Htown Harry
Thinks s/he gets paid by the post
- Joined
- May 13, 2007
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Unlocking the Two Mysteries behind SPIAs
Using the household balance sheet approach (see separate thread), Wade has some "new" ideas on SPIA's.
Using the household balance sheet approach (see separate thread), Wade has some "new" ideas on SPIA's.
Two mysteries confound planners who purchase single-premium immediate annuities (SPIAs) for their clients: Why does the present value of a SPIA often exceed its cost, and why do equity allocations appear to increase when a SPIA is purchased? Unlocking those mysteries requires advisors to use a different framework – based on the household balance sheet – for the withdrawal phase of retirement...
[Mystery #1]:
Calculating the survival-weighted present value with these alternative assumptions gives us a present value for the SPIA of $228,444. This is 54.5% larger than the cost of the SPIA...
[Mystery #2]:
... it turns out that from a balance-sheet perspective, partial annuitization ends up behaving as though it were a so-called bucket strategy, in which the retiree disproportionately spends down their fixed-income assets first, leaving their stocks to grow. The present value of remaining SPIA payments declines as retirement progresses and continued survival probabilities worsen. These factors cause stock allocations to increase as a percentage of the client’s assets....
[Summary]:
Strategies for the withdrawal phase of retirement require a different thought process than for when one is accumulating assets. The objective in this phase is not to maximize a risk-adjusted return, but to provide a sustainable income over an unknown length of time. Planning for this income requires a holistic process where issues are framed from the perspective of the client’s household balance sheet. This requires advisors to quantify the present values of different cash flow streams, whether they represent income or expenditures. I have solved two important mysteries facing advisors when incorporating the present value of a SPIA in their client’s balance sheet.