Poll:At what discount rate would you buy SPIA?

[nun]

Ok, so some people will never buy an annuity because you give up your principal and some people buy them without much regard for the interest rate because it involves assumptions about longevity and an annuity is more about cash flow and a lower BP than investing. I'm not talking about the payout rate here, but the underlying interest rate that you need to do the present value calculation.

But what about those of us on the fence, how good would the annuity interest rate have to be before you bought it?

 

[aja8888]

I think I'm in the camp of never buying an annuity.

 

[nun]

I think I'm in the camp of never buying an annuity.

I start from the assumption that I'm going to live at least as long as the actuarial tables say I will....because that's what I do for the rest of my retirement finances. I have one defined benefit pension that has a COLA and an interest rate of 7.6% when I do the present value calculation.....that's hard to ignore.

 

[Sunset]

I'd be more concerned with the payout amount compared to a withdrawal rate of 4% on X dollars. With a lifetime payout and minimum residual payout time of at least 20 yrs.

Why would the underlying interest rate be important since it ends up producing the payout amount which is what you get for X dollars ?

 

[karluk]

Even though OP made it clear that the poll is about annuity interest rates, the fact that the early results favor the higher interest rates leads me to suspect that at least some responses are from people who are using the payout rate instead of the interest rate. I currently have a 15 year annuity purchased through my pension plan, which has an annual payout of over 10% per year of the purchase price, but has an interest rate of "only" 5%. I contributed as much as I could, and would have contributed even more if the rules had allowed it. The choice was between getting a 5% return on my investment or getting maybe a couple of percent in a stable value fund or some other fixed income investment. To me it was a no brainer to take 5%, especially since the 10% per year payout made the duration of the investment much shorter than, say, buying a 15 year bond, where one has to wait the entire 15 years for return of principal.

 

[Huston55]

I start from the assumption that I'm going to live at least as long as the actuarial tables say I will....because that's what I do for the rest of my retirement finances. I have one defined benefit pension that has a COLA and an interest rate of 7.6% when I do the present value calculation.....that's hard to ignore.

How did you calculate the interest rate?

 

[Car-Guy]

I'm also in the camp of probably not buying an annuity. When I first retired a few years ago, it was on my financial radar of things to consider but it has fallen way down on my list for a number of reasons. Current interest rates, and longevity expectations certainly have been factors but I have also grown very comfortable that my conservative post retirement investment strategy will easily meet my needs.

 

[MooreBonds]

I said 6%.

I'd be open to considering one, but since I'm only 37 currently, I have a number of years before getting to the "go/no-go" evaluation. It will depend on a host of variables that are still up in the air:

Future Social Security payments - I'll likely delay until 70 to make SS a little bit of a longevity hedge, but even if I take it at full age (67), that's 30 years of policy changes by Washington that will make any planning now a complete wild guess.

Future inflation - Economic factors can always change, but I would also look at what future inflation expectations might be. If I were in my early 60s today, I'd likely buy just 1/2 of an annuity, IF all other factors were equal, since I would be expecting future inflation starting, say, 8-10 years from now to be a little more significant than current.

Alternative rates - You'd also have to consider what other interest rate options are. If the annuity 'yield' is only 3%, and I can get 3% on a 10 year CD, I'm going with the CD. If I happened to find an annuity that paid reasonably higher than other rates I could find, I'd look very closely at it....but, the odds of such an annuity existing outside of a sweetheart pension clause in some small municipality's pension set-up are probably slim.

Overall portfolio and my minimum budget - If I could take just 1/4 of my portfolio and fund my "basic/minimum" living needs with a lifetime annuity, I'd strongly consider it, since it would help give a strong base. I'm hoping SS will function to do a good part of funding most of the basic budget anyway, so my needs for an annuity would be less - but I'd still consider it with the above variables. Since I'm hoping to be married down the road, the "minimum budget" is open to interpretation (and lifestyle creep) by the future Mrs. MooreBonds.

 

[nun]

How did you calculate the interest rate?

I used online calculators for the present value of an increasing annuity and compound interest using the same interest rate for both calculations and adjusted the rate until the income match my pension income. I used the IRS life expectancy tables to come up with the number of periods. I then checked it with excel.

Present Value of a Growing Annuity

This way you can back out the interest rate as distinct from the payout rate, which is simply the ratio of the principal to the annual income you get....for a COLAed annuity/pension the payout rate changes....on my DB pension that starts at 7% at 55 and increases to 12% when I'm in my 80s.

 

[nun]

Future inflation - Economic factors can always change, but I would also look at what future inflation expectations might be. If I were in my early 60s today, I'd likely buy just 1/2 of an annuity, IF all other factors were equal, since I would be expecting future inflation starting, say, 8-10 years from now to be a little more significant than current.

The state pension/annuity that I'm going to buy into is inflation adjusted which makes it attractive and increased the underlying interest rate. I already have both US and UK SS that will start at 67 and both of those are also inflation linked....so I'll be well set for income that keeps up with inflation. The nice thing about the state pension is I can take it at 55 and bridge the gap between 55 and 59.5 without having to do 72t or tap my regular savings.

 

[aja8888]

My reasons for not considering an annuity are as follows:

1. DW and I currently collect over $45K in SS annually

2. I am starting the RMD phase and my annual IRA withdrawls are more than enough with the SS payments to cover living expenses and taxes.

3. We have fairly healthy non-taxable reserves in addition to the IRAs.

4. Our current living expenses are low and we have two paid off cars that are less than 2 years old.

Given that we are 70+ and have no loans, paid for house, etc and a portfolio that has ample reserves, I see no need to annuitize a big lump of cash.

Why would I need any annuity?

 

[nun]

I'd be more concerned with the payout amount compared to a withdrawal rate of 4% on X dollars. With a lifetime payout and minimum residual payout time of at least 20 yrs.

Why would the underlying interest rate be important since it ends up producing the payout amount which is what you get for X dollars ?

Well its a good way to see if you are getting anything better than the prevailing annuity rates and see how that rate fits in with your financial plan. It's probably only worth doing if you have a work related plan that might be better than the one you'd buy form an insurance company.

 

[Totoro]

But what about those of us on the fence, how good would the annuity interest rate have to be before you bought it?

The annuity interest rate is only part of the equation (a big part though).

I would buy a SPIA if and only if the interest rate becomes substantially higher (say 2%) than the withdrawal rate I can afford to fund my maximum remaining life.

In practice, this means the moment to go SPIA is when the variability in my remaining life years becomes very large in proportion to my average expected remaining life.

Say I was 75 years old. There is a <1% chance I'll make it to 100, on average though I'll be dead within 10 years. For planning purposes however, I need to take the maximum scenario into account.

So, I need +/- 25 years of expenses to fund the maximum scenario, let's say that amounts to a WR of 6% if I do it with my own capital.

Now, a SPIA might yield me 9% at that point, so it makes sense to go for it then, but only barely. Especially since I'll be giving up inflation adjustments.

The crux of the matter is that you stop self-insuring your longevity 'risk' when the variability becomes too high.

Note that this scenario only makes sense when you are not considering leaving money to heirs.

 

[nun]

My reasons for not considering an annuity are as follows:

1. DW and I currently collect over $45K in SS annually

2. I am starting the RMD phase and my annual IRA withdrawls are more than enough with the SS payments to cover living expenses and taxes.

3. We have fairly healthy non-taxable reserves in addition to the IRAs.

4. Our current living expenses are low and we have two paid off cars that are less than 2 years old.

Given that we are 70+ and have no loans, paid for house, etc and a portfolio that has ample reserves, I see no need to annuitize a big lump of cash.

Why would I need any annuity?

I agree.

 

[Independent]

My answer depends on what I'm selling to pay for the SPIA.

Suppose I'm selling long term bonds that have about the same interest rate as the insurance company will get when it invests my SPIA premium.

In this case, the question is moot. I've already "locked in" that interest rate. There is no interest gain or loss when I sell the bonds and buy the annuity.

 

[nun]

My answer depends on what I'm selling to pay for the SPIA.

Suppose I'm selling long term bonds that have about the same interest rate as the insurance company will get when it invests my SPIA premium.

In this case, the question is moot. I've already "locked in" that interest rate. There is no interest gain or loss when I sell the bonds and buy the annuity.

This is why it's good to look at the underlying interest rate. My state pension has a calculated rate of return of 7.6% given an average lifespan. That looks like a good replacement for my bond investments. I will sell equities to buy into the plan, but then rebalance so that my remaining portfolio is almost all equites. A 7.6% return on the fixed income bit of a portfolio is nice, that's a nice premium over long term bond rates.

There are risks though. The politicians could change the terms or default.

 

[karluk]

My answer depends on what I'm selling to pay for the SPIA.

Suppose I'm selling long term bonds that have about the same interest rate as the insurance company will get when it invests my SPIA premium.

In this case, the question is moot. I've already "locked in" that interest rate. There is no interest gain or loss when I sell the bonds and buy the annuity.

This is a very good point. My reason for jumping at the chance to buy a 15 year annuity with a 5% interest rate is that I was taking the money out of the fixed income portion of my portfolio and leaving the other asset classes untouched. I immediately got roughly a 3% boost in yield (5% in the annuity vs. about 2% from what I sold to buy it.)

You also have to look at duration. Selling long term bonds to purchase an annuity will tend to shorten your duration, because the annuity payments are partly an early return of principal. The annuity offers better protection against a future rise in interest rates because you can reinvest more money sooner at the higher rate. However, the annuity is worse than a long term bond with the same rate if interest rates stay low.

 

[nun]

This is a very good point. My reason for jumping at the chance to buy a 15 year annuity with a 5% interest rate is that I was taking the money out of the fixed income portion of my portfolio and leaving the other asset classes untouched. I immediately got roughly a 3% boost in yield (5% in the annuity vs. about 2% from what I sold to buy it.)

You also have to look at duration. Selling long term bonds to purchase an annuity will tend to shorten your duration, because the annuity payments are partly an early return of principal. The annuity offers better protection against a future rise in interest rates because you can reinvest more money sooner at the higher rate. However, the annuity is worse than a long term bond with the same rate if interest rates stay low.

Nice analysis, I also think about buying into my state pension as replacing fixed income in my portfolio. Currently I'm at a 60/40 AA and I'm going to use about 20% of my portfolio to buy into the pension and then go 100% equities as the pension, together with some rental income, will cover my expenses.

 

[Car-Guy]

Another consideration is the health of the insurance company that would be backing the annuity over the next 20, 30 or more years. They are not FDIC insured but I understand most (maybe all) states have an insurance guaranty association (GA) that backs up the insurance company policies in the event of a bankruptcy. Seems I've also read that the bankruptcy insurance amounts can vary by state. I've haven't checked recently but a few years ago I knew that some states had 100k and some had 250k limits.

I also read an article recently claiming that at least 20 insurance companies have failed between 2003 and 2011 and the GA's had to rescue some policy holders. It was unclear if these policy holders got all of their money (up to the insured limits) or not.

I know when I was considering SPIA's in the past, I had planned to spread them out over several different insurance companies to stay below the insurance limits of my state.

Just something else to consider and read up on before buying.

 

[karluk]

Nice analysis, I also think about buying into my state pension as replacing fixed income in my portfolio. Currently I'm at a 60/40 AA and I'm going to use about 20% of my portfolio to buy into the pension and then go 100% equities as the pension will cover my expenses.

I definitely think you're on the right track using the annuity to replace fixed income. I'm fairly sure that the financial experts who advocate buying a SPIA with part of one's nest egg are thinking along the same lines. You can use the annuity to replace fixed income and keep the same stock allocations, or even increase them. The annuity gives you a lot more longevity protection than an equvalent amount of fixed income investments, so in a lot of measurable ways you are better off with the annuity, assuming a favorable interest rate and good credit quality on the part of the annuity provider.

Just be sure to avoid the high fee products like variable annuties and the rapacious salesmen that are just looking to line their own pockets at your expense.

 

[Midpack]

Interest/payout rate (within what's realistically plausible) isn't a trigger for me, so I didn't vote. If we annuitize any of our nest egg, it probably won't be before we're about 80 years old and/or we find ourselves headed toward our 'annuitization hurdle.'

I've linked several times before FWIW http://www.schulmerichandassoc.com/Modern_Portfolio_Decumulation.pdf. Same basic concept as Otar's green-gray-red zones.

 

[nun]

I definitely think you're on the right track using the annuity to replace fixed income. I'm fairly sure that the financial experts who advocate buying a SPIA with part of one's nest egg are thinking along the same lines. You can use the annuity to replace fixed income and keep the same stock allocations, or even increase them. The annuity gives you a lot more longevity protection than an equivalent amount of fixed income investments, so in a lot of measurable ways you are better off with the annuity, assuming a favorable interest rate and good credit quality on the part of the annuity provider.

Just be sure to avoid the high fee products like variable annuties and the rapacious salesmen that are just looking to line their own pockets at your expense.

Well the "annuity" I'm buying is the MA state pension fund. The starting payout rate is 7% which increases to 12% when I'm 80 because it has a COLA. The internal interest rate is 7.6% which blows away bond rates..... Without the COLA and if I was getting basically 30 year bond rate returns I would not consider buying an annuity.

 

[Sunset]

I guess by default, I'm going to be, or have been buying a SS annuity.
I plan to delay taking it until 70 for the higher income earner to max the income stream.

 

[nun]

If people are planning out to ages like 95 I'm amazed that 50% of the votes on the poll would only buy an annuity with an internal interest rate of over 8%. Is this just prejudice against annuities? The payout rate you'll get for an SPIA today starting at 55 are around 5.5% with an interest rate of maybe 3.5% for an average life span, no matter how long you live your interest rate will never be more than 5.5%.....so that's not a good deal IMHO......but if you could get an interest rate of 6% and a payout rate of maybe 8% why wouldn't a healthy person going into retirement grab it?

 

[Closet_Gamer]

A ways in the future for me, but if rates have returned to something like normal, I'm favorably pre-disposed to buying a dual life, inflation adjusted immediate annuity with part of my assets just to create an income floor so I never have to worry about the roof over the head or the food on the table again.

But it's all theoretical for me right now. We'll see when we get there.