against IA's.  However, recent data would indicate that a small portion 25 - 50% of your funds allotted to an immediate annuity should result in improved portfolio survivablity.   Many of the people that are against AI's have a pension and that does the same thing so they are in a different postion from you.

You indicated in your previous post that you worry about sleeping at night.  I say then go for the annuity as long as it is only a portion of your total portfolio.  Recognize that you are giving up a large potential gain in the market but you are gaining stability and a sure base income.

Immediate annuities are not the best choice for everybody - true - but they can work for some.

BTW - I would check to see what your states coverage is in case of insurance company default (in most cases it is 100K) and I might split my annutity companies for best safety.

 

[brewer12345]

Personally, I think you are putting a little too much faith in a supposedly safe option, and 25% is a LOT of one's portfolio to expose to a single credit (AIG) regardless of how solid it may appear.

If one could get comfy with the credit exposure and CPI cap (I cannot), what you are giving up is the potential for a mammoth amount of money in between now and when you croak, whether you choose to spend some of the extra or not.  The 4% rule of thumb is safe for the worst historical cases.  In anything but the worst cases, the portfolio would have beaten the daylights out of the annuity.  As a though exercise, try sticking in a plain vanilla 60/40 portfolio into firecalc.  Make the same amount as what you are thinking about ptting into the annuity and assume a 4% inflation-adjusted wthdrawal ver 30 years.  Check out teh range of ending portfolio vales, paying special attention to the high, median, average, bottom and the range.  That will give you an idea of what you would have given up in the past.

 

[donheff]

John:

Just go for it. It will help you sleep at night and a lot of very smart financial people recommend them. I have a substantial Federal pension and I STILL find an SPIA intriguing to cover a little extra of the must have expenses. You will be giving up a substantial chance of a lot left over for insurance against disaster.

Yeah, inflation may go into double digits again. But how far and how long? And if inflation goes wild, how could you be sure your diversified portfolio would work. Yeah, Vanguard may go belly up but states have guarantee programs for annuities. See how much your state would cover - if not enough see if you can diversify your annuity amoung a couple of carriers. Brewer or someone knows what the good companies are.

Bottom line: this is a very gray area topic with strongly divergent opinions. Re-read the threads and then go with your gut.

 

[Rich_by_the_Bay]

John,

You probably searched the topics here and read the prior discussions of this very topic. I came to similar conclusions to yours but have modified them a bit based on further readings and points made here.

1. I'd wait til age 65 or so if you can - payments are much higher then, more in the 7-7.5% range. You'll also be able to change your mind if health problems surface.
2. I'd expose no more than 20% of my savings.
3. I'd divide them among 3-4 different companies to spread the credit risk
4. I'd pass if at that age I don't need the extra cash flow, have serious health problems, or if the market has been soaring.

Good luck.

 

[donheff]

I like what Rich says. But then again You have that SWR in hand. What if Harry Dent (Dow 36K guy) is right and the whole world goes into a massive slump from 2010 until 2023 - that would sure be bad timing. Thats why this thread goes round and round. It is also why so many of us keep rehashing it.

 

[astromeria]

Have you considered implenting a 5-year CD ladder instead? At the absolute lowest point in my ladder, mid-2003, the 5-year CD I bought that yeat pays 4.75%. All other 5-year CDs have paid/do pay at least 5%, and my lastest is at 6%.

 

[brewer12345]

I like what Rich says.  But then again    You have that SWR in hand.  What if Harry Dent (Dow 36K guy) is right and the whole world goes into a massive slump from 2010 until 2023 - that would sure be bad timing.    Thats why this thread goes round and round.  It is also why so many of us keep rehashing it.

And what if space aliens blow up Uranus? You are talking about a very unlikely set of circumstances that shouldn't mortally wound anyone with a well diversified portfolio.

In any case, it is easy and cheap to hedge these downside scenarios with a small investment of index puts. Roght, Ha?

 

[donheff]

In any case, it is easy and cheap to hedge these downside scenarios with a small investment of index puts. Roght, Ha?

I don't know anything about index puts. Can you explain how that would work? E.g. how you actually do it and what it does, how much $ is at risk, and what the results might be in a down market?

 

[Dawg52]

I've batted annuties around too and just can't convince myself its the way to go. I will probably go with a ladder of cd's and t-bills to cover my basic cash flow needs and the balance will be invested in a 60/40 mix. But I do think if it makes you sleep well, go for it. Good luck with whatever you decide.

 

[brewer12345]

I don't know anything about index puts.  Can you explain how that would work?  E.g. how you actually do it and what it does, how much $ is at risk, and what the results might be in a down market?

What I mentioned was basically buying put options on an equity index ETF. The one I use most often is QQQQ because it is very liquid and you get relatively good pricing on options on this ETF. A put option gives you the right, but not teh obligation, to sell something at a specific price. So, for example, you could buy a put on QQQQ yesterday for about 60 cents that would allow you to sell the ETF at 37 any time between now and the third friday of January, 2007, regardless of what the open market price of QQQQ is. Obviously, the farther QQQQ might drop the more valuable the put would be. If QQQQ is above the strike price (37 in this case) by the time the option expires (January in this case), the option expires worthless. But you might not care, since that would mean that no disaster scenario heppened in your portfolio. Basically, you pay a smallish insurance premium to limit your losses while preserving your upside.

Obviously, more reading and a thorough understanding of the basics of options is required before doing any of this, but that's about what it boils down to.

 

[REWahoo]

One thing I don't see discussed in all these annuity threads is the other "sleep at night" factor. While many who favor IA's say they want the peace of mind provided by knowing they will never run out of money, how about the psychological barrier some people (including me) have of writing a check for $250,000 or so to buy that IA?

It was difficult enough to transition from the accumulation phase to the 'depleting my stash' phase, and that's just $5k or so a month. Sorry, but I worked, saved, and invested for a long time to accumulate that $250k and I'm not about to part with it to be repaid (maybe) on the installment plan.

Anyone else suffer from this separation anxiety disorder?

 

[brewer12345]

One thing I don't see discussed in all these annuity threads is the other "sleep at night" factor.  While many who favor IA's say they want the peace of mind provided by knowing they will never run out of money, how about the psychological barrier some people (including me) have of writing a check for $250,000 or so to buy that IA? 

It was difficult enough to transition from the accumulation phase to the depleting my stash phase, and that's just $5k or so a month. Sorry, but I worked, saved, and invested for a long time to accumulate that $250k and I'm not about to part with it to be repaid (maybe) on the installment plan.

Anyone else suffer from this separation anxiety disorder?

I don't think it is a disorder. More like a healthy skepticism and an innate understanding that a giant, illiquid credit exposure probably isn't too smart. Would any of us deliberately buy a long term CD that was well in excess of FDIC insurance limits? That is basically what OP is contemplating.

 

[Dawg52]

One thing I don't see discussed in all these annuity threads is the other "sleep at night" factor.  While many who favor IA's say they want the peace of mind provided by knowing they will never run out of money, how about the psychological barrier some people (including me) have of writing a check for $250,000 or so to buy that IA? 

It was difficult enough to transition from the accumulation phase to the 'depleting my stash' phase, and that's just $5k or so a month. Sorry, but I worked, saved, and invested for a long time to accumulate that $250k and I'm not about to part with it to be repaid (maybe) on the installment plan.

Anyone else suffer from this separation anxiety disorder?

Yes.

 

[astromeria]

I might consider partially annuitizing in my late 60s/70s (the immediate kind). I don't think I'd put more than $100k in any one annuity. This might make particular sense if we enter a CCC facility, making it easier to stay on top of (increased) monthly payments while our brains are fuzzing out.

 

[brewer12345]

I might consider partially annuitizing in my late 60s/70s (the immediate kind). I don't think I'd put more than $100k in any one annuity. This might make particular sense if we enter a CCC facility, making it easier to stay on top of (increased) monthly payments while our brains are fuzzing out.

That's a scenario where an annuity might make sense. Plus it kind of fits:

- Put the cat in the oven
- Wear underpants on head
- Buy an annuity

 

[youbet]

  Basically, you pay a smallish insurance premium to limit your losses while preserving your upside.

Agree except for "smallish." In the example you cited, if you had a 60% equity allocation and hedged all of it, you would spend more than half of your 4% withdrawal rate just on the hedge!

Puts can be useful tools, but the user should carefully understand the cost!

 

[brewer12345]

Agree except for "smallish."  In the example you cited, if you had a 60% equity allocation and hedged all of it, you would spend more than half of your 4% withdrawal rate just on the hedge!

Puts can be useful tools, but the user should carefully understand the cost!

Since options typically change % value much faster than the underlying, I presume you wouldn't want/need to hedge the entire notional amount of your equity position. You also might be in the position of owning the S&P500 but buying puts on the QQQQ. You would likely require less of the much more volatile QQQQ protection to protect your S&P500 position.

But, yes, buying insurance does cost money. That's why you generally don't come out ahead buying insurance. But we were talking about sleep-at-night alternatives that might be less costly and irreverible than a SPIA.

 

[youbet]

Sometimes things are the same even though they are named differently.  I'm generally not interested in immediate fixed annuities, although I understand their pros and cons and that they have a legitimate purpose under some circumstances.

However, it dawned on me that when I choose whether to take my DBP pension as a lump sum or a monthly income stream for life, I'll actually be chosing between buying an annuity or not!    I had been planning on taking the income stream or "annuity."    Suddenly, I realize that I better go do an analysis and decide if I would buy an immediate annuity that pays equal to my pension with an amount equal to the lump sum payout.  If not, then I guess I should take the lump sum from my pension..........

Comments?

 

[brewer12345]

Suddenly, I realize that I better go do an analysis and decide if I would buy an immediate annuity that pays equal to my pension with an amount equal to the lump sum payout.  If not, then I guess I should take the lump sum from my pension..........

Comments?

I would look at two things:

- Can I buy the same annuity for less money than the lump sum?
- Can I reasonably expect to draw a larger inflation-adjusted stream of money out of the lump sum than from the annuity payments?

Obviously, if you aren't sure that the entity paying the pension out is a very solid credit, it might be wise to ignore all of this and just take the money and run.