Lump Sum vs Annuity

[tcaron20]

Still on the fence about the lump sum or monthly payments. I agree with the piece of mind benefit with the payments but do not like the fact that there is no COLI. The longer I wait, the higher interest rates will go reducing the lump sum amount.

Fixed Indexed Annuities look interesting but I do not like the indexes, bogus Ins. Company forecasts in their marketing materials and the 10 year wait period. Basically they are just giving you back your own money for about 15 - 20 years.

Can anyone here convince me that these annuities are a goof deal? I see too many variables with forecasts that are too rosey.

Tom C


Sent from my iPad using Early Retirement Forum

[nun]

Quote:

Originally Posted by ETFs_Rule You are being suckered into the annuity with the fixed payment that seems high now, but down the line it will put you in poverty. https://www.youtube.com/watch?v=bqabsWE_V_c

People need to do the maths and see if the annuity is good value for money given your circumstances. Right now a lump sum payout might be good value because interest rates are so low......and obviously the payments from a commercially available annuity will also be low. However, if we are talking about DB pensions there might still be some good deals available. Also videos like the one above make no distinction between annuity products and assume that putting all your eggs into the "market basket" is going to be the best in all scenarios and circumstances. It also ignores differing financial personalities and the possibility that some people might like to trade potential returns for a lower guaranteed return and stable income. There are obviously many annuities that are really bad value for money and should be avoided in basically all circumstances, but you need to do the calculations and think about your required income stream and make a considered choice rather than just rejecting all annuities.

Personally I just took a lump sum from a company pension plan because the implied interest rate was 5% and I already have sufficient pension/annuity type income at better rates. This is because I have the opportunity to buy into another employer's DB plan for $263k and it will give me a $19.5k annual payment starting at age 55 (I'm 54 now) with a 2% annual COLA. I'd be an idiot not to buy into this as if I have an average lifespan the internal rate of return is 8.4%.

Is there anyone who wouldn't use part of their portfolio to buy into an annuity that has an internal interest rate of 8.4% assuming you live an average lifespan?

[nun]

Quote:

Originally Posted by tcaron20 Still on the fence about the lump sum or monthly payments. I agree with the piece of mind benefit with the payments but do not like the fact that there is no COLI. The longer I wait, the higher interest rates will go reducing the lump sum amount. Fixed Indexed Annuities look interesting but I do not like the indexes, bogus Ins. Company forecasts in their marketing materials and the 10 year wait period. Basically they are just giving you back your own money for about 15 - 20 years. Can anyone here convince me that these annuities are a goof deal? I see too many variables with forecasts that are too rosey. Tom C Sent from my iPad using Early Retirement Forum

I'd have a hard time buying a fixed lifetime annuity now because you'd lock in historically low rates and I would never buy an indexed annuity because of their expense and complexity.

You might consider a fixed term annuity, but I wouldn't want to invest a lot in one and would do it to guarantee income rather than see any substantial growth. In fact forget about annuities as investments, they are really insurance.

[Midpack]

Quote:

Originally Posted by tcaron20 Still on the fence about the lump sum or monthly payments. I agree with the piece of mind benefit with the payments but do not like the fact that there is no COLI. The longer I wait, the higher interest rates will go reducing the lump sum amount. Fixed Indexed Annuities look interesting but I do not like the indexes, bogus Ins. Company forecasts in their marketing materials and the 10 year wait period. Basically they are just giving you back your own money for about 15 - 20 years. Can anyone here convince me that these annuities are a goof deal? I see too many variables with forecasts that are too rosey. Tom C Sent from my iPad using Early Retirement Forum

I have no intention of trying to convince you to buy an annuity. Odds are I won't, but if I do it won't be until I am 75-80 years old.

However, while they are becoming scarcer, you can buy COL adjusted annuities from some providers still. They cost about twice as much as a fixed SPIA (or have initial payouts of about half that of a fixed SPIA, for a given initial same cost). So you could take the lump sum and buy a 'pension' by buying a COL adjusted annuity. Another option...

If I wanted an increasing payout SPIA, I'd be looking for a fixed increase (e.g. 3% per year) annuity, and not a CPI based COL adjustment. The uncertainty of CPI based over future (up to 40) years forces providers to charge a lot to protect themselves and other annuitants. From what I've read, COL adjusted annuities are becoming understandably scarce.

[nun]

Quote:

Originally Posted by Midpack I have no intention of trying to convince you to buy an annuity. Odds are I won't, but if I do it won't be until I am 75-80 years old. However, while they are becoming scarcer, you can buy COL adjusted annuities from some providers still. They cost about twice as much as a fixed SPIA (or have initial payouts of about half that of a fixed SPIA, for a given initial same cost). So you could take the lump sum and buy a 'pension' by buying a COL adjusted annuity. Another option... If I wanted an increasing payout SPIA, I'd be looking for a fixed increase (e.g. 3% per year) annuity, and not a CPI based COL adjustment. The uncertainty of CPI based over future (up to 40) years forces providers to charge a lot to protect themselves and other annuitants. From what I've read, COL adjusted annuities are becoming understandably scarce.

The maths for annuities right now isn't good, so if you buy one it has to be for other reasons and for some people those reasons do exist.

[ETFs_Rule]

Quote:

Originally Posted by nun People need to do the maths and see if the annuity is good value for money given your circumstances. Right now a lump sum payout might be good value because interest rates are so low......and obviously the payments from a commercially available annuity will also be low. However, if we are talking about DB pensions there might still be some good deals available. Also videos like the one above make no distinction between annuity products and assume that putting all your eggs into the "market basket" is going to be the best in all scenarios and circumstances. It also ignores differing financial personalities and the possibility that some people might like to trade potential returns for a lower guaranteed return and stable income. There are obviously many annuities that are really bad value for money and should be avoided in basically all circumstances, but you need to do the calculations and think about your required income stream and make a considered choice rather than just rejecting all annuities. Personally I just took a lump sum from a company pension plan because the implied interest rate was 5% and I already have sufficient pension/annuity type income at better rates. This is because I have the opportunity to buy into another employer's DB plan for $263k and it will give me a $19.5k annual payment starting at age 55 (I'm 54 now) with a 2% annual COLA. I'd be an idiot not to buy into this as if I have an average lifespan the internal rate of return is 8.4%. Is there anyone who wouldn't use part of their portfolio to buy into an annuity that has an internal interest rate of 8.4% assuming you live an average lifespan?

And it looks like based on past market performance, 1969 was the worst year. A conservative portfolio survived that OK. So the basic bond stock portfolio has survived all past market scenarios including the great depression the last recession. Insurance salesmen love to sell fear that has never exited.

NO annuity pays an 8.4% ROI when it's all said and done. You are mixing up "interest rate" with ROI. Again, insurance salesmen love to confuse the two. Your actual ROI with a SPIA is going to be between zero and 3% over a lifetime. The insurance company always wins. 8.4%? Not a chance.

[hnzw_rui]

Quote:

Originally Posted by ETFs_Rule And it looks like based on past market performance, 1969 was the worst year. A conservative portfolio survived that OK. So the basic bond stock portfolio has survived all past market scenarios including the great depression the last recession. Insurance salesmen love to sell fear that has never exited. NO annuity pays an 8.4% ROI when it's all said and done. You are mixing up "interest rate" with ROI. Again, insurance salesmen love to confuse the two. Your actual ROI with a SPIA is going to be between zero and 3% over a lifetime. The insurance company always wins. 8.4%? Not a chance.

Iirc, worst case starting point so far is 1966.

Please note, poster said IRR not ROI. Also, pensions with COLA can have nominal IRR of 8.4% or even higher assuming you and/or your survivor live long enough. Some DB pension plans allow you to buy a larger pension by putting in after-tax money or transferring funds from a qualified, tax-deferred plan and terms are generally more favorable than what you can get commercially.

SPIA from an insurance company, though, you're right. Based on quotes from immediateannuities, IRR I'm seeing after 20 years is typically just at 0-2% nominal and even if you live forever, IRR is just 5-6% nominal.

[pb4uski]

Quote:

Originally Posted by ETFs_Rule ....NO annuity pays an 8.4% ROI when it's all said and done. You are mixing up "interest rate" with ROI. Again, insurance salesmen love to confuse the two. Your actual ROI with a SPIA is going to be between zero and 3% over a lifetime. The insurance company always wins. 8.4%? Not a chance.

I plugged nun's opportunity into an annuity IRR spreadsheet that I developed and the IRRs are decent if you live long enough,,, no surprise there as you get the benefit or mortality credits if you live long. There is not much to argue with here... it is just basic math calculating an IRR that equates the benefit payments commensurate with the premium.

A 55 year old male would be expected to live to 82... at that age the IRR for the fixed annuity is 5.9%... much better than the 0-3% you suggest. Again simple math in that the IRR of $1,625/month for 27 years based on a $263,000 premium is =RATE(27*12,1625,-263000)*12 or 5.9%.

Note that if you live long enough, the IRR would eventually converge to equal the payout rate (benefits/premium).

Also, these are returns based on a fixed annuity and his is a COLA so the IRRs will be higher because the premium will be the same but the benefits will increase 2% a year.

Lump Sum		263,000
Monthly benefit		1,625
Age	n	IRR
55	0
56	1	-326.2%
57	2	-140.8%
58	3	-79.2%
59	4	-50.2%
60	5	-33.8%
61	6	-23.6%
62	7	-16.8%
63	8	-11.9%
64	9	-8.4%
65	10	-5.7%
66	11	-3.6%
67	12	-1.9%
68	13	-0.6%
69	14	0.5%
70	15	1.4%
71	16	2.2%
72	17	2.8%
73	18	3.4%
74	19	3.8%
75	20	4.2%
76	21	4.6%
77	22	4.9%
78	23	5.1%
79	24	5.4%
80	25	5.6%
81	26	5.7%
82	27	5.9%
83	28	6.0%
84	29	6.2%
85	30	6.3%
86	31	6.4%
87	32	6.5%
88	33	6.6%
89	34	6.6%
90	35	6.7%
91	36	6.8%
92	37	6.8%
93	38	6.9%
94	39	6.9%
95	40	7.0%
96	41	7.0%
97	42	7.0%
98	43	7.1%
99	44	7.1%
100	45	7.1%
101	46	7.1%
102	47	7.2%
103	48	7.2%
104	49	7.2%
105	50	7.2%
106	51	7.2%
107	52	7.2%
108	53	7.3%
109	54	7.3%
110	55	7.3%

[pb4uski]

Actually, I was curious so I calculated the IRR at each age assuming the annuity is bought at age 55 for $263,000 and pays $19,500 the first year and increases 2% each year thereafter.

The IRR exceeds 4% from age 72 on... and is 7.7% if he lives to age 82.

Age	Cash Flow	IRR
55	(263,000)
56	19,500	-92.6%
57	19,890	-68.5%
58	20,288	-48.6%
59	20,694	-34.7%
60	21,107	-24.9%
61	21,530	-17.9%
62	21,960	-12.8%
63	22,399	-8.9%
64	22,847	-5.9%
65	23,304	-3.5%
66	23,770	-1.6%
67	24,246	-0.1%
68	24,731	1.2%
69	25,225	2.2%
70	25,730	3.1%
71	26,244	3.9%
72	26,769	4.5%
73	27,305	5.1%
74	27,851	5.5%
75	28,408	5.9%
76	28,976	6.3%
77	29,555	6.6%
78	30,147	6.9%
79	30,750	7.1%
80	31,365	7.3%
81	31,992	7.5%
82	32,632	7.7%
83	33,284	7.9%
84	33,950	8.0%
85	34,629	8.1%
86	35,322	8.2%
87	36,028	8.3%
88	36,749	8.4%
89	37,484	8.5%
90	38,233	8.6%
91	38,998	8.7%
92	39,778	8.7%
93	40,573	8.8%
94	41,385	8.8%
95	42,213	8.9%
96	43,057	8.9%
97	43,918	8.9%
98	44,796	9.0%
99	45,692	9.0%
100	46,606	9.0%
101	47,538	9.1%
102	48,489	9.1%
103	49,459	9.1%
104	50,448	9.1%
105	51,457	9.2%
106	52,486	9.2%
107	53,536	9.2%
108	54,606	9.2%
109	55,699	9.2%
110	56,812	9.2%

[pb4uski]

Quote:

Originally Posted by hnzw_rui .......SPIA from an insurance company, though, you're right. Based on quotes from immediateannuities, IRR I'm seeing after 20 years is typically just at 0-2% nominal and even if you live forever, IRR is just 5-6% nominal.

I agree. Below is a IRR analysis based on a quote for a 5.78% payout rate for a 55 year old male from immediate annuities.com. Note that the IRR converges towards the payout rate at older ages.

Lump Sum		100,000
Monthly benefit		482
Age	n	IRR
55	0
56	1	-348.3%
57	2	-155.3%
58	3	-90.0%
59	4	-58.8%
60	5	-41.2%
61	6	-30.0%
62	7	-22.4%
63	8	-17.0%
64	9	-13.0%
65	10	-10.0%
66	11	-7.6%
67	12	-5.7%
68	13	-4.2%
69	14	-2.9%
70	15	-1.8%
71	16	-1.0%
72	17	-0.2%
73	18	0.4%
74	19	1.0%
75	20	1.5%
76	21	1.9%
77	22	2.3%
78	23	2.6%
79	24	2.9%
80	25	3.1%
81	26	3.4%
82	27	3.6%
83	28	3.8%
84	29	3.9%
85	30	4.1%
86	31	4.2%
87	32	4.3%
88	33	4.4%
89	34	4.5%
90	35	4.6%
91	36	4.7%
92	37	4.8%
93	38	4.9%
94	39	4.9%
95	40	5.0%
96	41	5.1%
97	42	5.1%
98	43	5.1%
99	44	5.2%
100	45	5.2%

[hnzw_rui]

Quote:

Originally Posted by pb4uski I agree. Below is a IRR analysis based on a quote for a 5.78% payout rate for a 55 year old male from immediate annuities.com. Note that the IRR converges towards the payout rate at older ages.

Stands to reason IRR convergence point is the same as payout rate as that's the rate at which you just make payouts from interest only never needing to touch the principal. Of course, it'll probably take a hundred years or so to reach anywhere near that point.

For fixed COLA, just add it to the initial payout rate (e.g. if COLA is 2%, convergence is at 7.78%).

By the way, IRR seems wrong for the first couple of years. How is it lower than -100%? Mind, Excel does have a built-in IRR function.

[pb4uski]

It can be lower than -100%. Remember,the definition of IRR is the discount rate that makes a series of cash flows equal to zero.

The proof is to calculate the PV using the IRR for the requisite periods (in this case months).

=PV(-348.329193618076%/12,12,-482)
=$100,000

So the PV of 12 payments of $482 at -348.32919361876% annually is $100,000 so the IRR is -348.32% or

		-348.3%
Month	Pmt	PV
1	482	679.14
2	482	956.90
3	482	1,348.27
4	482	1,899.70
5	482	2,676.67
6	482	3,771.41
7	482	5,313.90
8	482	7,487.26
9	482	10,549.51
10	482	14,864.21
11	482	20,943.60
12	482	29,509.43
		100,000.00

or alternatively create a list of cash flows of -$100,000 and $482 for 12 months, compute the IRR using Excel's IRR function and you'll get -29.03%, but then you need to multiply that by 12 to get an annual rate since the $482 are monthly payments.

	-348.33%
-100000	-29.03%
482
482
482
482
482
482
482
482
482
482
482
482

[hnzw_rui]

Quote:

Originally Posted by pb4uski It can be lower than -100%. Remember,the definition of IRR is the discount rate that makes a series of cash flows equal to zero. The proof is to calculate the PV using the IRR for the requisite periods (in this case months). =PV(-348.329193618076%/12,12,-482) =$100,000 So the PV of 12 payments of $482 at -348.32919361876% annually is $100,000 so the IRR is -348.32%

Think about it. If you have an IRR of -348%, that means future value isn't even 0, it's already in the negative. A -100% IRR means your lump sum drops from 100,000 to 0 without any withdrawals. If you have -348%, your lump sum drops from 100,000 to -248,000. Remember, the rate function is based on compounding for a specific number of periods. It's not a simple average.

By the way, if the rate was correct, PV on the first table in post #53 should all be -$100,000.

In this case, I think the better option in order to get the annual IRR would be to do the ff:

RATE(NPER_Years,PMT_Monthly*12,-PV)

Mind, doing the above matches IRR of yearly distributions of $5,784 ($482 * 12).

Years	Cash Flow	IRR
	-100000
1	5,784	-94.2160%
2	5,784	-72.8848%
3	5,784	-54.1246%
4	5,784	-40.5641%
5	5,784	-30.8815%
6	5,784	-23.8286%
7	5,784	-18.5614%
8	5,784	-14.5340%
9	5,784	-11.3894%
10	5,784	-8.8889%

[nun]

8.4% comes from a more detailed analysis I did. The pension actually pays a COLA on the first $13.5k and for the last few years its been 3%, but I've projected the increase on the COLA amount given historical data. I am not confusing payout rate with interest rate. This is a DB pension plan and not a commercial annuity. I would not buy a commercial annuity now, but given the chance to buy into a DB plan that returns 7.7% using current numbers and if I live an average lifespan, I'm not going to pass that up.

With any annuity with no COLA the IRR cannot ever be greater than the payout rate. The IRR will asymptotically approach the payout rate as you get older.

If you have a COLA the IRR can be larger than the initial payout rate. My payout rate is 7.4%, but with a simple 2% COLA and living to 82 the IRR is 7.7%

My main point in all this is that people need to know how to assess an annuity before they dismiss them out of hand. This is even more important if you are buying a deferred annuity. The difficulty is you have to assume lifespans and the return you might expect on your money if you kept it in the market.

[pb4uski]

After further review, I concede. I had a glitch in the compounding calc converting from monthly to annual. For one year, the IRR is -98.37% (sticking with monthly benefit payments).

n	n in years	Cash flow	PV factor	Cash flow
0	-	(100,000.00)	1.00	(100,000.00)
1	0.083	482.00	1.41	679.14
2	0.167	482.00	1.99	956.90
3	0.250	482.00	2.80	1,348.27
4	0.333	482.00	3.94	1,899.70
5	0.417	482.00	5.55	2,676.67
6	0.500	482.00	7.82	3,771.41
7	0.583	482.00	11.02	5,313.90
8	0.667	482.00	15.53	7,487.26
9	0.750	482.00	21.89	10,549.51
10	0.833	482.00	30.84	14,864.21
11	0.917	482.00	43.45	20,943.60
12	1.000	482.00	61.22	29,509.43
				(0.00)
IRR per period (month)	-29.03%
Coverted to annual rate		-98.37%

Though it is a bit academic as it is painfully obvious that if you buy an annuity and die soon thereafter that its a big time losing proposition.

[Big_Hitter]

yes but it would be a stress free death

[hnzw_rui]

Quote:

Originally Posted by pb4uski After further review, I concede. I had a glitch in the compounding calc converting from monthly to annual. For one year, the IRR is -98.37% (sticking with monthly benefit payments). n n in years Cash flow PV factor Cash flow 0 - (100,000.00) 1.00 (100,000.00) 1 0.083 482.00 1.41 679.14 2 0.167 482.00 1.99 956.90 3 0.250 482.00 2.80 1,348.27 4 0.333 482.00 3.94 1,899.70 5 0.417 482.00 5.55 2,676.67 6 0.500 482.00 7.82 3,771.41 7 0.583 482.00 11.02 5,313.90 8 0.667 482.00 15.53 7,487.26 9 0.750 482.00 21.89 10,549.51 10 0.833 482.00 30.84 14,864.21 11 0.917 482.00 43.45 20,943.60 12 1.000 482.00 61.22 29,509.43         (0.00) IRR per period (month) -29.03%       Coverted to annual rate   -98.37%     Though it is a bit academic as it is painfully obvious that if you buy an annuity and die soon thereafter that its a big time losing proposition.

There still seems to be something wrong in those calcs. If you were able to get one full year's worth of payments (5,784), IRR for the first year would be (100,000 - 5,784) / 100,000 or 100% minus payout rate which is -94.216%.

But yes, dying immediately after you buy an annuity sucks for the retiree. Very profitable for the insurance company, though. If I were buying, life with 20-year period certain is what I'll probably get (~0-1% IRR at 20 years). However, given the effects of inflation, I'd be more inclined to create an I-bonds ladder sufficient to supplement SS to cover necessities.

[hnzw_rui]

Quote:

Originally Posted by Big_Hitter yes but it would be a stress free death

Lol, that's certainly true as long as you don't plan on leaving anything to your heirs.

[nun]

To worry about dying soon after you buy an annuity for money reasons seems to miss the point that you are dead. If you are worried about heirs then you should not be planning on spending down your retirement money and should stop using the 4% rule. Also I forgot to mention that my DB plan has a contingent beneficiary so they get a lump sum payment if I die early.

[hnzw_rui]

Quote:

Originally Posted by nun To worry about dying soon after you buy an annuity for money reasons seems to miss the point that you are dead.

Alas, just because you're dead doesn't mean some obligations disappear. One of my grandmothers lived to 89 years and 361 days and outlived 4 out of her 7 children. The other is 92 and still okay physically although she has dementia now. Should I predecease my parents, I'm hoping to leave them well provided for with a steady income stream.