Vanguard Inflation-Indexed Annuities?

[Gearhead Jim]

I'm retired at 60 and DW is 58. If we plan a 40 year future, the FIRE Calculator says the 100% SWR for our investment mix is 3.77% (50/50 stocks-bonds, fixed kept in 5 yr treasuries while TIPS are 2%, .5% expenses), keeping up with the CPI. If we just keep up with the PPI, the SWR creeps up to 3.8%

Vanguard is now offereing inflation-indexed immediate annuities, at our current age they equal 3.8%. If you are 65/63, they equal 4.27%.

I don't consider them to be totally risk free- there is a 10% per year cap on the inflation index, and of course Vanguard or AIG (the company backing the annuities) could default. On the other hand, our own investments could do worse than expected, mutual funds get embezzled, etc.

Please do not confuse this annuity with any kind of variable annuity that starts paying out years ahead, different animal.

So is there perhaps a place for this kind of annuity as a part of a retired portfolio?

 

[sgeeeee]

Hi GJ,

First, a few questions: Are you eligible for social security benefits? If so, did you include them in your FIRECALC calculations?

Even if you believe that ss benefits might be cut back in the future, any social security benefits you get are a form of inflation-indexed annuity. So if you are considering putting some of your investments into an annuity, you might want to consider your expectations about social security so you don't overweight.

Now, about your question. . . A lot of individual investors don't like annuities because they tend to have very high fees and expenses. The odds of beating annuity returns using a simple balanced indexed investment stategy are pretty high.

But there are various kinds of risk. One risk is that you outlive your investments -- either because you live a long time, your investments do poorly, or a combination of the two. An annuity is protection against this kind of risk. Placing some of your money in an annuity might make sense for some investors.

TIAA-CREF produced a research paper a few years ago that looked at annuities as a portion of asset allocation using a monte carlo financial simulation. Their study concluded that some money invested in an annuity could improve the safety of your retirement.

In my case, my DW and I have a couple of small pensions and both will be eligible for social security in 11 -12 years. When I add those annuity benefits up, it will total about 1/3 of our annual expenses. That seems like enough for me, so I haven't shopped for other annuity purchases.

 

[uncledrz]

So is there perhaps a place for this kind of annuity as a part of a retired portfolio?

GJ
As part of an overall portfolio, sure, an annuity with an inflation protection component sounds good. The obvious benefit is that assuming the company is good (and the state behind it is solvent) there is a much higher assurance that the funds will not run out. OTOH, prices are high right now, and future needs are not set in stone, so flexiblity should also be maintained by not putting all in one basket.

Have you checked with other companies to see if Vanguard's price is competitive?

 

[brewer12345]

Jim, the research I have seeen suggests that purchasing an annuity is likely only marginally helpful in portfolio survival. Whether you choose to put a chunk of your portfolio into suh a thing is up to you, but it would not be high on my list of priorities because A) putting money into a payout annuity means you are committed, so you lose flexibility, and B) the annuity company keeps the residual. The lattter is particularly important. Why? If you run firecalc and look at portfolio terminal values, many of the scenarios show huge terminal values. Presuming you do not wish to leave your heirs vast sums of money, a better than expected portfolio return allows you to increase your standard of living because you can re-calibrate your withdrawals to the larger portfolio balance after several years of outperformance. Can't do that with an annuity.

 

[Peter]

A) putting money into a payout annuity means you are committed, so you lose flexibility, and B) the annuity company keeps the residual.

Both good and valid points. But their importance depends on your personal view of risk and opportunity.

The lack of flexibility is somewhat covered by inflation indexing of the payouts. (Yes, I realize that the inflation measure used may not match your personal inflation rate!)

And, keeping the residual is the other side of the coin from never outliving your assets. Many people will be happier with a merely adequate, but certain outcome, even if it means giving up the possibility of a much higher, but less certain return.

Peter

 

[Gearhead Jim]

Lots of worthwhile comments. Thanks.

SG- Yes, I'm eligible for SS and also have a moderate non-indexed pension. I include those in our "normal" calculations, but for illustration purposes I just used the assets that we can control. One of my fears about SS is that other income sources may be considered as a partial or complete replacement for SS, for example "You still get your previous SS benefit but minus the money you receive from your pension or annuity or 401 or " I'm not sure when we will know how that will play out, but it leans me in the direction of NOT locking money into an annuity. Paranoid? Maybe not...
Some authors say that annuities have high fees and expenses, but other say that applies mostly to deferred or variable annuities; immediate annuities are fairly efficient (except for the low rates right now)

UNCLEDRZ- I'm not sure if there are any other companies besides Vanguard/AIG offering inflation-indexed annuities. Does anyone here know?

BREWER- Flexibility is indeed an issue, see my comments to SG about social security. Being able to spend more money after several years of good investment performance is nice, but that also leaves the possibility of being able to spend LESS due to poor performance. And as someone said, "Do you really plan to buy a new Corvette when you're 75?" Those who retire at age 40 or 50 might look at it differently from me at age 60.

Keep posting!!!

 

[brewer12345]

I'd be surprised if there were not other companies offering an inflation-indexed annuity. Presumably an annuity sales man or possibly one of the direct to consumer companies could tell you if you ask.

As to the possibility of lower returns early on: remember that a safe withdrawal rate is based on the historically WORST outcome. In other words, it represents a floor. The immediate annuity quote you got puts you at the floor, which doesn't seem like a very attractive option. Oh, and if you are afraid of a worse than historical record outcome, hedge for the first few years. Take 1/2 of 1% of the portfolio and buy some options.

 

[Gone4Good]

I'm not sure if there are any other companies besides Vanguard/AIG offering inflation-indexed annuities.  Does anyone here know?

I know New York Life offers this option.  I'd check with all the other major insurance companies too.  Inflation indexed annuities haven't really taken off but I suspect with all the boomers nearing retirement this product is probably going to enter a growth phase.  If you can hold out, you'll probably see a plethora of new options and better pricing as financial service companies trip over themselves to fleece serve the burgeoning retiree class.

As you mentioned in your original post, credit risk is also a consideration here.  This is especially true if you are thinking of using a large percentage of your net worth to buy an annuity.  Lifetime income is a nice concept as long as the other party to the transaction is around for at least as long as you are.  Moody's Investors Service publishes a default study every year that is based on more than 80-years of data.  According to their last report, the cumulative default rate for a 'Aaa' rated company over a 20-year period is about 2.1%.  They don't say what the rate is for 30 or 40 year time horizons, but it is safe to assume it is higher.  So if you believe that history is any guide, your ‘Aaa’ rated insurance company has about a 1 in 50 chance of going broke over the next 20 years, and a greater chance over longer-periods of time.  You can reduce this risk by splitting your money between two or more insurance companies and diversify your annuity income streams like you would diversify your other investment holdings.

 

[brewer12345]

Good points, Yrs. It also would make sense to be careful in your choice of insurers. Very large, highly rated mutuals would be my first choice. Humongous public companies like Met, Pru and Hancock might be OK, too.

 

[Gearhead Jim]

Unfortunately, I don't believe that the 100% SWR in FIREcalc is a floor, it only shows what the worst has been in the past. Perhaps things will not be any worse than that during my remaining years but some day it will happen.
Somewhere I saw that New York Life's inflation indexed annuities are only in that state for Vanguard, in the other 49 states Vanguard uses AIG. I'll try to check to see if that's true.
Although these policies may become more popular in the future, that does not necessarily mean they will become cheaper or "better", the papers in England recently had a bunch of stories about the scarcity of long term inflation protected bonds to finance such policies. High Demand + Low Supply = High Prices (which means low yields).

Still gathering information here!

 

[brewer12345]

Unfortunately, I don't believe that the 100% SWR in FIREcalc is a floor, it only shows what the worst has been in the past.  Perhaps things will not be any worse than that during my remaining years but some day it will happen.
Somewhere I saw that New York Life's inflation indexed annuities are only in that state for Vanguard, in the other 49 states Vanguard uses AIG.  I'll try to check to see if that's true.
Although these policies may become more popular in the future, that does not necessarily mean they will become cheaper or "better", the papers in England recently had a bunch of stories about the scarcity of long term inflation protected bonds to finance such policies.  High Demand + Low Supply = High Prices (which means low yields).

Still gathering information here!

Remember, you don't have to go through Vanguard to buy a payout annuity. If you wish to buy one, shop around and get competitive quotes from different insurers/agents. If you would like an opinion on the stability of a given insurer, I would be happy to offer my opinion (used to do this for a living).

 

[New Thinking]

A couple of additional thoughts.. "Safe Withdrawal Rates" using Monte Carlo simulation like FireCalc are not a floor and are based on historical averages in the US. Future returns could be lower than we've seen before in the US. SWRs also involve "self-insuring" and thus you take a smaller amount of retirement income than if you "pooled" longevity risk with others via an immediate annuity. Of course, as mentioned above, you forego any potential terminal value when you buy an annuity. The big problem with mutual funds IMO is that the "average" investor never stays the course and as the DALBAR Quantitative Analysis of Investor Behavior shows each year, most people lose money in mutual funds even when the market is hot.. S & P 500 increased 12.98% from 1984-2003, yet the average investor who dollar cost averaged the same amount only gained 6%..All other equity investors who didn't dollar cost average actually lost 3% annually...Fear and greed drive behavior.