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

[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]

+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]

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]

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

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-we-offer/annuities/annuities-through-vanguard

Click "obtain a quote."

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

 

[haha]

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]

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]

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]

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]

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]

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]

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/forums/f28/are-annuities-worth-it-or-too-expensive-66669.html
http://www.early-retirement.org/forums/f28/variable-annuity-question-66414.html

 

[Independent]

I believe the paper has shown up on another thread. This article provides a nice summary:

Another way to look at it is this: less affluent retirees already have most of their retirement “wealth” in an annuity–Social Security–and need to keep their other retirement savings liquid to pay for extraordinary healthcare costs and other emergencies.

This makes sense as a general statement.

 

[mickeyd]

Nice get Independent.

SS, especially SS@70, is a beautiful base for the wealthy as well as the not-so-wealthy. So is a COLAd pension or two. With guaranteed income streams flowing each month it is quite easy to avoid spending financial assets that have been thoughtfully stashed away for later use.

These are the kind of problems that we all wish for.

 

[Midpack]

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

Well I didn't realize that, thanks! I didn't want to be contacted by an advisor along with the quote, but I just assumed...

 

[pb4uski]

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

GM, its not that certain questions can't be asked. It is just that there is oodles of materials on that subject in various threads and VAs are controversial and are likely to derail this thread. If after looking at other threads that discuss VAs you still have questions, please feel free to start a new thread.

 

[Running_Man]

As I was on my way in to work this morning, my mind starting working on the question - "What is the impact to my retiree @ 65 with 300K of assets if he were to take Ha's advice and wait until age 70 to claim social security instead of utilizing 16.67% of his portfolio in an annuity?"

So to set the stage I needed to have SS figures so I am using mine:

His income @ 65 as I detailed before would have been $11,583 from the portfolio and $24,990 from Social Security for a total income of $36,573. This would mean our retiree is dependent on Social Security for 68.3% of his net income, for a potential frugal but liveable retirement. Recall the investments would have been:

50K annuity
50K 30 Year Treasuries
100K Short Term Bonds
100K Stock Market

Now our retiree sees by deferring to age 70 the Social Security will become $35,814 @ age 70, an increase of $10,824 per year and decides to purchase that annuity instead of the fixed annuity. The retiree would like to know how to establish a portfolio that will provide an increased income for life utilizing this. My suggestion is:

Will need $35,814 per year for 5 years to represent the Social Security you will claim, this results in a need for $179,365 which I am going to round to 180K for portfolio purposes and allow our retiree a dipped ice cream cone from Mc Donalds 3 times a week for the next five years.

I would then use the following from the previous portfolio to pay for the Social Security deferreal :

Short Term Cash: 100K
Annuity 50K
Long term bonds 15K
Stock Market 15K

This leaves the retiree with a portfolio of 35K short term bonds and 85K stock market, but as the remainder of his money is invested in the security of short term payouts for the next 5 years followed by social security I think this is the best hope of an improving retirement. The income generated by these will be:

Bonds: $1,680
Stocks $2,337
--------------------
Total $4,017 Together with the Social security of $35,814 total retirement income will be $39,831 an increase of $3,258 or a 9 percent increase in this case. This is a significant increase to this retiree, and virtually all of this I think will be tax free if this is the total income of our retiree. So I totally understand the benefit social security deferral affords. And if there is a spouse or if there is more money in the portfolio, this only makes more and more sense. The downsides are:

1) If the retiree dies before age 95 his legacy portfolio will be smaller.
2) Percentage of income relying on social security has now increased to 90%, however this is where those percentages of reliance on social security are deceiving. But there is surely a risk here, as the previous portfolio of about 12K per year is a very meager life but still possible to eek out on if SS were drastically curtailed.
3) Rebalancing of the stock/bond portfolio is going to be problematic but still possible, this could change results in a deflationary enviroment where Social Security would be effected as well. This is a small risk.

But overall I think this is a good demonstration of the results Ha is talking about when he says deferring social security is a no-brainer. In general I believe the more money you have the more it makes sense to defer but perhaps the risks are worth taking for an intermediate wealth retiree as well.

 

[rayvt]

Really? As I see it, the more money you have the less sense it is to defer.
The absolute max for a 70 yo (2013) is $3350/mo. For a 66 yo, $2533.

If yo have $1M and take 4% SWR, that's $3333/mo, so the total would be $5866 if you don't defer or $6683 if you defer. But in order to get that $6683 you'd have to take 4 years of only $3333. Where's the sense in that?

 

[teejayevans]

Really? As I see it, the more money you have the less sense it is to defer.
The absolute max for a 70 yo (2013) is $3350/mo. For a 66 yo, $2533.

If yo have $1M and take 4% SWR, that's $3333/mo, so the total would be $5866 if you don't defer or $6683 if you defer. But in order to get that $6683 you'd have to take 4 years of only $3333. Where's the sense in that?

Depends...how long you going to live??
Also, delaying SS allows you to spend down your pretax accounts, lowering your RMDs, by selectively moving money from pretax to tax accounts you can minimize tax bite.
TJ

 

[pb4uski]

+ assuming that DW outlives me which is statistically likely then she will have more financial security having a higher cola-adjusted "pension" in higher SS. It seem to me that delaying SS is just a call option to buy a cola-adjusted joint life annuity at a very favorable cost. Crazy not to do it in my situation where DW was a SAHM and my SS earnings were much higher than hers.

 

[rayvt]

Obviously it all depends on how one emotionally views it. The SSA itself says that whether you take at 62 or 66 or 70, it's actuarially identical. Therefore there is no *financial* reason to prefer one age to another.

I think that people tend to get hung up over the percentage differences and ignore the absolute dollar difference. If the bulk of your income comes from SS, then you need the extra money --- but you can't get it because you can't defer because you need the money to live on.

If you have $1M-$2M or more, then the additional money you get from SS is pretty small. In the above example, by deferring from 66 to 70 you'll get an additional $817/mo from SS. Sure, that's 33% more -- but 33% more from the SS portion of your income. But it's only 14% increase in your total income -- and to get it you have to take $2533 LESS income for 4 years.

I think focussing on the RMD tax aspect is an error, it's letting the tail wag the dog. Not to mention that -- with all the news of the financial issues that the goverment is having -- that spending your own money first and hoping to grab a larger SS payout in the future seems a high risk plan.

 

[Independent]

Really? As I see it, the more money you have the less sense it is to defer.
The absolute max for a 70 yo (2013) is $3350/mo. For a 66 yo, $2533.

If yo have $1M and take 4% SWR, that's $3333/mo, so the total would be $5866 if you don't defer or $6683 if you defer. But in order to get that $6683 you'd have to take 4 years of only $3333. Where's the sense in that?

I think you missed part of running_man's plan. Did you notice the $180,000?

I'll convert your numbers to annual and do a little rounding because it's easier for me to see what's happening.

You say the choice is:

A. Take SS today.
Starting now, $30,400 from SS + $40,000 from 4% SWR = $70,400 total, indefinitely.

B. Defer SS for four years. Your plan is has two income levels.
First four years, $0 from SS + $40,000 from 4% SWR = $40,000
After that, $40,200 from SS + $40,000 from 4% SWR = $80,200

Given the choice between A and B, you'd take A. I suppose most of us would.

But, rm has a different plan. Again using your numbers:

A. Take SS today.
Starting now, $30,400 from SS + $40,000 from 4% SWR = $70,400 total, indefinitely.

C. Defer SS for four years
Move $160,000 from my $1 million portfolio into short assets (CD's, short TIPS), leaving $840,000 invested in stocks etc.
First four years, $0 from SS + $40,000 from ST + $33,600 from 4% SWR = $73,600 total.
After that, $40,200 from SS + $0 from ST + $33,600 from 4% SWR = $73,800 total

Notice that Plan C allows me to spend more money in the first four years, and spend more money in the remaining years then Plan A. I prefer Plan C over both Plan A and Plan B. (Note that if I'm a more conservative 3% SWR person, the advantage of C is even larger.)

In fact, that's what we did. When I retired, we had a laddered portfolio of CDs and I-Bonds that was designed to fill the gap between retirement date and SS start date. We've mostly spent that portfolio down.