Is an Annuity a good way to get over a SWR of 5%?

[FIRE'd@51]

Quote:

Originally Posted by Cut-Throat My FIRECalc runs are for 45 years

If your horizon is that long, then this wouldn't be useful to you. But there must be plenty of people, let's say 60-70 years old, would like something that would given them a guaranteed inflation-indexed SWR of 4.6% for 30 years.

[JohnEyles]

Quote:

Originally Posted by FIRE'd@51 IBut there must be plenty of people, let's say 60-70 years old, would like something that would given them a guaranteed inflation-indexed SWR of 4.6% for 30 years.

Now I'm confused. If I go to Vanguard's annuity instant quoter **, and
pretend I'm 60yo, I get an inflation-indexed WR of about 5%. Of course,
I probably wouldn't live 30 yrs, so we're back to the whole inheritance
thing again.

** Like annuities or not, Vanguard has done a huge service by making this
instant-quote thing available. It's a great way to analyze some investment
option, talk about delaying-or-not SS: just see what Vanguard quotes for a
SPIA !

[FIRE'd@51]

Quote:

Originally Posted by JohnEyles Now I'm confused. If I go to Vanguard's annuity instant quoter **, and pretend I'm 60yo, I get an inflation-indexed WR of about 5%. Of course, I probably wouldn't live 30 yrs, so we're back to the whole inheritance thing again. ** Like annuities or not, Vanguard has done a huge service by making this instant-quote thing available. It's a great way to analyze some investment option, talk about delaying-or-not SS: just see what Vanguard quotes for a SPIA !

Thanks for that info, John. If you compare the product I'm talking about (the SWR - lol), Vanguard would give you a slightly higher payout (about 9% higher). That's a plus. Another plus, is if you live to be 110 you will still be collecting from Vanguard, and not with this. On the SWR's side, if you die before 90, your estate still has something left. Also, the credit would be the US gov't rather than AIG. Also, this has a YTM of 2.25%. To get a 2.25% YTM on Vanguard, according to my calculations, you would have to live to the age of 87. According to the actuarial table on the SS website, the life expectancy of a 60 year old male is 20 years. If you die at 80, the YTM of Vanguard's product is 0%.

I'm not saying this is better than Vanguard. I don't even know if this product exists. But I will tell you this. If it doesn't exist, it will, because I believe there will be a demand for a product like this. Somebody will start buying TIPS and sell off the coupon stream to one set of investors (probably retirees) and the principal piece to someone who wants a single inflation-indexed payment in the future (maybe a parent saving for a kid's college education).

[donheff]

Quote:

Originally Posted by FIRE'd@51 I'm not saying this is better than Vanguard. I don't even know if this product exists. But I will tell you this. If it doesn't exist, it will, because I believe there will be a demand for a product like this. Somebody will start buying TIPS and sell off the coupon stream to one set of investors (probably retirees) and the principal piece to someone who wants a single inflation-indexed payment in the future (maybe a parent saving for a kid's college education).

I confess, I have not understood this thread since the imaginary product was introduced. I am a little dense on investment details but I suspect some other readers are as well, so humor me and explain this in simple terms. As I understand (or thought I understood) TIPS, you have a coupon rate (e.g. 2.5% over inflation) and a principle amount. At maturity, you are guaranteed to get your principle back plus an income stream for the entire period that = inflation + 2.5% of starting principle (i.e. portfolio). I don't see how you can turn that into a guaranteed 4.6% inflation protected return. Even if you liquidated your principle (to make it equivalent to an SPIA) the return on the principle would depend on the inflation rate - there is no mechanism to inflate the principle.

If what I outlined is not the case, please give me a TIPS basics lesson before tossing out numbers. I would like to understand what this product would look like if it really existed.

[REWahoo]

Quote:

Originally Posted by donheff I would like to understand what this product would look like if it really existed.

Me too. My best guess is it either looks something like this...


...or sometihing like this.

[donheff]

Back to the OP, The Financial Page blog has a paper from some analysts at TIAA-CREF discussing the efficacies of taking a life annuity and whether it is better to delay. The paper basically says that an annuity can assure a larger "lifetime income" by which they appear to mean a larger withdrawal rate - something we seem to have concluded here. What surprised me is that they find that waiting fro 5-10 years to purchase an annuity reduces the efficacy. You can read the Executive Summary or download the entore study in PDF form.

Quote:

Originally Posted by donheff What surprised me is that they find that waiting fro 5-10 years to purchase an annuity reduces the efficacy.

Please explain what you mean here.

[New Thinking]

It is good to see that some people are coming around to how delaying SS is appropriate for some people. As I've mentioned before, I keep seeing numbers of individual calculations at age 62,66,70 that ignore the inflation adjustments that will occur between those ages..You should increase the age 66 number by an assumed COLA over 4 years of waiting and same with the age 70 amount.

The tax benefits can also be substantial due to the way that the Combined Income forumula works..Its not just going over the thresholds, but the fact that SS income goes into the formula at a 50% rate...The tax is also determined by the lesser of three tests..The most favorable for those delaying SS being

• 50% of the excess over the first threshold, plus 35% of the excess over the second threshold...Thus, when the first threshold is $32k for a married couple, you could theoretically draw 64k of SS (counting at a 50% rate) before you would face any taxes..This is pre deductions, exemptions etc...

[donheff]

Quote:

Originally Posted by me What surprised me is that they find that waiting fro 5-10 years to purchase an annuity reduces the efficacy.

Quote:

Originally Posted by Cut-Throat Please explain what you mean here.

They argue that despite the lower rates at a younger age, waiting until age 70 or so actually reduces the likely lifetime income. I'm not sure whether they analyzed the immediate spendable amount issue - as you have pointed out here for SS. You would need to read the article to get the details.

[New Thinking]

Just to give an example, if you assumed a $1000/mo benefit at age 62 and a 3% COLA..the age 70 benefit would be $2228/mo. Over twice as much in the intial starting amount.

[Rich_by_the_Bay]

Quote:

Originally Posted by donheff They argue that despite the lower rates at a younger age, waiting until age 70 or so actually reduces the likely lifetime income. I'm not sure whether they analyzed the immediate spendable amount issue - as you have pointed out here for SS. You would need to read the article to get the details.

It appears that in the comparison they assume the retiree's entire savings returns the same as the annuity. Nothing is mentioned about the opportunity cost - the money you dropped on the annuity would likely generate more than the interest paid by the annuity since it would be diversified and returning more like 7%, at least in part.

After spinning the annuity question forever, I seem to always land in the same place: it provides longevity insurance and volatility protection at the cost of insurance company expenses and it takes a chunk off the estate table. These priorities are entirely personal.

I worry less about the future insolvency issue since you can spread your risk over a few insurance companies and Florida, at least, provides some protection of your assets in that event. Will I buy an annuity some day? Don't know but I have NOT ruled it out (a SPIA, at least) and it would likely be as I near age 65.

[donheff]

Quote:

Originally Posted by Rich_in_Tampa It appears that in the comparison they assume the retiree's entire savings returns the same as the annuity. Nothing is mentioned about the opportunity cost - the money you dropped on the annuity would likely generate more than the interest paid by the annuity since it would be diversified and returning more like 7%, at least in part. After spinning the annuity question forever, I seem to always land in the same place: it provides longevity insurance and volatility protection at the cost of insurance company expenses and it takes a chunk off the estate table. These priorities are entirely personal. I worry less about the future insolvency issue since you can spread your risk over a few insurance companies and Florida, at least, provides some protection of your assets in that event. Will I buy an annuity some day? Don't know but I have NOT ruled it out (a SPIA, at least) and it would likely be as I near age 65.

I agree with your conclusions. I noticed that TIAA-CREF analysis held the underlying returns for investments underlying the annuity and for the alternative portfolio to be drawn down to be the same -- to keep it apples to apples. Yet, most of us would invest the portfolio in a diversified mix, while insurance companies use bonds (as I understood Brewer's explanation) and rely on the actuarial effect to cover the costs. So the real world isn't apples to apples. In their defense, they do say they ran the numbers with the portfolio returning 2% greater than the annuity investment and still reached similar conclusions.

But the bottom line remains the same - it provides longevity insurance with a chance to increase spendable income while alive in return for zero remains at death.

[New Thinking]

One additional point I would like to make is that delaying SS is not beneficial if you want to leave assets to heirs...I think for some people, delaying SS can be very beneficial because it can replace the bond portion of one's portfolio and thus a higher % of the portfolio can go into equities..Per other threads, I do think SS should be part of the asset allocation discussion..It also means with higher SS that you might not be pulling $$s out of the market when returns are negative...Also, as we have mentioned, since many assets in the SWR portfolio are qualified, they won't be worth as much down the road since they will face higher marginal rates.

I think many folks would be golden if they could delay SS to 70, convert much of IRAs to Roth and thus income is tax-free, no RMDs are required and heirs receive Stretch IRA ability on a tax-free Roth basis. This also will help as means-testing gets more prevalent with Medicare premiums...

[astromeria]

I'll check it out in detail when the time comes, but we're planning to move into Senior housing in our 70s. If our combined Social Security isn't enough to pay the monthly fees and property taxes, I will consider annuitizing enough to pay them. That way I won't have to worry about losing my marbles--and my home.

[JohnEyles]

Quote:

Originally Posted by donheff I confess, I have not understood this thread since the imaginary product was introduced. I am a little dense on investment details but I suspect some other readers are as well, so humor me and explain this in simple terms. As I understand (or thought I understood) TIPS, you have a coupon rate (e.g. 2.5% over inflation) and a principle amount. At maturity, you are guaranteed to get your principle back plus an income stream for the entire period that = inflation + 2.5% of starting principle (i.e. portfolio). I don't see how you can turn that into a guaranteed 4.6% inflation protected return. Even if you liquidated your principle (to make it equivalent to an SPIA) the return on the principle would depend on the inflation rate - there is no mechanism to inflate the principle.

OK, I'm going to copy here something I posted in another thread, hope nobody minds ...

Folks. I've been wondering and thinking about these TIPS for awhile. The return
of inflation plus 2.375% doesn't seem so appealing (but of course it's the "safe"
portion of your portfolio - hopefully the equity allocation has far better returns).
However, if you do a simple withdrawal spreadsheet, you find that inflation plus
2.5% is really good enough for a 4% SWR over 40 years **IF** the return is
flat (consistent from year to year). Of course, this is what TIPS gets you, the
consistency. So it seems pretty appealing to me. But how do you make this
work in real life, since you obviously must get some of the principal out in order
to actually withdraw 4% ?

To see how this might work, I've put together a spreadsheet that shows laddered
5-year TIPS, staggered a year apart. The PDF is attached here (I'm not quite
sure how to make the XLS file available if folks wish to mess with it themselves.
I trimmed it a bunch so it'll fit on one page, so the basic parameters for the run
below are 3.5% inflation, nestegg $100K, inflation-adjusted withdrawal of 3.75%,
and a TIPS coupon of 2.375%. I'm making simplifying assumptions, such as
the coupon rate will be the same on all TIPS purchased til the end of time, that
inflation will be a flat 3.5% until the end of time, that TIPS mature and are
purchased (at auction) on December 31 of each year, and that they are always
purcahsed at par value. It'd be nice to random vary inflation and TIPS cost, but
my Excel kung-fu is not strong enough at this point; I think it's fair to say that
such variations would not be as devastating to portfolio survivability as variations
in return are to an equity portfolio.

The basic prescription is: At end of 2006, five TIPS of 1-5 year maturities are purchased
by equally dividing the lump-sum minus the year-2007 payout. At the end of each
subsequent year (starting with 2007), one of the five TIPS will mature. Take the
proceeds, plus the year's accumulated interest from all five TIPS. Set aside the next
year's payout and buy a new 5-year TIPS with the remaining amount.

As you can see, this 3.75% payout lasts almost 40 years. At some point, one of the
maturing TIPS fails to cover (together with the years interest on all 5) the payout for
the coming year; but of course, the other 4 can be prematurely liquidated to eke
out another year or so. (There's a little built-in pessimism for algorithmic convenience -
the paid out interest isn't earning any return while it's waiting to be spent the following
year, and the current year's payout is set aside at the end of the previous year and
earning no interest). Interestingly, I can vary the inflation number fairly wildly (1-6%)
and the payout time remains almost identical - so I guess the TIPS works as advertised !

A 4% payout lasts about 35 years. A 5% payout last about 25 years.

Please don't think I'm trying to hijack this into a SPIA debate, but the TIPS
ladder IS a sort of self-annuitization. How does it stack up against a SPIA (for me) ?
Currently, Vanguad/AIG quote represents about 4.2% for a 53yo male. That's
inflation adjusted life-only. To be fair, I should compare against SPIA with a
guaranteed period; a 30-year guarantee cuts the payout down to 3.78%, nearly
the same. The TIPS ladder has the huge advantage of being able to end the annuity
and get my principal out at any time - although this could be very disadvantageous
if interest rates are high when I might want to do so. Also, the TIPS is a bit more
secure, being guaranteed by the USA rather than AIG, and with no 10% cap on
CPI adjustment.

So, I think I have more or less mathematically convinced myself that a TIPS ladder
is a better idea than a SPIA - what many have been saying here for awhile. It's too
bad the coupon ain't a WEE bit higher, or it'd be a no-brainer.

[JohnEyles]

Quote:

Originally Posted by FIRE'd@51 Does anyone know if they strip TIPS into an interest-only and principal-only part, like they began doing with mortgages 20 years ago (IO's & PO's)? If they do, the interest-only part could IMHO be very useful to some of us. If that doesn't exist, is there a zero-coupon TIPS? It could be shorted against the regular TIPS to create the interest-only piece, and we would have a 30yr annuity at a fair price. Take a 30-yr TIPS bought at auction with a 2.25% coupon for 100 PV of principal repayment for 30 yrs at 2.25% = 51.30 100 - 51.30 = 48.70 = cost of annuity 2.25/48.70 = 4.6% SWR

I'm not convinced this doesn't exist - I've seen stuff in some articles that alludes
to stripping of TIPS ...

http://www.riskglossary.com/link/treasury_strips.htm

but I don't quite understand how strips work. It looks like each individual
(biannual) interest payment is a separate security, rather than just buying
all the interest payments (without the principal return at maturity) in one
fell swoop like you imply. I guess it's simply a procedural thing, and you
just purchase a bunch of the interest payments with staggered maturities.

[FIRE'd@51]

Quote:

Originally Posted by donheff I confess, I have not understood this thread since the imaginary product was introduced. I am a little dense on investment details but I suspect some other readers are as well, so humor me and explain this in simple terms. As I understand (or thought I understood) TIPS, you have a coupon rate (e.g. 2.5% over inflation) and a principle amount. At maturity, you are guaranteed to get your principle back plus an income stream for the entire period that = inflation + 2.5% of starting principle (i.e. portfolio). I don't see how you can turn that into a guaranteed 4.6% inflation protected return. Even if you liquidated your principle (to make it equivalent to an SPIA) the return on the principle would depend on the inflation rate - there is no mechanism to inflate the principle. If what I outlined is not the case, please give me a TIPS basics lesson before tossing out numbers. I would like to understand what this product would look like if it really existed.

The mechanism that "inflates" the principal is inflation. Take your example of a 2.5% coupon, and assume you pay 100 for the TIPS. If inflation is 10% the first year, the adjusted principle will be 110. The 2.5% coupon is applied to the adjusted principal, so your interest payment the second year would be 2.75 (0.025 x 110), and so on. Both the principal and the interest payments are adjusted for inflation (the 2.5% coupon rate stays constant). So when the TIPS matures you get, in addition to the last interest payment, a maturity payment of the inflation-adjusted principal (this way the maturity payment has the same purchasing power as your initial investment). If you were able to sell off this maturity payment (it would be a zero-coupon TIPS), what you would have left would be just the interest payments. At a 2.5% YTM, the PV of a 100 payment 30 years out is 47.67, so the value of the stream of interest payments by themselves would be 100 - 47.67 = 52.33. Thus, your investment would be 52.33 and your current yield (not YTM) would be 2.5/52.33 = 4.8%. This would also be your SWR. So if you invested 100K in this "imaginary security", you would collect a SWR of $4800 annually for 30 years. There would be no maturity payment to you because you sold that off when you initially bought the TIPS. But you would have a guaranteed SWR of $4800 which would be adjusted for inflation each year.

In the example I presented earlier in this thread I used the current rate for a 30-year TIPS of 2.25%. The same analysis as above would provide a SWR of 4.6%, or $4600 per year on a $100K investment. I played around a bit with the Vanguard annuity calculator for a 60 year-old male. A life only SPIA (with CPI inflation adjustments subject to the 10% cap) that would provide $4600 per yeaar costs $92.8K (a 5% SWR). If you were to add a 30-year guarantee, the price rises to $113.7K (a 4% SWR). So the value of the 30-year guarantee is substantial, nearly $21K. The TIPS structure I was talking about would cost $100K. It has the 30-year guarantee, but does not have the extra protection should you live beyond 30 years, which appears to have a value of $13.7K (113.7 - 100). Of course, fees are also embedded in the price of the Vanguard SPIA, so we would need a separate calculation of what the "back-end" (years beyond 30) is worth to be able to extract the fees. It looks like there is enough information in the actuarial life table on the SS website to do this calculation, but I haven't done it yet. In any case, as was mentioned before, it seems to boil down to how a given individual looks at the trade-off of dying early vs living beyond 30 years, and how much he is willing to pay for that protection. All I'm trying to do here is present my thoughts on how to analyze the financial aspects of this decision. Whatever our decision, we don't want to overpay for it, if there is a cheaper way to achieve it.

I think we are all pretty much in agreement that, for those of us who want an annuity at age 70, delaying SS seems to be the best way to achieve it, given that we have already paid (overpaid?) for our SS benefits.

[FIRE'd@51]

Quote:

Originally Posted by REWahoo! Me too. My best guess is it either looks something like this... ...or sometihing like this.

More like this since the discounted maturity payment is about half the total PV