New Wrinkle on Annuities

[JOHNNIE36]

I'd like to highlight this article in the Tampa Bay Times (2-6-12) but can't find it online in their business section. It is a reprint from the New York Times and talks about a new method the Fed has come up with to deal with old age. They are hyping it as a way for retirees to save money by allowing withdrawals from your 401k or IRA (tax free) to buy an annuity to cover you in your old age. I'm talking 85 years old and up. They say one big problem is people outliving their money and one way to help this is to allow this type annuity purchase. It's also being called "longevity insurance".

One example cited is that a 65 year old would have to pay $277500 for a $20000-a-year annuity that started immediately. However, it would only cost $35200 for an annuity that started at age 85. I guess the major point here is that one could take this $35200 out of an IRA or 401k tax free. Maybe I don't care what happens at age 85. And what happens to the money if I die at 84?

The Treasury Dept is also changing the way it calculates MRD's to exclude any money used for longevity insurance or an annuity. Some of these changes will take place immediately and others are in the public comment period. Sorry I can't hook you into the article but maybe y'all have heard something along these lines.

 

[MissMolly]

It's also reported here in the Baltimore Sun

Annuities: Until now, the focus of retirement planning has been helping workers accumulate savings - baltimoresun.com

 

[brewer12345]

Longevity insurance is not a new idea, but is being marketed by an increasing number of insurers. These are a pure risk transfer product: if you drop dead before payout starts, you generall get nothing. I think that when there is significant competition in this product it will be an attractive way to hedge longevity risk without plunking down an enormous amount of capital for a SPIA.

 

[haha]

Longevity insurance is not a new idea, but is being marketed by an increasing number of insurers. These are a pure risk transfer product: if you drop dead before payout starts, you generall get nothing. I think that when there is significant competition in this product it will be an attractive way to hedge longevity risk without plunking down an enormous amount of capital for a SPIA.

The giant flaw I see with this, other than the usual insurance company fraud, is that I see no mention of inflation indexed annuities, and a great deal of inflation can happen in the 20 years between age 65 and age 85. Enough to make this annuity a cruel joke.

Tehee senior, gotcha! We got your money long ago, now you lucky guy can treat yourself once a year to a donut and coffee at Dunkin Donuts on your annuity payout!

Ha

 

[brewer12345]

The giant flaw I see with this, other than the usual insurance company fraud, is that I see no mention of inflation indexed annuities, and a great deal of inflation can happen in the 20 years between age 65 and age 85. Enough to make this annuity a cruel joke.

Tehee senior, gotcha! We got your money long ago, now you lucky guy can treat yourself once a year to a donut and coffee at Dunkin Donuts on your annuity payout!

Ha

So size your future payout to cover what inflation you anticipate. The insurers are basing this product on the current interest rate curve and studies of the tail of longevity for the appropriate population. They cannot forecast future inflation any better than anyone else.

 

[sheehs1]

Rather than coming up with something like this, why didn't they simply propose a change to the RMD dates so that those that do not have to take it at age 70 can take it later? Or come up with some staggered percentage of RMD one doesn't have to take until age 80 or 85.? Or allow us a year by year decision we could make...depending. That way one still has some say over their money.

I see the possible benefit but if it is as brewer says, in that, if you die before payout starts you get nothing...and your heirs get nothing from that bucket....then "ummmm"

 

[ziggy29]

Seems like a product like pure "longevity insurance" would be subject to some adverse selection, as "low risk" folks with a family history of dropping dead in your 60s -- or someone who is very unhealthy and doesn't expect to live long -- isn't as likely buy it as a "high risk" person who takes care of themselves reasonably well and has many relatives in their late 80s and 90s.

 

[pb4uski]

So size your future payout to cover what inflation you anticipate. The insurers are basing this product on the current interest rate curve and studies of the tail of longevity for the appropriate population. They cannot forecast future inflation any better than anyone else.

The main reason we don't see a lot of inflation adjusted annuities is that the insurers have a hard time finding assets that can match the liability cash flows. For such a product they would like to invest in variable rate loans and bonds but the market for those assets is so thin the product isn't viable.

 

[samclem]

So size your future payout to cover what inflation you anticipate. The insurers are basing this product on the current interest rate curve and studies of the tail of longevity for the appropriate population. They cannot forecast future inflation any better than anyone else.

This "longevity insurance" could be a nice product. My two worries would be:
- Ability of the issuer to pay (fix: Govt insurance pool?)
- Inflation. Insurers can buy inflation protected investment vehicles, and if their wiz-bang pros can't find investments that stay ahead of inflation over the long haul, what chance do any of us have?

 

[haha]

So size your future payout to cover what inflation you anticipate. The insurers are basing this product on the current interest rate curve and studies of the tail of longevity for the appropriate population. They cannot forecast future inflation any better than anyone else.

I still think it is a bad idea. If and when inflation adjusted products like this come along, I suppose there might be a small chance that I would be interested. I understand the point that posters made, these things would be hard to fund.

In general, I think that once central banking and the fiat money system came along, a wise person wants to be an owner, not a lender. Other than in speculative propositions.

Even though I am no kid, I carry way more equities than the average person who posts his allocation here. And I am into 25+ years of retirement that has been completely funded this way, other than my SS contribution which began last spring.

Ha

 

[obgyn65]

I still believe that an annuity-like product (i.e. SPIA, etc) is appropriate when one cannot manage his/her portfolio any longer. I cannot imagine managing my portfolio of many CDs and munis when I reach 90 (if I get ever there).

Tehee senior, gotcha! We got your money long ago, now you lucky guy can treat yourself once a year to a donut and coffee at Dunkin Donuts on your annuity payout!

 

[pb4uski]

I still believe that an annuity-like product (i.e. SPIA, etc) is appropriate when one cannot manage his/her portfolio any longer. I cannot imagine managing my portfolio of many CDs and munis when I reach 90 (if I get ever there).

A good argument for keeping one's portfolio simple (mine is 4 tickers) and annual rebalancing. Though when I am 90 I may be able to downsize to 1 ticker.

 

[FinanceDude]

I still believe that an annuity-like product (i.e. SPIA, etc) is appropriate when one cannot manage his/her portfolio any longer. I cannot imagine managing my portfolio of many CDs and munis when I reach 90 (if I get ever there).

Or, like some people do, just buy enough SPIA to get your necessity living expenses covered. Then take the rest and buy munis or whatnot. I have yet to see a CD that over time beats inflation. Munis don't necessarily do that either, but you get a tax break and the right fund or ladder can give you a sporting chance........

 

[Texas Proud]

Rather than coming up with something like this, why didn't they simply propose a change to the RMD dates so that those that do not have to take it at age 70 can take it later? Or come up with some staggered percentage of RMD one doesn't have to take until age 80 or 85.? Or allow us a year by year decision we could make...depending. That way one still has some say over their money.

I see the possible benefit but if it is as brewer says, in that, if you die before payout starts you get nothing...and your heirs get nothing from that bucket....then "ummmm"

Why would changing RMD make a difference.... all that it requires is you take money out of an IRA and pay taxes... nothing about making you spend the rest of the money....

 

[Midpack]

Sounds like a deferred annuity, just using a lump sum payment instead of periodic investments. But nothing wrong with that...

 

[haha]

Why would changing RMD make a difference.... all that it requires is you take money out of an IRA and pay taxes... nothing about making you spend the rest of the money....

Tax payments perhaps? If you are running out of money in very old age, being able to get that IRA money without owing tax could matter a lot, as opposed to taking it starting at age 70 when you still may have relatively high taxable income.

Ha

 

[JOHNNIE36]

Why would changing RMD make a difference.... all that it requires is you take money out of an IRA and pay taxes... nothing about making you spend the rest of the money....

Unless I missed the point of this post, the break on the RMD revision is that it is TAX FREE if you use it to buy a longevity annuity.

Editing because I posted beforeI saw haha's reply.

 

[FIRE'd@51]

The giant flaw I see with this, other than the usual insurance company fraud, is that I see no mention of inflation indexed annuities, and a great deal of inflation can happen in the 20 years between age 65 and age 85. Enough to make this annuity a cruel joke.

+1

So size your future payout to cover what inflation you anticipate. The insurers are basing this product on the current interest rate curve and studies of the tail of longevity for the appropriate population. They cannot forecast future inflation any better than anyone else.

Why couldn't the insurance companies price a COLA'd product off the forward inflation rates embedded in the TIPS markets?

 

[pb4uski]

Why couldn't the insurance companies price a COLA'd product off the forward inflation rates embedded in the TIPS markets?

The problem is that there are insufficient investments that they could invest in that would also provide an inflation adjusted cash flow stream to match the inflation adjusted annuity obligation.

The inflation risk is too much for them to take on and it would probably require a lot of capital to support it without assets with a similar cash flow profile.

They prefer to simply issue products where they can find assets that match with the liabilities, take a spread and put it in their pocket. They don't mind assuming mortality or morbidity risk because they believe it is measurable, but to take on inflation is more than they can stomach.

Memories on how they got burned by LTC expanding into areas of risk that they thought they knew but later found out that they didn't know as much as they thought they knew are still pretty fresh.

 

[rescueme]

These are a pure risk transfer product: if you drop dead before payout starts, you generally get nothing.

Most SPIA's (inluding ours, a dual-life policy) has an option for a guaranteed term. The term is calculated on your (or in our case, our) remaining life expectancy. In our case, it's a 28-year period, for our policy purchased at age 59.

We could both die in an accident tomorrow (or any other reason) and the remainder payments go to our (son) estate.

OTOH, if we exceed the calculated term (possible, but no bets on that), payments continue at 100% until we both pass.

This "insurance on insurance" reduces our monthly payout by a few dollars a month, but it's worth it. IMHO, only a fool would get a policy without the assurance that "your money" can be passed on, even if you die after you sign the contract, but before receiving the first payment.

 

[haha]

The problem is that there are insufficient investments that they could invest in that would also provide an inflation adjusted cash flow stream to match the inflation adjusted annuity obligation.

The inflation risk is too much for them to take on and it would probably require a lot of capital to support it without assets with a similar cash flow profile.

They prefer to simply issue products where they can find assets that match with the liabilities, take a spread and put it in their pocket. They don't mind assuming mortality or morbidity risk because they believe it is measurable, but to take on inflation is more than they can stomach.

Memories on how they got burned by LTC expanding into areas of risk that they thought they knew but later found out that they didn't know as much as they thought they knew are still pretty fresh.

A very helpful explication. It also begs the question-if insurance companies cannot come up with such a prodect, how could an individual possibly do it?

Could't IMO, and that is why SS, as an indexed product, is unfunded. And also I believe why posters who say that SS will not be importantly modified for current recipients are wrong. All that has to be found is a politically defensible stance. The one I expect is "Look at all these rich old people! Why do they need money from hard working young Americans?"

Means testing coming down the pike.

Ha

 

[samclem]

IMHO, only a fool would get a policy without the assurance that "your money" can be passed on, even if you die after you sign the contract, but before receiving the first payment.

Pretty strong opinion, and I disagree with it. When you buy the annuity, it's no longer "your money." You've given an insurance company that money in exchange for a stream of future payments. If you price out the rider that you bought and look at the mortality tables, I think you'll find that the insurance company made even more money by selling you this additional product (the refund of premiums benefit) Cha-ching.

 

[pb4uski]

The only inflation adjusted asset cash flows that I can think of are TIPS, variable rate bonds and variable rate mortgages; not much in the whole scheme of things.

The best solution that I know of is stocks and REITS, but there is substantial investment risk associated with those but in the long run a diversified portfolio should grow enough to provide inflation adjusted cash flow. That's the theory at least and why pension plan assets include healthy AA to equities and commodities.

 

[REWahoo]

All that has to be found is a politically defensible stance.

Therein lies the rub.

I have a great deal of difficulty believing the do-whatever-it-takes-to-get-reelected bunch tasked with making these decisions won't continue to take the path of least resistance and make only minor changes. Doing anything more will likely not be 'politically defensible' and won't really get serious consideration - at least not for two or three more decades when you and I are dead. (If not physically, certainly mentally... )

 

[pb4uski]

....IMHO, only a fool would get a policy without the assurance that "your money" can be passed on, even if you die after you sign the contract, but before receiving the first payment.

That's why they call it insurance. You have a pool of policyholders and the money from those who die early help fund the benefits for those who live long (and prosper).

Same principle as car insurance - premiums from those who have no claims help fund the claims of those who have accidents.