Why Don't Retirees Buy Annuities? They Get Something Most Economists Don't

[haha]

Quote:

Originally Posted by MikeTN I have the greatest respect for Ha, his comments are insightful and he obviously has finincial knowledge...but.. in this case I don't get his point. Sure inflation could decimate an annuity that is not inflation-protected. But the same is true of the portion of our portfolio that is in non-inflation-protected bonds or other fixed income instruments such as CDs. So should a person with these fixed income assets annuitize a portion of them. The paper under discussion says it depends largely on your level of wealth. Their model suggests that not everyone should buy annuities (largely because you need a lot of cash when entering LTC) but those who will benefit are those with wealth levels at age 65 that are at least 10-15 times the average wage per figure 9 (I assume they mean annual wage). My guess is that most of the people on this forum are at this wealth level or higher. Of course, the reason for an annuity is to safely allow higher spending in retirement. Many of our forum members have been LBYM for a long time and seem content to continue to do so.

First thank you Mike TN for your kind words. I will try to briefly address your issues.

I certainly agree with most of what you say, as you have presented it. In the abstract, all the things you mention are fixed income investments, or contracts in the case of annuities. If there is any difference between annuities and long term bonds, it might be in how long they might go on, and the ease or difficulty to impossibility of getting out of the position.

IMO, CDs are different from annuities regarding inflation, in that they are usually relatively easy to exit at low cost. Bank accounts and money market funds are different because they essentially have floating interest rates. Lately these rates are being suppressed below inflation, but this is not the usual case, at least in the past.

Bonds are different because we are not forced to purchase long term bonds. We can give up some interest rate in return for shorter duration. We can also make other discriminations based on our perception of credit worthiness, and we can change positions relatively cheaply (at least relative to annuities).

Something not related to inflation but IMO a disadvantage of annuities is that relative to other fixed income investments, it is hard to achieve true diversification.

The features you mention positive for annuities are certainly positive. I cannot say how the inflation risk stacks up against these advantages. But I can say that in the late 70s or early 80s, it was very hard to sell annuities with payouts much greater than todays! These conditions may never return again, but it is not a bet I would be willing to make.

My major intention with this post was as a reminder that in stressed circumstances, emotions are very strong, and things can look quite different than they looked in earlier, less volatile times. I think this is especially true, when as today an entire generation of investors has seen only one thing-in this case overall falling interest rates.

I believe this trumps other considerations, because if it breaks bad the loss can be very large. But there are surely other equally valid ways of framing this.

I do own a small number of ten year treasuries, bought at 2.7x% ytm. I doubt I will hold them until maturity, but we'll see.

Ha

[youbet]

Quote:

Originally Posted by haha Almost the entire investing history of people investing today has been spent with falling interest rates and low inflation. This makes it more or less impossible for us to really imagine the ravages of moderate to high inflation. Annuities are an extremely poor long term bet. I would not touch one with a stick, other than the inflation indexed one that we all will get some of. Ha

+1

I'm always amazed when I hear folks pooh-poohing the impact of moderate inflation on the purchasing power of non-cola'd income streams over time.

I agree, I wouldn't touch a non-cola'd annuity with a stick. And a cola'd annuity only if the rates were extremely attractive.

[Running_Man]

Quote:

Originally Posted by FIRE'd@51 A typical payout rate on a SPIA for a 65 year-old male is about 6.2%. The Vanguard LT Investment Grade Fund (VWETX) currently has a yield of 4.8%. In order for the annuity to achieve a 4.8% IRR, the annuitant would have to live until age 97.

Yes but it is the extra $1,400 in interest payments per year that you get to spend that makes the difference. True there is not a bond balance for your heirs but for spending I fail to see how an annuity does not add in increased spending in a retirement.

For instance assume a retiree with 300K in funds at age 65 planning for 30 years. One strategy obviously could be just to use the 4% withdrawl and adjusting as most on the board here would.
Many non Early Retirement retirees though would have an "emergency" and consume more than should be consumed and ultimately end up with only SS as 31% of retirees do.

A strategy of 1/3 in long bonds paying 4.8% 1/3 in shortterm bonds (amortize over 30 years) and 1/3 in dividend stocks paying an average of 2.75%.

this would produce the following income:
$4,800 Bonds
$3,333 ST BONDS
$2,750 Stocks

Total = $10,883 or 3.62% This income would have protection from inflation on the stock dividends and the ST bonds.

If then the bonds were split 50/50 between annuity and bonds you would have $3,100 and $2,400 for LT interest or $5,500 which increases the annual spending to $11,583 or 3.86%. If inflation were to become an issue the performance of ST Bonds and dividend increases at greater than inflation would be needed to maintain a steady increase in spending for the 30 years, but I think the retiree receives an additional 6.4% portfolio income with very little increase in risk. For retirees with smaller portfolio's I feel this is a worthy improvement.

[pb4uski]

Can you even buy a cola'd annuity today? I thought they are rare at best and extinct at worst.

[clifp]

Quote:

Originally Posted by Running_Man Yes but it is the extra $1,400 in interest payments per year that you get to spend that makes the difference. True there is not a bond balance for your heirs but for spending I fail to see how an annuity does not add in increased spending in a retirement. For instance assume a retiree with 300K in funds at age 65 planning for 30 years. One strategy obviously could be just to use the 4% withdrawl and adjusting as most on the board here would. Many non Early Retirement retirees though would have an "emergency" and consume more than should be consumed and ultimately end up with only SS as 31% of retirees do. A strategy of 1/3 in long bonds paying 4.8% 1/3 in shortterm bonds (amortize over 30 years) and 1/3 in dividend stocks paying an average of 2.75%. this would produce the following income: $4,800 Bonds $3,333 ST BONDS $2,750 Stocks Total = $10,883 or 3.62% This income would have protection from inflation on the stock dividends and the ST bonds. If then the bonds were split 50/50 between annuity and bonds you would have $3,100 and $2,400 for LT interest or $5,500 which increases the annual spending to $11,583 or 3.86%. If inflation were to become an issue the performance of ST Bonds and dividend increases at greater than inflation would be needed to maintain a steady increase in spending for the 30 years, but I think the retiree receives an additional 6.4% portfolio income with very little increase in risk. For retirees with smaller portfolio's I feel this is a worthy improvement.

I think that is a very good analysis. The $11,583 is certainly close to the $12K for the traditional 4% SWR. I think it would result in far less sleepless nights than we've seen in the 21st century. You still have $200K for an emergency fund.

I am personally thinking about purchasing a deferred annuity to kick in my 80s. However with rates artificially low I don't think it make sense now.

[Brooks Saddle]

Cola (inflation index annuities) are available and I know of two that are available; I don't know of others that might be available as I've never explored them. Vanguard has one available and Principal Insuance sells them. As mentioned, not all insurance carriers, however, have them. The problem is they are very expensive because insurors don't have any insight on what inflation is going to be in the future any more than the rest of us so they hedge their bets with an expensive product.

[Midpack]

An example below of the relative income from same initial annuity purchase price - fixed, variable, GLWB & inflation protected. IIRC, with the current low yields/interest rates, inflation protected annuities generally offer 30% less initial income (OR cost 40% more for same initial income) lately compared to a flat SPIA.

I've always had trouble finding quotes for inflation protected annuities online, and they seem more scarce as time passes. Some firms offer fixed annual % increase annuities (ie, a flat 3%/yr vs CPI which is unpredictable) and some others no longer inflation protected annuities at all. I used to look at the Principal Financial Group website to compare SPIAs vs inflation protected SPIAs, but I don't find the SPIA rate web page any more , though maybe I just missed it.

And no, I am not interested in annuities for another 20 years or so, if then.

Retirement income scorecard: Immediate annuities - CBS News

[haha]

Leaving aside the hen's tooth rarity of a truly inflation adjusted annuity, I am reading Sidney Homer and Martin Leibowitz, Inside the Yield Book-1972 edition. Now1972 was before the 70s inflation got going, but the first example he gives to illustrate some aspect of bond yields was a 20 year 8% investment grade bond.

As I see it, annuities per se are not the problem, the problem is artificially suppressed interest rates. It takes an amazing lack of respect for history to be long 20-30 or more year instruments reflecting sub 4% long term rates. People may say, oh, I only have xx% in these, but unless xx is truly meaningless, in which case why go through the hassle, it is meaningful, in which case why pick an investment which can really bite you in the butt, but cannot actually do much for you should it work out OK?

It is easy to get confused about what an annuity is actually yielding, but really it does not matter. Unless the insurance company is stupid, and therefore it will go bankrupt while you hold its annuity, the most important thing is at what interest rate can these contracts be funded. Unless the purchaser is very old, mortality credits can somewhat improve but not transform his rate on an annuity.

Some pretty smart people, most prominently Gary Shilling, have steadfastly promoted long term treasuries, and even zeros pretty much through the entire bond bull market, and if we settle into a Japanese style deflation this may go on for who knows how long. But I sure would not risk money on it, as it seems that there are much smarter risks that one could take.

To me the greatest puzzle in this area is how many people take SS early-not just people who are hanging on for dear life until they can get their hands on some money to get their teeth fixed, but even well off people like those who are attracted to this forum. Before even reading an article about annuities, one should mentally commit to taking SS as late as he can. This might no longer hold true if the S&P 500 dropped to 600 or so, but it does make sense now.

Ha

[nun]

Quote:

Originally Posted by youbet +1 I'm always amazed when I hear folks pooh-poohing the impact of moderate inflation on the purchasing power of non-cola'd income streams over time. I agree, I wouldn't touch a non-cola'd annuity with a stick. And a cola'd annuity only if the rates were extremely attractive.

This is where the annuities offered by TIAA-Traditional look pretty good. You can choose a graded payout method where you payments increase over time to keep up with inflation and the rates are pretty good too. Right now I'm getting 4.418% on new deposits and 4.5% on the vast majority of the money as I contributed it before 1992. If I turn the accumulation into an annuity I'll get a pay out interest rate of 7.75% on those pre-1992 contributions and 4.418% on more recent contributions. That's the interest rate......not the payout rate of the annuity.

[Running_Man]

Quote:

Originally Posted by haha It takes an amazing lack of respect for history to be long 20-30 or more year instruments reflecting sub 4% long term rates. People may say, oh, I only have xx% in these, but unless xx is truly meaningless, in which case why go through the hassle, it is meaningful, in which case why pick an investment which can really bite you in the butt, but cannot actually do much for you should it work out OK?

The following numbers represent the year, CPI and the 30 year treasury rate for US treasuries, for 40 years 1924 -1964 long term treasuries rarely went over 4% and I think forecasting interest rates is even harder than forecasting the stock market. There is an assumption inherent in your arguement that inflation is a certainty which I think is not necessarily so. In a deflationary scenario like the 1930's long term treasuries @ 4% can return the equivalent of 15% after price declines and as such offset losses in the stock market, which is why I believe they need to be a part of my portfolio (25% of total)
1924 - 4.061925 3.50 3.861926 (1.10)3.681927 (2.30)3.341928 (1.20)3.331929 0.60 3.61930 (6.40)3.291931 (9.30)3.341932 (10.30)3.681933 0.80 3.311934 1.50 3.121935 3.00 2.791936 1.40 2.651937 2.90 2.681938 (2.80)2.561939 - 2.361940 0.70 2.211941 9.90 1.951942 9.00 2.461943 3.00 2.471944 2.30 2.481945 2.20 2.671946 18.10 2.191947 8.80 2.391948 3.00 2.441949 (2.10)2.191950 5.90 2.391951 6.00 2.71952 0.80 2.751953 0.70 2.791954 (0.70)5.591955 0.40 2.911956 3.00 3.41957 2.90 3.31958 1.80 3.81959 1.70 4.271960 1.40 3.881961 0.70 4.061962 1.30 3.871963 1.60 4.141964 1.00 4.14

[Mike Piper]

Quote:

Originally Posted by pb4uski Can you even buy a cola'd annuity today? I thought they are rare at best and extinct at worst.

Quote:

Originally Posted by Midpack I've always had trouble finding quotes for inflation protected annuities online, and they seem more scarce as time passes.

Vanguard has a system through Hueler's Income Solutions platform that allows you to get quotes online -- though you need a Vanguard account and you have to create an Income Solutions username.

Go here:
https://investor.vanguard.com/what-w...rough-vanguard

Click "obtain a quote."

Sign in, and you'll be redirected to Income Solutions.

[haha]

Quote:

Originally Posted by Running_Man The following numbers represent the year, CPI and the 30 year treasury rate for US treasuries, for 40 years 1924 -1964 long term treasuries rarely went over 4% and I think forecasting interest rates is even harder than forecasting the stock market. There is an assumption inherent in your arguement that inflation is a certainty which I think is not necessarily so. In a deflationary scenario like the 1930's long term treasuries @ 4% can return the equivalent of 15% after price declines and as such offset losses in the stock market, which is why I believe they need to be a part of my portfolio (25% of total)

You chart is the best explanation of why you and I see this differently. You are absolutely correct that I expect that chronic inflation will reassert itself, in the US and worldwide, except perhaps Japan. Japan is a study as the first modern society to voluntarily and strongly change its demography from growth if moderate, to population decline and inverted age distribution. No desire on either of our parts to argue why this will or will not happen, suffice it to say that we have very different opinions that lead to very different actions. I sense that you, like me, tend to be satisfied with your own analysis

You chart shows a massive change in the very early 1970s. Well what happened then? The post war western monetary system worked out at Bretton Woods and adhered to thereafter was cast aside. All through the 60s, though inflation in the US was not particularly high, there was pressure on the dollar, especially with reference to the Deutschmark and Swiss franc. DE Gaulle demanded and got a large gold payment, and there was concern that our huge gold hoard in Fort Knox was disappearing. Germany first revalued the Deutschmark against the dollar, and Nixon on Sunday August 15, 1971, announced that the last link of the dollar to gold was being cast aside. Although Americans could not take their greenbacks to a Federal Reserve Bank and get gold, nations or at least certain nations could. I don't remember the extent of his devaluation, perhaps 10%. Moderate exchange controls were started, as well as the Interest Equalization Tax. He presented it as a defense against foreign price gougers, and Americans bought it happily. I remember it well, a friend and I were sitting in an outdoor café on UC Berkeley North Campus that Monday, and the WSJ covered the story in depth. I bought some South African gold miners very shortly afterward.

Then an inflation got going in America that was strong and persistent, and only Paul Volcker by nearly choking the economy got it stopped 10 years later. There could not be a Volcker today, our economy and monetary and political systems could not survive it.

Therefore, it will happen, barring ongoing recession which will lead to big political problems in today's America. I think all your data prior to 1971 is drawn from a different universe that is no longer relevant. It is hard to bet as to when, but no cost at all to refraining from betting that it will not happen.

Now if a person has the bias to take all events as equally probable, my outlook is meaningless.

I don't see investing or economics that way, but in the extremely unlikely case that I did, I still would not buy an annuity. If one were concerned about this kind of outcome, and felt that is must be hedged against, why not square the circle and open a 10 year CD?

Of course, for all annuity lovers everywhere, ymmv.

Ha

[Grammymissy]

I am curious if there is anyone who has purchased a variable annuity, and what was their reasons for purchase.

[Running_Man]

Quote:

Originally Posted by haha You chart shows a massive change in the very early 1970s. Well what happened then? The post war western monetary system worked out at Bretton Woods and adhered to thereafter was cast aside. All through the 60s, though inflation in the US was not particularly high, there was pressure on the dollar, especially with reference to the Deutschmark and Swiss franc. DE Gaulle demanded and got a large gold payment, and there was concern that our huge gold hoard in Fort Knox was disappearing. Germany first revalued the Deutschmark against the dollar, and Nixon on Sunday August 15, 1971, announced that the last link of the dollar to gold was being cast aside. Although Americans could not take their greenbacks to a Federal Reserve Bank and get gold, nations or at least certain nations could. I don't remember the extent of his devaluation, perhaps 10%. Moderate exchange controls were started, as well as the Interest Equalization Tax. He presented it as a defense against foreign price gougers, and Americans bought it happily. I remember it well, a friend and I were sitting in an outdoor café on UC Berkeley North Campus that Monday, and the WSJ covered the story in depth. I bought some South African gold miners very shortly afterward. Then an inflation got going in America that was strong and persistent, and only Paul Volcker by nearly choking the economy got it stopped 10 years later. There could not be a Volcker today, our economy and monetary and political systems could not survive it. Therefore, it will happen, barring ongoing recession which will lead to big political problems in today's America. I think all your data prior to 1971 is drawn from a different universe that is no longer relevant. It is hard to bet as to when, but no cost at all to refraining from betting that it will not happen. Now if a person has the bias to take all events as equally probable, my outlook is meaningless. I don't see investing or economics that way, but in the extremely unlikely case that I did, I still would not buy an annuity. If one were concerned about this kind of outcome, and felt that is must be hedged against, why not square the circle and open a 10 year CD? Of course, for all annuity lovers everywhere, ymmv. Ha

My main contention is that the difference is currently the way the economy is built is deflationary in nature and generally speaking we have overcapacity issues. Soon it will be possible to drive cars entirely on electricity, computers have led to allowing businesses to be developed anywhere, this is leading high cost states like California, Illinois, New York to a lesser degree to lose jobs to less costly less debt ridden states in the midwest where job growth is.

There has been an overabundance of capital employed by business to offset the need for employees, resulting in lower percentage of work force participation than is normal for any recovery. Therefore, despite the fact the Federal Reserve very clearly desires inflation, it is unable to garner any.

Now I really don't know if this will lead to deflation, years of stagnation or inflation, I think all are possible. To offset the deflationary scenario, a good way to do so is to a secure long term bond portion in your portfolio and to me that is US 30 year treasuries.

For if the economy were to contract in a major way, stocks could fall a long ways, but if inflation were to go negative even a 3.8% 30 year bond could garner a large capital gain that could be sold in balancing to purchase cheap stocks. And for balancing purposes I would double the bond value in my portfolio to account for the annuity purchased. One though is going to need a level of income in retirement anyway, locking in a higher return for part of the fixed asset portion and allowing the other portion to act as the balancing act for a deflation scenario makes sense to me in a retirement phase ( I have a different opinion on accumulation phase). If stocks perform better than bonds due to an inflationary outburst, then I would anticipate balancing by buying more bonds at a higher interest rate over time and still the annuity would be providing more income than I would otherwise be getting old 30 year bonds.

[pb4uski]

Quote:

Originally Posted by Grammymissy I am curious if there is anyone who has purchased a variable annuity, and what was their reasons for purchase.

Let's please not go there with this thread. Please do a search on "variable annuities" in the search box above and you'll find plenty of info.

[Grammymissy]

No worries, did not realize that only certain questions can be asked, I won't bother you again.

[Koolau]

Quote:

Originally Posted by haha Then an inflation got going in America that was strong and persistent, and only Paul Volcker by nearly choking the economy got it stopped 10 years later. There could not be a Volcker today, our economy and monetary and political systems could not survive it. Therefore, it will happen, barring ongoing recession which will lead to big political problems in today's America. I think all your data prior to 1971 is drawn from a different universe that is no longer relevant. It is hard to bet as to when, but no cost at all to refraining from betting that it will not happen. Now if a person has the bias to take all events as equally probable, my outlook is meaningless. I don't see investing or economics that way, but in the extremely unlikely case that I did, I still would not buy an annuity. If one were concerned about this kind of outcome, and felt that is must be hedged against, why not square the circle and open a 10 year CD? Of course, for all annuity lovers everywhere, ymmv. Ha

I too recall those days of the early 70's. The rampant inflation of the late 70's and early 80's was frightening - even to one who had a j*b that could (pretty much did) keep income up with inflation. Now with inflation protection only available for my (as yet not-taken SS), I too would hate to commit to an annuity or long-term "anything" (bonds, CDs, name-your-paper-asset-tied-to-debt).

With this thinking in place, I struggle to find a strategy likely to prepare for similar or worse inflation (knowing that the Volckers of the world have been relegated to the ash-heap of history.) Perhaps changing the discussion 90 degrees, has anyone established a strategy to prepare for inflation but leaving an "escape" just incase deflation occurs instead? Back when I was still considering annuities as a possible tool, I considered buying (smaller units) at intervals (say age 70, then 75, then 80, etc.) to account for inflation. I've rejected that approach as unwieldy and probably ineffective. YMMV

[Midpack]

Quote:

Originally Posted by Mike Piper Vanguard has a system through Hueler's Income Solutions platform that allows you to get quotes online -- though you need a Vanguard account and you have to create an Income Solutions username.

Thanks. I am aware of the quotes Vanguard provides and I do have an account, but I am only looking for quotes online that don't require any interaction with the provider. I don't think it would be fair to waste Vanguard or any providers times requesting a quote when I have no plan to buy.

[Mike Piper]

Quote:

Originally Posted by Midpack Thanks. I am aware of the quotes Vanguard provides and I do have an account, but I am only looking for quotes online that don't require any interaction with the provider. I don't think it would be fair to waste Vanguard or any providers times requesting a quote when I have no plan to buy.

It's a fully automated online system, so I don't think you're wasting anybody's time, per se.

[MichaelB]

Quote:

Originally Posted by Grammymissy I am curious if there is anyone who has purchased a variable annuity, and what was their reasons for purchase.

This is a topic frequently discussed, so you will find many past threads that might help by using the search function. If you want to pursue it in more detail or have a specific question you might want to start a new thread.

Two examples
http://www.early-retirement.org/foru...ive-66669.html
http://www.early-retirement.org/foru...ion-66414.html