SPIA for Mortgage

[Lagniappe]

I recently got a 30 year fixed rate mortgage on my new retirement home and was planning to pay off as quickly as possible. With all the talk of SPIA's for those without pensions lately, I looked at the rates for someone my age. Right now, the best quote I could find (from the Vanguard affiliate) was 5.65% with no inflation adjustment. Since my mortgage rate does not increase with inflation either, would the difference between the two rates provide both peace of mind (I don't have to worry about how the market is doing to know that I can pay my mortgage - same reason I was going to pay off such a low rate early) and profit (the difference between the payoff rate and the SPIA payout)? I am not sure how payouts from SPIA's are taxed, since I already paid taxes on the money used to buy it.

Not sure if it's relevant, but I am mid 40's, and the amount would be about 15% of my liquid net worth. No dependents, so no concerns about leaving an estate.

 

[nun]

If you want to pay off the mortgage "as quickly as possible" why not refinance to a 15 year and get a better interest rate. I assume that the interest rate you quote includes return of capital as it seems very high given today's interest rates.

 

[LOL!]

A problem may arise if you are collecting Social Security. If you had your mortgage paid off, then you would not need the income to make the monthly mortgage payment. However, if you did not have the mortgage paid off, you would need the income. That income then raises your adjusted gross income and may make your Social Security taxable or more taxable.

So be careful. In certain income ranges, your SS benefits are not taxed. Above that, then 25% of your benefits are taxed. Above that 85% of your SS benefits are taxed. The marginal income tax rate can be as high at 46.5% when you are on the cusp of going from 25% taxed (i.e. added to taxable income) to 85% taxed.

With the SPIA you end up paying more taxes. Without the SPIA you may get more tax breaks than you think.

 

[Independent]

Remember that you may divide the payment from an SPIA by the premium and get a number that can be expressed as a percent, but that payment is both interest and principal. So just looking at two percentage rates isn't apples-to-apples, you need to look at cash flows.

It seems to me that if you've got the cash to buy an SPIA big enough to pay your mortgage bill, then you've also got enough cash to pay off the mortgage in a lump sum. That's the comparison you want to make.

Even if you don't have that much cash on hand (so the SPIA was only going to pay part of the mortgage) you can imagine that you had the full amount as a way to simplify the math.

 

[brewer12345]

I would say that the arbitrage between the mortgage payment and the SPIA income would have to be really huge in order to make me want to do this. You add a few notable risks by such a strategy:

- tax risk, as others have noted
- carrier risk. You are expecting a 30+ year stream of payments. That is a long time to hope an insurer stays in one piece.
- inflexibility. You can pay off the mortgage any time you like if life changes. You cannot undo the SPIA.

The last item would bother me most. 3 years ago I was extremely well paid and expecting full ER within 5 years. A year ago I was slogging through a low paid (for me) grunt job and figured out I could just about pull off ESR by late 2013/early 2014. Within the last week I have started talking to interested parties about an internal transfer that may result in me relocation halfway across the country and taking a position possibly as high as a junior level executive (nothing well developed yet). There are lots of twists and turns in life and a SPIA is completely inflexible.

 

[chinaco]

I will admit that I have not put much thought to this general idea... but my knee jerk response is I doubt it would be worth it.

Remember there are expenses on both sides of the equation and you are paying both sets of expenses.

One of the first thoughts that hit me was... if you can buy the annuity, why not just pay cash for the house?

Get some quotes and do the math. Create some models... don't just compare rates. Also consider what might go wrong!

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IMO - I would not do it... I would keep it simple and and keep my options open.

 

[rescueme]

I am not sure how payouts from SPIA's are taxed, since I already paid taxes on the money used to buy it.

As to the question of SPIA income taxability, only a portion of your monthly payment would be taxable, since you are purchasing the SPIA with non-qualified (e.g. after tax) funds. The return of "your" money in the monthly payment would not incur federal tax - however the interest received would incur tax.

Most SPIA's are purchased during retirement with qualified (e.g. tax deferred) funds, such as rollover 401(K) or TIRA funds, and are subject to taxes on 100% of payments.

You would receive a 1099 at year end showing what portions of the payments are taxable, from a federal standpoint. As far as states, each has their own way of taxing SPIA's. Although I live in PA and there is no tax involved with purchasing or receiving retirement income from an SPIA, I've heard states such as CA do tax a portion of the premium payment.

 

[Gill]

You're kidding yourself. You're not receiving interest of 5.65% on the SPIA, you're receiving a cash flow of that amount, only a small part of which is interest. You're ignoring the principal portion of the mortgage payment also. Be assured the insurance company is not paying 5.65%.
Bruce

 

[Animorph]

The type of SPIA also matters. The "normal" cash stream for life style might leave your estate with mortgage debt if you die before the mortgage is paid. You may not care, but that's gamble for me. I haven't seen 30-year certain annuities, but maybe your mortgage is shorter. Still, if inflation goes crazy, maybe some future annuity will look more attractive.

 

[haha]

I think OP's question was answered definitively by Brewer. You are gaining little to nothing if everything should go well, but actually assuming quite a bit of risk. Forget it, and move on to the next issue which perhaps has more to offer.

Ha

 

[rescueme]

I haven't seen 30-year certain annuities...

Again, just a "technical point" - not related to the OP's question.

While you may not see a 30-year term, you can get a SPIA life annuity that well may span and even exceed that period of time.

I/DW purchased our first SPIA at age 59 with a life benefit, but also a guaranteed length of payback which computed on our joint age was for 28 years at the time.

If we live/exceed that 28 year term, our payments continue at 100%, as long as one survives. If we're both gone before the 28 year term is up, payments continue to our estate at 100%.

As to the person that stated that the interest also includes return of your own money? That's true; it's not a true return. However also realize that if you are one of the lucky folks that exceed the normal estimated lifetime, the continuing monthly payments will raise that return rate month by month and will affect the total return rate for the entire period of time you have been receiving monthly income.

When we considered an SPIA and started looking at "return rates", we simply made up an IRR spreadsheet showing the initial premium along with the annual payments for the period of guaranteed payments. What we found was for every year beyond the guarantee period, the total return of the entire period was increased by .0015%.

Just some info, FWIW...

 

[rescueme]

One of the first thoughts that hit me was... if you can buy the annuity, why not just pay cash for the house?

One reason might be that the SPIA could pay much more than just the initial amount of the note/mortgage.

For example, our SPIA is a life annuity for DW/me, with a payout period computed at the time of purchase (both aged 59) and a 28-year minimum term, computed on our expected joint lifetime.

While we paid $X.00 for the premium, over the base 28-year period we will receive a bit over twice what we paid. Let's not get into how we could have done better with an alternative "investment". We know that, and that's what the other 90% of our joint portfolio is used for. However, to "insure" a revenue stream for basic expenses without market risk and have a monthly income source of both our original "investment" along with gains was a defined need for us (something a CD ladder or alternative “guaranteed” investment from day one, could not provide).

While I won't comment on the OP's theory, I will say that for that period of time where the SPIA income along with the note/mortgage payment offsetting each other, they could purchase/build much more of a home than just the initial premium would have covered. And that doesn’t even reflect the reduction in taxes, assuming note/mortgage deductibility remains in the future.

 

[rescueme]

I think OP's question was answered definitively by Brewer.

Sorry - I don't see it that way.

- We already established that a good deal of the SPIA payments (in this case) would not be taxable, since it's a return of already taxed monies.

- Carrier risk? Sure. But it's no different than any other risk involved in life, such as marriage, job, investment, or any other long-term situation. With an SPIA you can "measure" the carrier (by rating) and realize that probably a good portion of your premium will be insured from loss, depending on state guarantees. Heck, that’s better than most marriages …

- Inflexibility (due to j*b change?) I don't see it that way. While we purchased our initial SPIA at retirement (no j*b to worry about), even if we were still employed and subject to relocation, what would be the impact? It's no different than any other note/mortgage funding. You sell your current home, you move, you buy/rent another place, and you pay it from your income - be it a paycheck or SPIA.

The OP's idea is not something I would consider, but then, DW/me live in a different set of circumstances. I have to commend the OP for even bringing the idea up; something I would have not thought about. But then again, the idea that my DW/me had in purchasing our SPIA was driven by retiring a bit earlier than normal, not having pensions, and the desire to delay SS till age 66 for DW and 70 for me.

It's just another way to look at an SPIA as a solution to a "non-traditional" situation, regardless of what it may be rather than just think it is a vehicle that should only be considered as we approach the end of life to ensure our revenue stream.

At the risk of repeating myself once again, an SPIA is not for everybody and every situation. However it is an option that should be considered and not dismissed without understanding the possible solution it may provide, based upon a specific need.

 

[Lagniappe]

Thanks for all of the responses. For me, it is not worth it at this time because of the point brewer brought up around inflexibility. But that may change in the future, and this thread has helped me understand some of the pros and cons of SPIA's for my particular situation.