Annuity post to end all annuity posts...

[Midpack]

Won't end the questions I'm sure --- but the link below makes the most sense to me by far. Why buy an annuity unless and until it's clearly your best option? The later you buy the less it will cost and the less the risk of insurer(s) defaulting. And if the market takes off during your retirement, you're going to really kick yourself for buying an annuity before it made sense. This strategy let's you "have your cake (investment risk) and eat it (longevity risk) too." Here's how to know exactly when (if ever) to annuitize:
FPA Journal - Modern Portfolio Decumulation: A New Strategy for Managing Retirement Income
Brilliant IMO...

 

[chinaco]

The guarantee is for income (assuming the insurer does not default). One is paying for mitigation of longevity risk and (basic market risk).

The insurer covers their longevity risk by pooling money. They cover their market risk by diversification.

The annuitant still takes on inflation risk. Even if there is an inflation component, the annuitant paid for it and it seems to just be an increasing percent.

I agree that fees are high on an annuity. But if one can catch a decent interest rate at the right age (65 or so)... it can make sense to round out a base income with one. But you still need to have some sort of plan for inflation.

I would never put the entire portfolio in an annuity.

 

[donheff]

This paragraph seems to be a short summary:

This method considers failure to mean "having to annuitize your assets before you really hoped to." For most retirees, this is a more comforting threshold to use than financial ruin.

The concept seems to make sense and is easy to implement. You simply put a (moving) floor on your accepted minimum portfolio value that lets you bail out to an annuity when you otherwise risk financial ruin. This requires carefully monitoring annuity costs and availability.

It would seem to work fairly well for someone with enough assets to have a decent breathing space between desired income and "acceptable minimum" income. You have a good chance that market returns will be sufficient to keep you from ever reaching that "annuity funding floor." You can also set your "floor" to leave a chunk of change in the portfolio for bequests or "surprises." For those who start out on the edge - i.e. their SWR matches their acceptable minimum income - it would appear that they are already at the floor and need to annuitize now.

 

[Independent]

This paragraph seems to be a short summary:

This method considers failure to mean "having to annuitize your assets before you really hoped to." For most retirees, this is a more comforting threshold to use than financial ruin.

The concept seems to make sense and is easy to implement. You simply put a (moving) floor on your accepted minimum portfolio value that lets you bail out to an annuity when you otherwise risk financial ruin. This requires carefully monitoring annuity costs and availability.

It would seem to work fairly well for someone with enough assets to have a decent breathing space between desired income and "acceptable minimum" income. You have a good chance that market returns will be sufficient to keep you from ever reaching that "annuity funding floor." You can also set your "floor" to leave a chunk of change in the portfolio for bequests or "surprises." For those who start out on the edge - i.e. their SWR matches their acceptable minimum income - it would appear that they are already at the floor and need to annuitize now.

You've explained it exactly the way I see it.

In fact, I used this type of analysis before I retired. It gave me an additional measure of confidence in retiring when I did.

I don't feel comfortable with the other claim in the article that a "dynamic" investment strategy is better. It may or may not be, but the author didn't do anything to convince me.

 

[Midpack]

The guarantee is for income (assuming the insurer does not default). One is paying for mitigation of longevity risk and (basic market risk).

The insurer covers their longevity risk by pooling money. They cover their market risk by diversification.

The annuitant still takes on inflation risk. Even if there is an inflation component, the annuitant paid for it and it seems to just be an increasing percent.

I agree that fees are high on an annuity. But if one can catch a decent interest rate at the right age (65 or so)... it can make sense to round out a base income with one. But you still need to have some sort of plan for inflation.

I would never put the entire portfolio in an annuity.

I am assuming a (relatively) low cost annuity and I am also assuming an inflation adjusted annuity unless I am certain I'm in the final years of my life. And the bequest amount (Fig 5), which doesn't have to be used as a bequest (wouldn't be in my case), avoids putting the 'entire portfolio in an annuity.' But given these assumptions, if you reached the crossover point and did not seriously consider an annuity to sustain your minimum expense needs - would seem to me you're taking on some serious longevity risk. What am I missing, how would you deal with longevity risk if you actually found yourself at the crossover point on the graph (Fig 9, about age 92)? I understand the insurer risk, which is why delaying annuitization as long as possible makes sense to me. At age 92, I'd hope insurer risk would be reduced considerably...

 

[Texas Proud]

Sooo....

What the graph shows is if your portfolio is doing crappy... you annuitize at 82... if it is doing 'mean' then 92... if great... never...

Now, this does mean that you were only going to annuitize the percent of your portfolio that the graph shows (maybe 60%) when you first made the decision at age 65... but now have to annuitize 100% when you cross the line...

To me the amount to leave for 'bequests' should be taken out of all calculations on the annuity....

As an example.... a male aged 65 in Texas would have to pay $740,741 to get an annuity of $48,000 per year ($4,000 per month)... (almost a 6.5% payout, but with nothing when you die)... OR using a 4% SWR you need to have $1,200,000....

So if for SOME reason, you retire with your $1.2 mill... and on day 2 the market crashes and you now have $750,000... Well, time to buy that annuity...

My concern would be... can you buy one for $750,000 that will pay you the $48,000? This is a real risk... and maybe it is muted in that probably the market will not go down 38% in one day.... but it has come close to that a couple of times...

And if it DID... would you be willing to 'pull the trigger' on such a down market? Not likely... you would think that the market will come back and you don't want to buy when it is SO down....


To me... there is NO way to get rid of risk... you just have to live with it... some more than others.. we try to minimize them as much as we can, but in so doing usually create some other risk that we did not have in the first place....

 

[Rich_by_the_Bay]

I've never seen anything written about "laddering" SPIAs. That is, if your holdings dip for a while despite a sensible SWR, annuitize a small amount at a time until your SPIA distribution income and remaining assets are sufficient to meet your needs. Probably you'd purchase the SPIA with proceeds from selling fixed equities.

Advantages might include minimizing the total amount annuitized since you do it as needed only and in smaller amounts; more bang for the buck as you age; avoid inflation adjustments in favor of reassessing the timing of the next annuity (if any); spreading the risk of insurer insolvency, etc.

Anyone actually seen a plausible analysis of that strategy? It "feels" safer than just dropping 20% of your holdings in to an annuity all at once.

 

[Gumby]

Hey! No fair! You guys are having a rational discussion about this topic. Don't you know that when discussing annuities we are supposed to rant and disparage each other's parentage?

Rich: I have read somewhere about an annuity "laddering" strategy, but I can't recall where right at the moment. I will think on it and maybe find something for you.

Midpack: I read the chart the same way and can see some rationality to it.

 

[RockOn]

Emotionally I don't think that plan works. After losing a good portion of the portfolio I think it would be highly unlikely that anyone would have the discipline to just throw in the the towel and buy the annuity. Good plan on paper, not realistic in practice IMO.

If you want to buy an annuity to lower volatility that's fine. If you don't, that's fine too. But thinking you can time the decision to just before the disaster....... good luck on that. Sounds like market timing to me.

 

[youbet]

That is, if your holdings dip for a while despite a sensible SWR

And indeed, FireCalc runs show that a significant number of outcomes do take scary dips along the way, even if they eventually wind up "surviving." A sensible SWR doesn't protect from dips nearly as well as it protects from depletion......

 

[REWahoo]

And indeed, FireCalc runs show that a significant number of outcomes do take scary dips along the way, even if they eventually wind up "surviving."

Yep. Early retirement isn't for the faint of heart...

 

[cashflo2u2]

I've never seen anything written about "laddering" SPIAs. That is, if your holdings dip for a while despite a sensible SWR, annuitize a small amount at a time until your SPIA distribution income and remaining assets are sufficient to meet your needs. Probably you'd purchase the SPIA with proceeds from selling fixed equities.

Advantages might include minimizing the total amount annuitized since you do it as needed only and in smaller amounts; more bang for the buck as you age; avoid inflation adjustments in favor of reassessing the timing of the next annuity (if any); spreading the risk of insurer insolvency, etc.

Anyone actually seen a plausible analysis of that strategy? It "feels" safer than just dropping 20% of your holdings in to an annuity all at once.

I think there was a book called "Die Broke" that promoted that approach. Pretty good book, as I recall.

 

[Rich_by_the_Bay]

I think there was a book called "Die Broke" that promoted that approach. Pretty good book, as I recall.

Here's a summary of that book. Set your desired income (e.g. 4.5% SWR). Buy SPIAs only, buy as late as you can, buy only what you need, hedge inflation by buying a little more SPIA as needed.

He also says to handle the inheritance thing by gifting what you will in your later years (you will have accumulated enough annuity income not to worry about how much you had in your nest egg, you'll enjoy the act of giving) or through charitable gift annuities.

Of course he also advocates working forever and a few other flukey ideas.

 

[youbet]

Yep. Early retirement isn't for the faint of heart...

The problem for me was that my last job wasn't for the faint of heart either. Responsible for many people, responsible to many people. Sort of the "between a rock and a hard place" phenomona we keep hearing about. But sometimes a thick skull makes up for a faint heart.......

 

[ERD50]

Rich: I have read somewhere about an annuity "laddering" strategy, but I can't recall where right at the moment. I will think on it and maybe find something for you.

Along with the idea of spreading annuity risk across several providers - doesn't this reduce your income? I always heard (never ran the numbers) that there is a significant amount of fixed cost to an annuity. Such that four separate $250K policies won't pay the same as a single $1M policy.

Not sure if that has a big impact or not. - ERD50

 

[Rich_by_the_Bay]

Along with the idea of spreading annuity risk across several providers - doesn't this reduce your income? I always heard (never ran the numbers) that there is a significant amount of fixed cost to an annuity. Such that four separate $250K policies won't pay the same as a single $1M policy.

Not sure if that has a big impact or not. - ERD50

Only to the extent that distributions from a SPIA are partly a return of your principle, and thus not taxable, to my understanding. I think 4 x 250K should be very similar tax-wise to $1mm all at once, corrected for the same tax bracket of course.

 

[chinaco]

Some good ideas on using annuities.


In the next few years new Immediate Annuity features and options will be available (more common) such as cash-out early, more elaborate inflation protection, etc. Same with Life Insurance to cover LTC and other life events. Of course, the issues with Life Insurance is anti-selection... by the time you know you need it... it is too late and you are not insurable.

But all of those features (protection and flexibility) will come with a cost.

I like the idea of Longevity Insurance... not sure if it is cost effective. But since money is pooled, one would expect it to be. If one lives to 90, they get the face amount of the policy... say $500k or $250 with a CPI inflater (product backed with long-term CIPS or TIPS). This is the reverse of life insurance... betting you will die early.

 

[ziggy29]

Rich: I have read somewhere about an annuity "laddering" strategy, but I can't recall where right at the moment. I will think on it and maybe find something for you.

Actually, this is something Scott Burns just wrote about:

You're on the right track and, yes, the sales people who promote the living-benefit route ARE receiving handsome commissions. You can reduce your risk and possibly increase your estate by doing exactly what you suggest: laddering a number of single-premium life annuities. While the principal will be gone, your current monthly payments will increase. Less (or none) of your required minimum distributions will need to come from liquidating equity investments. You'll get the security of a solid monthly income, and your equity investments may grow with less risk of being sold in a down market.

 

[FinanceDude]

Actually, this is something Scott Burns just wrote about:

You're on the right track and, yes, the sales people who promote the living-benefit route ARE receiving handsome commissions.

Not the folks selling them at Fido, or Jefferson National............

I know that VG doesn't offer the living benefit annuities through AIG, but AIG is still giving VG the normal 4-5% commissions on the product, so I guess "someone" at VG is getting the commisions??

 

[ESRBob]

I think we worked out a really simple rule for the optimum time to buy an annuity in a previous thread:

When 50 year old investors can get 7% inflation-adjusted annuities with 2nd-to-die clauses, then we're all buying!

 

[explanade]

I think we worked out a really simple rule for the optimum time to buy an annuity in a previous thread:

When 50 year old investors can get 7% inflation-adjusted annuities with 2nd-to-die clauses, then we're all buying!

What do you mean by that, that for a $100k premium, you get $7k a year in payments with inflation adjustments while both spouses are alive?


On some other issues raised in this thread, VG won't give a quote for $1 million SPIAs. Could that mean the payments would be at a higher rate the quotes they show for 0-999,999?

Also, do the payments they quote at any given time, beyond the gender, state and age criteria, reflect market conditions? Do they index it to some benchmark rate or otherwise base their payments on what other financial instruments are doing?

 

[chinaco]

I am on the fence about using an annuity. The issues are complicated.

On the use of longevity insurance (basically a deferred annuity)... I have not gotten a quote... but I suspect that I might be better off self insured by taking the premium and investing it in a target 2045 fund... stick 50k in there and let it grow for 35 years.

Those target funds are really good vehicles. I am thinking that they can be used as an auto-pilot vehicle for DW if anything happens to me (she is not interested or knowledgeable about finance).

I like the idea of the Managed Payout funds also, but I am still mulling it over. I have a few years before ER... so I can see how they perform and study them closer.

Would any of you put your entire portfolio in the managed payout fund during FIRE?

 

[RockOn]

I think we worked out a really simple rule for the optimum time to buy an annuity in a previous thread:

When 50 year old investors can get 7% inflation-adjusted annuities with 2nd-to-die clauses, then we're all buying!

Checking for myself at age 53.5, that's about 4.2% right now at Vanguard, (CPI COLA'd, 100% survivorship). It's 7.3% with no COLA and no survivorship.

At 7%, you bet. Not holding my breath! I'd like 7% on investment grade 30yr bonds. Not holding my breath on that either.

 

[RockOn]

What do you mean by that, that for a $100k premium, you get $7k a year in payments with inflation adjustments while both spouses are alive?


On some other issues raised in this thread, VG won't give a quote for $1 million SPIAs. Could that mean the payments would be at a higher rate the quotes they show for 0-999,999?

Also, do the payments they quote at any given time, beyond the gender, state and age criteria, reflect market conditions? Do they index it to some benchmark rate or otherwise base their payments on what other financial instruments are doing?

Just trying to help. I am not an expert on this. (Go ahead CFB, I'll be waiting)

1) yes
2) maybe, you have to call them and ask, I doubt it would be much higher, if at all. If you call, let us know what they said. I'd never put that much into one annuity, I'd spread it around for some diversification.
3) yes, I'm not sure what they use and you probably would have a hard time finding out but it is likely tied to interest rates, such as the 10 year treasury, or current corporate bond rates. As rates rise, the payments go up, probably not a lot though, they have to be looking very long term at average investment returns. Berkshire uses a 30 year Treasury strip rate of about 4.65% according to their site in their payout calcs, they pay less than Vanguard. From what I can tell Vanguard uses around 5.25% to 5.5% for their payout calcs, based on living to the age in the Mortality Tables. These rates are what I would call the IRR (internal rate of return) they allow the investor for on an incoming investment. We can argue about the preciseness of that, but it is at least very close to correct.

 

[FinanceDude]

I think we worked out a really simple rule for the optimum time to buy an annuity in a previous thread:

When 50 year old investors can get 7% inflation-adjusted annuities with 2nd-to-die clauses, then we're all buying!

I have MANY clients for those....... Maybe NML can figure that out with their dividend rates..........