Are safe bonds safe enough & why wait on SPIA Annuity?

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Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Freelife » Sat Jun 08, 2013 11:58 am

I expect stocks to go up and down but have thought bond funds were to be the safe, stable and slow growing part of an AA. I have what I understood to be safe bond funds. I was looking at my fixed income and some changes I made 4/1/13 when I bought my new Fidelity Spartan FSBAX short term treasury fund which is losing value. I also exchanged my TIP ETF fund and purchased $50,000. in the Fidelity Spartan FSIYX inflation protected Index fund (it has a lower cost)and it has gone down $1,756. Since 4/1/13 my older Fidelity Spartan FIBAX Intermediate Treasury fund is down 3 to 4000 dollars.

I have looked at SPIA annuities and considered the possibility of putting some of fixed income there. I always hear you should wait to buy an annuity and it is better to buy when you are older. I am single and will be 62 this month. Before 4/1/13 I looked at an annuity that would generate $500. a month and it cost $2367. less than it does today for the same policy. Theoretically if purchased I would have saved some money and would have some money in my pocket from monthly payments. At that time I did a little figuring. If I would start at 62 instead of 63 it would cost $980. more to buy it but by the time I was 63 I would have received $6000. in payments – $980 = $5,020.00 more in my pocket. I was figuring this with beneficiaries so if I died early they would get the balance minus my payments so I would not actually lose the money. Then I used the annuity calculator to compare buying it at 62 and 72 years old with the current pricing before 4/1/13. If I bought the SPIA at 62 verses 72 it cost $17,038 more to buy at 62. 10 years later at 72 I would have $60,000. in monthly payments minus $17,038 cost difference so I would have made $42,962. more by age 72 after deducting the difference in cost. I know this is very simple thinking, there is inflation going on with no payment increase which I have not calculated, taxes, the cost may be less for the amount of income in 10 years from now and there is likely more to this I am missing.

I’m trying to make a life change and be able to support myself without a job. I guess that is what you call retirement. I would be busy working and doing many things I have wanted to do but have no time to do now and do not expect to get paid for it. The clock is ticking and I would like to do these things while I still can. Time and less stress is what I desire more than money but I can’t afford to lose what finances I have. I’m finding my safe investments are losing dollars with no withdrawals or income and that does not even consider inflation. My tentative plan is to take Social Security at 66.

I’m trying to make good choices for something that will provide an income.

My life is in flux a little right now so I don’t know exactly what my total assets or expenses will be so this is somewhat a general question. My feeling from reading the forum is I am on the low end financially of where Bogleheads feel comfortable retiring. It may be a while before I actually buy an annuity and maybe I won’t even do it. I am not sure what to do if anything but figure this is the best place to get some feedback, thoughts and opinions. Is it best to stick with the bond funds? Why is it better to wait on a SPIA annuity? I’m searching for a good answer for income and even considering lending club. Thanks for your help, comments, and any suggestions or ideas.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby gerrym51 » Sat Jun 08, 2013 12:07 pm

there is no question bonds are down right now. before you do something rash on the annuity you might just put the money in your fidelity FCASH account for awhile and think about it

if annuity is what you want you would be better putting SS off to 70 and use that as your annuity
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby raywax » Sat Jun 08, 2013 1:40 pm

if annuity is what you want you would be better putting SS off to 70 and use that as your annuity[/quote]


Putting off SS until one is 70 is a bet you will live long enough to benefit from the delay; it might turn out that way or it might not. Taking an annuity know provides the desired income now; it also might turn out to be the correct bet or the wrong bet. It all depends on how long you will live.

Don't be too sure about your guess as to your life expectancy. I had no symptoms whatsoever that I had a heart problem but I ended it failing every heart test and having quadruple bypass surgery. I thought I was healthy; I wasn't. I am healthier now than before but I still don't know how long I will live.

Think about it; neither bet is a sure thing but you may have to choose one or the other. It likely is not an easy choice.

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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby bayview » Sat Jun 08, 2013 1:58 pm

One thing to think about in terms of taking an SPIA now is that the low interest rate environment means that you won't get as much annuity income for purchase price as if you purchased it when interest rates are higher. It doesn't mean not buying one now (although I like the suggestion to park your money in a cash account and let your thoughts percolate a bit), but you might want to look at an annuity ladder, or at least try to find an annuity with inflation coverage.

The other thing to keep in mind about annuities is that your health history will affect whether you can even get one, so that's also something to consider. :oops: Yikes, sorry; I've been researching long-term care options and had health history stuck in my overheated brain!
Last edited by bayview on Sat Jun 08, 2013 3:30 pm, edited 1 time in total.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby damjam » Sat Jun 08, 2013 2:05 pm

Freelife, at what rate would you need to withdraw from your portfolio to meet your expenses?
For instance if you had a $250K portfolio and need to withdraw 1K per month you are withdrawing at a rate of 4.8% (12,000/250,000 = .048)

If you purchased an annuity today would you be able to generate enough income for your expenses? Would you need to draw on SS immediately as well?
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby damjam » Sat Jun 08, 2013 2:17 pm

bayview wrote:The other thing to keep in mind about annuities is that your health history will affect whether you can even get one, so that's also something to consider.

I don't understand this. Why would an insurance company refuse to issue an annuity based on health?
It's my understanding that if your in good health you get the standard payout. If you are in poor health you may qualify for a larger payout. What am I missing?
Last edited by damjam on Sat Jun 08, 2013 2:26 pm, edited 1 time in total.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby fedsocprof » Sat Jun 08, 2013 2:26 pm

You might want to take a look at a monograph written by one Jeffrey K. Dellinger, “When to Commence Income Annuities,” which can be found by a Google search that will take you to the website of the Society of Actuaries. Or just go to http://www.soa.org/ and search for “Dellinger.”

“This analysis quashes the misconceptions that one should take withdrawals from mutual funds or deferred annuities for a number of years and then purchase an income annuity later of purchase income annuities on a staggered basis merely because a given amount of premium translates into higher periodic income with advancing age. To the extent one’s objective is to maximize retirement income with the potential to keep pace with inflation while minimizing the probability of outliving that income, delaying income annuity purchase can be suboptimal.”

I expect many folks here will express disagreement with Dellinger's conclusions.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby dhodson » Sat Jun 08, 2013 2:39 pm

damjam wrote:
bayview wrote:The other thing to keep in mind about annuities is that your health history will affect whether you can even get one, so that's also something to consider.

I don't understand this. Why would an insurance company refuse to issue an annuity based on health?
It's my understanding that if your in good health you get the standard payout. If you are in poor health you may qualify for a larger payout. What am I missing?



He/she is mistaken...Most annuities in particular SPIAs that we are talking about in this post don't consider your health. There are some that might and thus give you a larger payout bc you are so unhealthy but not the majority.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby ourbrooks » Sat Jun 08, 2013 2:56 pm

Tis true, many on this forum believe that you should wait until after age 70 to start an annuity and that you should hold bonds in your portfolio to dampen volatility.

More recent research questions this advice. http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2151259
This paper argues that fixed payment SPIAs, started early, and stocks will actually be safer than stocks/bonds and waiting on annuities.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby damjam » Sat Jun 08, 2013 3:00 pm

fedsocprof wrote:You might want to take a look at a monograph written by one Jeffrey K. Dellinger, “When to Commence Income Annuities,” which can be found by a Google search that will take you to the website of the Society of Actuaries. Or just go to http://www.soa.org/ and search for “Dellinger.”

Interesting read. OK I skimmed. :wink:
The only problem I have is the author compares Buying a Variable Immediate Annuity at age 62, vs holding the money in a Variable Deferred Annuity and taking withdrawals for 10 years then buying a Variable Immediate Annuity.
I wish the comparison were more on point with what people recommend here, which is to keep funds invested in standard mutual funds, IRAs, 401ks, etc. rather than a Deferred Annuity. Since the Deferred Annuity has higher fees associated with it, returns are lower than if the funds were invested in the other vehicles I mentioned. How much of a difference that would make is an important consideration.
Interesting, thanks for the link.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby dhodson » Sat Jun 08, 2013 3:05 pm

might also want to consider what happens when the insurance company promises "too much"

viewtopic.php?f=10&t=117726
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby bayview » Sat Jun 08, 2013 3:29 pm

dhodson wrote:
damjam wrote:
bayview wrote:The other thing to keep in mind about annuities is that your health history will affect whether you can even get one, so that's also something to consider.

I don't understand this. Why would an insurance company refuse to issue an annuity based on health?
It's my understanding that if your in good health you get the standard payout. If you are in poor health you may qualify for a larger payout. What am I missing?



He/she is mistaken...Most annuities in particular SPIAs that we are talking about in this post don't consider your health. There are some that might and thus give you a larger payout bc you are so unhealthy but not the majority.

Both of you are absolutely right. I stayed up last night researching long-term care plans, and the health history part stuck in my head. :oops: My apologies.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby fedsocprof » Sat Jun 08, 2013 3:37 pm

damjam wrote:
fedsocprof wrote:You might want to take a look at a monograph written by one Jeffrey K. Dellinger, “When to Commence Income Annuities,” which can be found by a Google search that will take you to the website of the Society of Actuaries. Or just go to http://www.soa.org/ and search for “Dellinger.”

Interesting read. OK I skimmed. :wink:
The only problem I have is the author compares Buying a Variable Immediate Annuity at age 62, vs holding the money in a Variable Deferred Annuity and taking withdrawals for 10 years then buying a Variable Immediate Annuity.
I wish the comparison were more on point with what people recommend here, which is to keep funds invested in standard mutual funds, IRAs, 401ks, etc. rather than a Deferred Annuity. Since the Deferred Annuity has higher fees associated with it, returns are lower than if the funds were invested in the other vehicles I mentioned. How much of a difference that would make is an important consideration.
Interesting, thanks for the link.


My reading of Dellinger's point is that deferral of any sort of annuity not only amounts to a loss of value of the mortality credits that the purchaser would have earned during the the period of deferral, but also results in the annuitant's receiving smaller mortality credits from the end of the deferral period to death.

Dellinger writes:
“Sometimes people believe they should wait to purchase an income annuity until a later date because the mortality credits are higher at higher ages. While it is true that mortality credits are higher at higher ages, it is equally true that an income annuity purchaser is entitled to these mortality credits whether the purchase is made at a younger age or at an older age; that is, the purchase of an income annuity at an earlier age does not somehow negate entitlement to the higher mortality credits at more advanced ages. To the contrary, purchase of an income annuity at a later date negates income attributable to mortality credits the purchaser could have enjoyed had he or she purchased the income annuity at an earlier date. The income annuity purchase is entitled to mortality credits at all ages for which his or her annuity income is subject to mortality risk.

Income annuities are really a long series of pure endowments; that is, each future payment is discounted for both interest and survivorship and the sum of all those present values equals the net premium. If this client waits until age 72 to elect an income annuity, her income payments will be smaller because she doesn’t receive the benefit of discounting for mortality for those 10 years.” Dellinger, “When to Commence Income Annuities,” at page 8.

Am I misreading this?
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Call_Me_Op » Sat Jun 08, 2013 3:41 pm

Freelife wrote:I expect stocks to go up and down but have thought bond funds were to be the safe, stable and slow growing part of an AA.


Really? Who told you that? You need to hit the books more. Bonds have several types of risks - mainly credit and interest rate risk. They also may have other lesser risks, such as reinvestment risk and call risk. Certain bonds may be relatively safe, depending upon how define the term "safe." But no bond is risk-free in the absolute sense. In today's environment, the interest rate risk tends to be the "biggie", and it is very large right now.
Best regards, -Op | | "In the middle of difficulty lies opportunity." Einstein
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby damjam » Sat Jun 08, 2013 6:41 pm

fedsocprof wrote:My reading of Dellinger's point is that deferral of any sort of annuity not only amounts to a loss of value of the mortality credits that the purchaser would have earned during the the period of deferral, but also results in the annuitant's receiving smaller mortality credits from the end of the deferral period to death.

I read it the same way.

However, maximizing mortality credits is not the goal. Maximizing income is the goal.

The author clearly shows that when comparing the income streams from the two scenarios (Variable Immediate Annuity at age 62, vs holding the money in a Variable Deferred Annuity and taking withdrawals for 10 years then buying a Variable Immediate Annuity) that buying the Variable Immediate Annuity at 62 wins out. But this comparison does not match what people on this forum suggest. In using the scenarios that the author has picked, he has avoided having to account for fees. I understand why the author has done this and it very conveniently highlights the mortality credit aspect of the income stream. But as we all know fees are very important.

I would have preferred to see a comparison of a SPIA purchased now vs holding the money in low cost mutual funds, taking withdrawals for 10 years and then buying a SPIA. Which would be closer to the scenario that those on this forum suggest.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Freelife » Tue Jun 11, 2013 12:08 pm

Thanks for the replies.
Gerrym51 and raywax: Concerning SS. My wife passed away over 2 years ago. She did not have much SS built up but my thought is to take Survivor Benefits at 66 and then take my SS at 70. I don’t have a bunch of cash waiting to be invested most is already invested. I have a house which may generate rental income or be sold but feels like a ball and chain sometimes. I am self employed and my income is unpredictable but trying to save when I can. If there is any way I can afford it I will wait to take SS.

Damjam: To be honest my portfolio is not big enough to support me in my present situation. Also I cannot afford to purchase an annuity that would generate enough income for all my expenses. I am considering buying one for some of my expenses in the near future to help get me to the time I start taking SS. Since I’m self employed I am considering easing into retirement and kind of testing it and “scaling back” on work if possible. It may be the only way I can do it.

Fedsocprof: What a long paper. Well he seems positive about an annuity if you need income now.

Call_Me_Op: “I expect stocks to go up and down but have thought bond funds were to be the safe, stable and slow growing part of an AA”.
I guess I didn’t say that exactly correct and at the time was a little frustrated with losing fixed income investments. It seems all fund based investments are cyclical and up and down in nature and nothing is risk free. In general in reading “the Books” it does seem bonds are used a lot to stabilize the AA. You use the stocks hoping to make more interest. More risk more gain. The bonds are used for safety so if stocks go down you don’t have to sell the stocks when they are down and can fall back on the bonds. Isn’t this why so many are advised to increase bonds with age? They can’t afford to take risks and lose what they have and the bonds grow at a slower rate though that is not always the case. Target funds are a good example. I admit I am just learning and came to investing late as all my investing was in my business and trying to make enough to pay my bills. I am definitely not here to argue with anyone. I want to hear any opposing view because I want to learn and achieve financial independence and hopefully some others can learn with me. In this post I am asking about using SPIAs in place of some of the bonds for possibly more safety and income and purchasing them early instead of waiting until older.

Damjam: “I would have preferred to see a comparison of a SPIA purchased now vs holding the money in low cost mutual funds, taking withdrawals for 10 years and then buying a SPIA. Which would be closer to the scenario that those on this forum suggest.”
I would also like to see this.

Well I have not heard anyone suggest I should make any changes in my bond funds. I’m not sure it is wrong to make changes as I see Vanguard is making some changes in some of their bond funds. I also have some Vanguard VAIPX Tips fund. I have noticed Vanguard changed this fund to VTAPX short term tips in the Target funds. I also noticed it takes 50,000 for admiral in VAIPX and it is rated 2 for risk. VTAPX only takes 10,000 for admiral and it is rated 1 for risk.
It sounds like SS is suggested as the best annuity and an SPIA will be fine at a younger age if you need the income. I’m not so sure if an annuity is best now if you are not retired exactly now for instance you bought it and were just putting the payments back into your investments until you were ready to use it. Not too sure about lending club either it seems to have pros and cons compared to other investments.
Thanks again for any ideas, comments or suggestions.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Quant » Fri Jun 14, 2013 1:06 am

It looks like we have our comparison of mutual fund withdrawals to immediate annuity income when fee differences are accounted for.

Section 1 of the Dellinger paper says “Section 3 summarizes decision making with respect to income annuity commencement timing in such a scenario where product fees are the same for the income annuity and the withdrawal program product.” This isolates the effect of mortality credits to make their effect alone easier to visualize. “Section 5 extends the earlier analysis to introduce product load and fee differences.” This section takes into account both mortality credits and fee differences between the lower-cost mutual funds used for the withdrawal program and the higher-cost IVA used for annuity income.

Table 7 of Section 5 shows the results when lower-cost mutual funds are used for the withdrawal program and a higher-cost IVA is used for annuity income. For example, if the mutual funds have a 0.20% annual fee and the immediate annuity has a 0.80% annual fee, then a male is better off taking income in the form of the annuity than in the form of mutual fund withdrawals provided he is at least 59 years old. For a female, the same holds true if she is at least 64 years old. These are the ages when the IVA has no load built into it to cover commissions, such as the one on Vanguard’s web site.

Prior to these ages, the higher annuity product expenses overwhelm the mortality credits, so it is better taking income in the form of mutual fund withdrawals. At and after these ages, mortality credits overwhelm the higher annuity product expenses, so it is better taking income in the form of the annuity. Mathematical proof of this result is found in Section 5 of the paper for those who wish to independently verify it.

The paper assumes identical investment funds, one without the annuity overlay (i.e., mutual fund) and one with the annuity overlay (i.e., IVA). This assures an apples-to-apples comparison; i.e., there is no difference attributable to underlying investments, only a difference in product fees and a difference in absence or presence of mortality credits. While the paper illustrates using an immediate variable annuity, the author shows on page 20 how the Table 1 illustration can equally be thought of as a fixed immediate annuity with guaranteed increasing payments.

So the question of generating income from mutual fund withdrawals or immediate annuity income is demonstrably resolved when one is using an identical asset allocation for both.

(If one is trying to decide whether to take withdrawals from stock mutual funds or bond mutual funds for awhile and then purchase a fixed SPIA at some future date with the hope that interest rates will be higher later, that’s a different question that is irresolvable with certainty, as it is in the realms of (i) market timing—where will interest rates be ten years from now, (ii) comparing disparate asset allocations—stock funds and bond funds versus a high-quality bond portfolio held by an insurer and intended to replicate the lifetime annuity payout pattern, and (iii) comparing disparate investment risk profiles—one where the investment risk associated with the mutual fund withdrawals is borne by the consumer with one where the investment risk associated with the fixed SPIA is borne by an insurer.)
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby damjam » Fri Jun 14, 2013 4:32 pm

Quant,
Thank you for taking the time to read the paper and post, and welcome to the forum. :)

Just as a reminder to others the paper being discussed is found here http://www.soa.org/ and search for “Dellinger.”

Just to be clear, this analysis is comparing a IVA (Immediate Variable Annuity) to withdrawing from a portfolio. Not a fixed SPIA to a portfolio. If you would like to address whether a IVA is preferable to a fixed SPIA, I would be most appreciative.

I have a question, in your post you said:
Quant wrote:Table 7 of Section 5 shows the results when lower-cost mutual funds are used for the withdrawal program and a higher-cost IVA is used for annuity income. For example, if the mutual funds have a 0.20% annual fee and the immediate annuity has a 0.80% annual fee, then a male is better off taking income in the form of the annuity than in the form of mutual fund withdrawals provided he is at least 59 years old. For a female, the same holds true if she is at least 64 years old. These are the ages when the IVA has no load built into it to cover commissions, such as the one on Vanguard’s web site.

My reading of Table 7 of Section 5 (page 40) is that the annual fee assumed for the mutual fund product is .30%, not the .20% you have quoted. Perhaps I am misreading the table? My read was if the mutual funds have a 0.30% annual fee and the IVA has a 0.90% annual fee and no load, then a male is better off taking income in the form of the annuity than in the form of mutual fund withdrawals provided he is at least 59 years old. For a female the annuity is better at 64. I'd like to know if I'm reading the table correctly.

Quant wrote:The paper assumes identical investment funds, one without the annuity overlay (i.e., mutual fund) and one with the annuity overlay (i.e., IVA). This assures an apples-to-apples comparison; i.e., there is no difference attributable to underlying investments, only a difference in product fees and a difference in absence or presence of mortality credits. While the paper illustrates using an immediate variable annuity, the author shows on page 20 how the Table 1 illustration can equally be thought of as a fixed immediate annuity with guaranteed increasing payments.

Most SPIAs do not have guaranteed increasing payments. Wade Pfau did a paper recently entitled An Efficient Frontier for Retirement Income, one of the conclusions he drew was that SPIAs with an inflation adjustment were not competitive with SPIAs that had a fixed payment. I wonder if the same could be said about SPIAs with guarnteed increasing payments? It would be interesting to see what would happen to the age of preference for an annuity if fixed payment SPIAs were used in the analysis.

To the OP, I suggest reading Pfau's paper because another conclusion of his paper was that SPIAs should be used in preference to bonds. Wade follows up on his research on his blog.

Quant wrote:(If one is trying to decide whether to take withdrawals from stock mutual funds or bond mutual funds for awhile and then purchase a fixed SPIA at some future date with the hope that interest rates will be higher later, that’s a different question that is irresolvable with certainty, as it is in the realms of (i) market timing—where will interest rates be ten years from now, (ii) comparing disparate asset allocations—stock funds and bond funds versus a high-quality bond portfolio held by an insurer and intended to replicate the lifetime annuity payout pattern, and (iii) comparing disparate investment risk profiles—one where the investment risk associated with the mutual fund withdrawals is borne by the consumer with one where the investment risk associated with the fixed SPIA is borne by an insurer.)

Agreed.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Quant » Sat Jun 15, 2013 3:14 am

Damjam wrote “If you would like to address whether an IVA is preferable to a fixed SPIA, I would be most appreciative.”

An IVA has certain advantages over a fixed SPIA:

(1) With an IVA, an individual retains control over his or her asset allocation. You can elect the investment funds (e.g., large cap domestic stock, small cap domestic stock, international stock, investment-grade intermediate bond fund, etc.) the performance of which will determine the monthly retirement income check that shows up in your mailbox each month. You can also change your allocation of investment funds at any time all throughout the rest of your life. You don’t have that control capability with a fixed SPIA.

(2) With an IVA you can allocate whatever percentage you want to the investment class (common stocks) with the best record of beating inflation. With a fixed SPIA, you don’t have this capability.

(3) With an IVA you assume investment risk in exchange for investment reward, where reward comes in the form of higher retirement income.

(4) With an IVA, there is no “wrong time” to purchase in the sense of the market being up or down at a given moment in time. If the market is up and you’re currently invested in a similar asset allocation, you’re applying more premium to the IVA—giving you a higher initial amount of monthly income, which may not initially climb as fast if the market is overvalued at time of purchase. If the market is down and you’re currently invested in a similar asset allocation, you’re applying less premium to the IVA—giving you a lower initial amount of monthly income, which can climb more rapidly if the market is undervalued at time of purchase.

(5) With a fixed SPIA, the insurance company takes your premium and invests in a portfolio of investment grade fixed income securities such as corporate bonds. The insurance company projects out the annuity payments it expects to make over the next several decades knowing that some annuitants will survive and continue to require retirement income while others will not survive and won’t. (To the extent additional guarantees are layered onto a basic lifetime annuity such as a guarantee that annuity payments will be made for 10 years regardless of survival, the insurance company’s projections account for these, too.) So whatever the yield curve environment looks like at the time you purchase a fixed SPIA, that is the interest rate environment that will govern your annuity payout forever. The insurance company prefers to match its assets to its immediate annuity liabilities and invests all premium remaining after any acquisition expenses (like preparing and mailing you an annuity contract) at the time you buy your fixed SPIA, so future rises in interest rates don’t help you. (Actually, they probably hurt you because that typically means higher inflation and now you’re receiving a fixed rate of income.)

(6) Because you’re taking the investment risk with an IVA whereas the insurer is taking the investment risk with a fixed SPIA, the insurer needs to put up less capital as a safeguard. For instance, with a fixed SPIA bond defaults are the insurer’s problem and it must hold a cushion against these, whereas with an IVA they’re the annuitant’s problem—assuming he or she has allocated money to a bond fund. The less capital an insurer has to put up, the less charges for doing so it builds into its annuity pricing. So an IVA would be expected to have a smaller fee extracted each year and a fixed SPIA a larger fee. With the IVA, the fee is transparent in the IVA prospectus. With a fixed SPIA, only the insurance company knows what this is. It is not transparent to the annuitant. The annuitant only sees the amount of monthly income he or she receives.

(7) If someone retires at 65 and lives to 95, inflation is a big worry over a three-decade retirement. An IVA offers the better chance to keep up with inflation due to being able to invest in asset classes with higher mean returns than a portfolio of 100% investment grade bonds (fixed SPIA). And an IVA offers less friction applied to these higher mean returns in the form of insurer fees that drag down gross investment performance.

That said, an individual has to be able to tolerate some fluctuation in monthly income—both up and down—to be a candidate for an IVA. If you’re living right on the edge where monthly income exactly covers monthly expenses (and you don’t have any more assets with which to generate more monthly income), then you probably aren’t a good IVA prospect because you couldn’t tolerate downside volatility—at least in the early years. If your IVA income went up over time and put you in a position where you could survive a certain drop in income for awhile because that would still cover or more than cover your expenses, then you could tolerate some downside volatility.

Other nuances: Someone considering an IVA might have above average wealth or education, both of which correlate positively with longevity. Because insurance companies don’t (at least as of now) underwrite for such things, these individuals may benefit from immediate annuities more than the average bear. The typical IVA premium exceeds the typical fixed SPIA premium; hence the supposition about IVA owners possibly having the larger wealth.

It’s not necessarily an “either / or” decision. One might want to use a fixed, guaranteed increasing SPIA to meet “must have” expenses and an IVA for “nice to have” expenses. One will still want to have a third pot of liquid assets for large, ad hoc expenses. (And perhaps life insurance, LTC insurance, …, although we’re focusing on retirement income in this forum.)

With regard to Table 7, I think you are reading it correctly, damjam. I talked about 0.20% and 0.80% fees, while the author used 0.30% and 0.90% fees in Table 7. Yet the paper mentions on page 39 that “It is the difference between the income annuity annual fee and the withdrawal product annual fee that is of primary importance, as opposed to their absolute magnitudes” and “Table 7 can be used as a general guide even if the two left-most columns are removed; that is, one needn’t reproduce Table 7 based on the income annuity annual fees and the withdrawal product annual fees specific to one’s case each time one wishes to make an evaluation, but rather can generally rely on Table 7 as it stands with only a knowledge of the difference in annual fees.”

While a lot of insurers don’t offer fixed SPIAs with guaranteed increasing payments, some do. Here we’re talking about payments that increase annually by a specific percentage (geometric increase as opposed to linear dollar increase) such as 3%, 4%, or 5%. These work just like fixed SPIAs with level (non-increasing) payments: The insurer projects out the expected annuity payments and buys a portfolio of bonds to cash-flow match, duration match, or whatever its investment policy calls for. Whether annuity amounts are level or increasing, in either case the insurance company knows at the time the SPIA is sold what those future amounts look like. It’s just that the amounts are smaller initially and larger later for the increasing SPIAs instead of flat. (Technically, the insurer should be able to invest longer, achieve higher yields, and pass the benefit of that to annuitants in the form of a better deal for increasing SPIAs than for level SPIAs, because a greater portion of the annuity benefits falling due occur further out in time.) As a result, the competitiveness of flat income SPIAs and guaranteed increasing income SPIAs are pretty close or identical.

Inflation-indexed SPIAs are different. The insurance company doesn’t know up front what it has to pay in the way of annuity income in the future. So there’s more risk assumed, more hedging to be done (which isn’t easy given the dearth of inflation-indexed corporate bonds, although there are ways to perform this hedging), etc. This increases costs and makes inflation-linked SPIAs less competitive than “traditional” SPIAs. (And insurance companies have reserve rules and risk-based capital rules to deal with, so it’s not simply a case of looking at how the insurance company’s asset portfolio backing its fixed SPIAs compares to its asset portfolio backing its inflation-indexed SPIAs. Its reserve valuation and capital requirements might differ for these two different kinds of immediate annuities.)

Damjam wrote “It would be interesting to see what would happen to the age of preference for an annuity if fixed payment SPIAs were used in the analysis."

If fixed payment SPIAs were used in an analysis similar to that in the paper we’re looking at, I would expect the results to be essentially the same. This is because it is the difference in product fees and presence or absence of mortality credits that matter—which holds for both fixed SPIAs and IVAs. At more advanced SPIA issue ages, however, the insurer wouldn’t be investing as long and so a new factor surfaces: a lowering of the investment return and thus the interest assumption the insurance company would use in pricing its SPIA. (This assumes the insurer is that sophisticated). A good analysis would need to account for that. At issue ages like 60 or 65 or maybe even 70 that might not have much of an effect, but it would at 75 or 80.

Fixed SPIAs sold by most insurers involve a commissioned salesperson. So you’d want to look at perhaps the right-hand side of Table 7 in the Dellinger paper, the column that shows a 4% load. And because the fee difference will be larger for a SPIA than for an IVA, perhaps you might look at the 0.80% or 1.00% fee difference row. Male ages would be 66 or 68 and female ages 71 or 73. (If you could find a directly sold SPIA involving lower commissions and hence a lower load, then the age at which SPIA income would produce more than mutual fund withdrawals would be lower.)

That raises the question “What is the mutual fund alternative from which the individual is making withdrawals in the case of a fixed SPIA?” If it’s to be an apples-to-apples comparison, it would seem like the mutual fund alternative would need to look like the insurer’s dedicated bond portfolio that replicates the projected annuity payout, involving some short-term bonds, some intermediate-term bonds, and some long-term bonds.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Sat Jun 15, 2013 12:49 pm

Quant wrote:That raises the question “What is the mutual fund alternative from which the individual is making withdrawals in the case of a fixed SPIA?” If it’s to be an apples-to-apples comparison, it would seem like the mutual fund alternative would need to look like the insurer’s dedicated bond portfolio that replicates the projected annuity payout, involving some short-term bonds, some intermediate-term bonds, and some long-term bonds.

I'll take my Total Portfolio Return, thank you very much. It easily surpasses the 5% nominal needed to beat an SPIA at today's rates. And I won't be taxed at ordinary income rates as I would in an annuity. We don't have to keep it totally apples to apples in what appears to be a suboptimal bond investing environment. We have CD's, stocks--foreign/domestic, REITS foreign/domestic, as well. For the possible upside gain I'll gladly forgo the modest guarantee. Are you a VA salesperson?
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby damjam » Sun Jun 16, 2013 1:20 pm

Quant, thank you for your response.

Quant wrote:(3) With an IVA you assume investment risk in exchange for investment reward, where reward comes in the form of higher retirement income.

I think we have our answer right there as to why Bogleheads do not recommend IVAs. When discussing an immediate annuity product, it is in the context of creating safety for the investor. A floor of income if you will.

I believe most Bogleheads would find investing in a IVA to be a total anathema. I'm sure most believe very strongly that the fees associated with an annuity product are just too much to overcome. (Although the paper clearly shows that there is a tipping point in which the mortality credit overcomes the drag of increased fees.) In addition the term variable will only help to associate it with the dreaded Deferred Variable Annuity (a product which is almost always a mistake).

Quant wrote:That raises the question “What is the mutual fund alternative from which the individual is making withdrawals in the case of a fixed SPIA?” If it’s to be an apples-to-apples comparison, it would seem like the mutual fund alternative would need to look like the insurer’s dedicated bond portfolio that replicates the projected annuity payout, involving some short-term bonds, some intermediate-term bonds, and some long-term bonds.

I agree with Frugal Al here. I'm not asking for a pure analysis of the effect of mortality credits. I'm asking for and apples-to-apples comparison to the standard Boglehead recommendation. Which is to keep your funds invested in a properly allocated portfolio until older ages (70+) before investing in a SPIA. I could imagine a comparison to SPIAs of various cost vs. portfolios of various costs and asset allocations. More of a three dimensional problem but I believe doable non the less.

There have been several researchers who have done analysis of this type of problem. I believe it is a rapidly growing area for financial planning experts. Wade Pfau, who I referenced in a prior post, is one. Others include Moshe Milevsky, Virginia Young, and Jim Otar.

There is a paper by Moshe A. Milevsky from 1996 entitled "Optimal Asset Allocation Towards the End of the Life Cycle: To Annuitize or Not to Annuitize?" You can download the paper here. Basically the paper concluded that annuitization made little sense before 80 and that the rate of return of the annuity could be beaten by alternative investment assets.

In a later paper entitled "Annuitization and Asset Allocation" (2000, rev. 2003), Moshe A. Milevsky and Virginia R.Young concluded something a little more nuanced. An abstract of the paper can be found here. In their paper one of the conclusions was that if a person were to think of annuitization as an all or nothing proposition then an annuity does not make sense until after age 70. (I think this conclusion was popularized in the press, perhaps one of the foundations for the recommendations by many on this forum.) They also concluded that in an all or nothing situation if the retiree is willing to take more risk that the tipping point for an IVA is earlier. Which would seem to comport with the paper we have been discussing. It is, also interesting that one of their other conclusions was this:
When we move towards an open institutional system in which annuitization can take place
in small portions and at anytime, we find that utility-maximizing investors should acquire a
base amount of annuity income (i.e. social security or a defined benefit pension) and then
annuitize additional amounts if and when their wealth-to-income ratio exceeds a certain level.
In this case, individuals annuitize a fraction of wealth as soon as they have opportunity to do
so — i.e. they do not wait — and they then purchase more annuities as they become wealthier.


Wade Pfau's paper entitled An Efficient Frontier for Retirement Income used the assumption that a retiree would annuitize various amounts of income immediately (age 65) and charted the outcome. He found that the efficient frontier moved in a positive direction as SPIAs were made an increasing portion of the portfolio. (This was a frontier in which the portfolio was varied from 100% stock to 100% SPIA on the y axis, and % of lifetime spending needs achieved on the x axis). However this research is rather preliminary and does not account for many of the variables one would want to address.

So based on my limited knowledge in this area I would say that the correct approach is still a somewhat uncertain. Fixed SPIAs clearly provide greater assurance that income needs will be met with predictability. IVAs may allow for greater return. But no one can no for sure what is the optimal strategy because the future is unknown.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Phineas J. Whoopee » Sun Jun 16, 2013 2:00 pm

raywax wrote:...
Putting off SS until one is 70 is a bet you will live long enough to benefit from the delay; it might turn out that way or it might not. Taking an annuity know provides the desired income now; it also might turn out to be the correct bet or the wrong bet. It all depends on how long you will live.
...

Hi Ray,

First of all, I'm sorry to hear about your heart condition. Best of health to you.

With respect to the part I put in bold, I certainly understand the reasoning, but I look at the question differently. My goal is not to [reference to a fastener] the government out of as much money as possible, but rather to reduce my financial risk as much as I can consistent with living an adequately satisfying lifestyle. If I opt for a lower risk of running out of money by delaying social security until I'm 70, and I die when I'm 68, I will have succeeded at what I was financially trying to accomplish - avoiding the outcome of running out of money during my lifetime.

If I opt for [ah, fasten it, just look up ticker FSCR] - er, I mean - maximizing the dollar amount of my SS draw by starting early, and then die at 68, I won't feel happy or gloat, because I'll be dead.

Couples have options singles don't which help mitigate their joint risks.

And I don't mean arthritis.

PJW
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby ObliviousInvestor » Sun Jun 16, 2013 2:35 pm

Freelife wrote:Concerning SS. My wife passed away over 2 years ago. She did not have much SS built up but my thought is to take Survivor Benefits at 66 and then take my SS at 70. I don’t have a bunch of cash waiting to be invested most is already invested. I have a house which may generate rental income or be sold but feels like a ball and chain sometimes. I am self employed and my income is unpredictable but trying to save when I can. If there is any way I can afford it I will wait to take SS.

If delaying your own retirement benefit until 70 and eligible for a survivor benefit now (at age 61.something), it's almost surely better to claim that survivor benefit now rather than at 66.

"Deemed filing" is the reason that people wait until FRA to claim spousal benefits before switching to their own retirement benefit at 70. But deemed filing does not apply to widow/widower benefits.
Mike Piper, author/blogger
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Quant » Mon Jun 17, 2013 8:22 am

Damjam wrote: “I think we have our answer right there as to why Bogleheads do not recommend IVAs. When discussing an immediate annuity product, it is in the context of creating safety for the investor. A floor of income if you will.”

If your objective is a guaranteed floor of income, then an IVA is not the product to achieve that objective, unless you purchase an IVA that includes a guaranteed floor level of income.

Suppose that you have a guaranteed level of income sufficient to meet your mandatory living expenses through a corporate pension plan, Social Security, existing fixed immediate annuity, etc.

Suppose also that you still have a pool of investable assets beyond this. You might elect to take withdrawals from this pool of investable assets to fund expenses beyond mandatory expenses, such as travel, gifts, home improvements, etc.

Let’s suppose that you invest that pool of assets in, say, a low-cost mutual fund that is highly diversified and contains domestic stocks, foreign stocks, bonds, etc. Now you take regular withdrawals from that mutual fund to fund discretionary expenses. Suppose you take regular withdrawals from that mutual fund of identical amount to what an IVA invested in the same fund would produce if starting with the same amount of money.

The low-cost, highly diversified mutual fund will be exhausted at approximately the point where 50% of the people who started such a program are still surviving. Those who elected to take withdrawals from the low-cost mutual fund have exhausted that mutual fund. They receive no further income. Those who elected to invest in exactly the same fund but with the IVA overlay will continue to receive income and do so for the rest of their lives.

The mutual fund withdrawal program is thus the more expensive, less efficient generator of retirement income. Starting with the same amount of money, it is exhausted while the IVA is the more efficient generator of retirement income and continues to provide income.

Now suppose you (at least conceptually) compartmentalize your wealth. For example, you might use a certain portion of it for bequests. You might use a certain portion of it for generating a fully guaranteed level of baseline income that fully meets your mandatory living expenses. You might use a certain portion of it for other financial objectives. To the extent one of those compartments is to generate the maximum amount of lifetime income on an expected value basis that will be used for discretionary expenses, this is one example where an IVA with low-cost investment funds best fulfills this objective.

(On an expected value basis, it’s not going to be beat by a fixed SPIA due to the all-bond investments used plus the higher costs for the insurer assuming certain expenses such as bond default risk and higher capital requirements. On an expected value basis, it’s not going to be a deferred variable annuity with a guaranteed lifetime withdrawal benefit because of the high expense drag. On an expected value basis, it’s not going to be a mutual fund or collection of mutual funds because, as just explained, the same amount of withdrawals from those as can be had from an identically invested IVA will fully deplete the mutual funds at the point where about 50% of the original group of people who can either take mutual fund withdrawals or use an identically invested IVA are still alive.)

One needs to take care to use the right financial vehicle for a specific financial objective. If the financial objective is to create a guaranteed floor of income, then that may imply that what is really sought is a guaranteed floor of income that is also guaranteed to last for life. If one wants a guaranteed floor of income that’s guaranteed to last for life, then a fixed SPIA is a common financial vehicle to make this happen. It’s a conservative vehicle that’s conservatively invested because it may be used to provide a baseline level of income. On the risk-reward spectrum, it’s conservative on both counts. That’s fine. It’s appropriate for fulfilling that particular financial objective.

Now suppose you and 99 of your friends get together and say, “We have enough guaranteed lifetime income to meet our mandatory living expenses. We also want to enjoy certain of life’s pleasures that cost money on top of that—which are discretionary expenses. Let’s each put $100,000 into a fund, have that fund pay out the maximum amount possible each month to everyone from the original group of 100 who is still surviving, and have that fund be exhausted upon the death of the last survivor among us.”

Given that these are discretionary expenses, the fund needn’t be invested as conservatively as with an SPIA nor need it come with all of the accompanying additional expenses of an SPIA such as provision for defaults, higher insurance company capital requirements ultimately borne by consumers, etc. What would likely emerge from such a discussion would be an IVA, where the investment fund could be partially invested in asset classes with higher mean returns (and the correspondingly higher volatilities) and with asset class diversification of less than perfectly correlated assets serving to keep the fund on the efficient frontier (or at least close to it given the usual practical constraints).

I’m not advocating an IVA for any situations where it’s not the right solution. It’s not the right solution for liquidity. It’s not the right solution for bequests. It’s not the right solution for an individual living so close to the edge financially in retirement that he or she cannot tolerate even a short period of a downward fluctuation in monthly income. It’s not the right solution for providing one’s baseline level of monthly income that is needed to meet mandatory monthly expenses.

There are a lot of psychological aspects to retirement income and retirement income approaches in general. There is “anchoring” with respect to one’s own past beliefs conditioned on six or seven decades of asset accumulation experience, where the beliefs that evolved might not apply to the new situation of systematic asset liquidation. There is “anchoring” with respect to what approaches others are commonly using and how the financial media speaks—either favorably or disparagingly—about certain concepts or products; e.g., think about deferred variable annuities with high fees of 2.25% even before the extra bells and whistles and how having similar words in the name of an entirely different product can taint one’s perception. There is the greater feeling of loss for a negative swing in dollar value than there is a feeling of joy for an equally sized positive swing.

A lot of retirement income product designs and sales concepts are wrapped around these psychological aspects. For example, people’s natural instincts often tell them to spend down their own funds through withdrawals from them, only annuitizing if they find themselves starting to run short and really being forced to deploy their remaining assets as efficiently as possible with respect to retirement income generation. “Deferred income annuities” or DIAs capitalize on this mindset. (With a DIA, one pays a premium at, say, age 65 but doesn’t start to receive income until age 85 and only if still alive. The long holding period, transfer of wealth from those who die during the deferral period to those who do not, and shorter future lifetime remaining due to the advanced age at which benefits begin allow a relatively small premium to translate into a relatively large monthly income.) Yet if one lives from age 65 to age 85, one would have wished he’d have generated income more efficiently during those 20 years, too, and not just from age 85 forward.

Frugal Al wrote: “Are you a VA salesperson?”

In the way of disclosure, I’m not a salesperson of any sort nor have I ever been. (Isn’t a potential benefit of this forum to help make each other sufficiently knowledgeable that we can avoid commissioned salespeople and the related expenses when it’s reasonable to do so?!) I’m not advocating anyone buy any product. Rather, the goal is to inform individuals about an efficient generator of retirement income for discretionary expenses. As with other financial vehicles one considers, anyone considering an IVA should focus on low costs for the investment funds. It’s no surprise that John Bogle’s company offers low-cost investment funds in the no sales commission IVA product on its website. Depending on one’s investment funds allocation, this can be the lowest cost retail IVA that’s available.

As damjam correctly states, “Maximizing mortality credits is not the goal. Maximizing income is the goal.” So one needs to seek low-cost IVAs where the mortality credits are least impeded by product fees. As the Dellinger paper Table 7 shows, the higher the fees, the later the age at which an IVA becomes the preferred choice over mutual fund withdrawals. If maximizing income is the goal, then investments with higher mean returns help achieve this and mortality credits help achieve this. (Mortality credits are worth more than the investment returns at higher ages.)

Some individuals (erroneously) believe, “I can generate more lifetime income by constructing a laddered bond portfolio and just taking withdrawals from it.” Clearly this cannot be true, for if one overlays mortality credits on that same bond portfolio then one has the same investment component generating income from original principal and appreciation and interest thereon plus the mortality credits that in effect transfer wealth from decedents who no longer require income to survivors who do. As long as the expense level doesn’t overwhelm the mortality credits, the statement in quotes above is by definition false.

Frugal Al wrote: “For the possible upside gain I'll gladly forgo the modest guarantee” in the context of investing in a collection of assets riskier than those used to back a fixed SPIA. This is a premise of an IVA: I prefer to invest in assets with higher appreciation potential in exchange for forgoing the guarantee of 100% assurance of never having any fluctuation at all in income. In both the case of the fixed SPIA and the IVA there is full transfer of mortality risk from the retiree to the insurance company. The distinction is one of where one desires to be on the risk-reward spectrum.

To conclude, if an objective is maximizing retirement income that is guaranteed to last a lifetime, how would you go about achieving this if you could start from scratch? Likely including assets with higher mean returns, factoring in mortality credits, using low-cost investment fund options, having a collection of investment options sufficient to offer meaningful diversification of risk, including the ability to transfer among asset classes anytime along the way to adapt to prevailing economic conditions, and achieving this without sales commissions would be components of such a program.

If one wanted to start adding in additional qualifiers such as “maximum retirement income with specific downside volatility constraints,” then one could start adding in hedging devices for a cost. One could hedge all the way down to a fixed SPIA with zero downside volatility. It’s just a question of where one wants to be on the risk-reward spectrum and what one’s objective is; e.g., (i) maximizing retirement income, with the understanding that one may be a candidate to do so only with respect to funds in excess of those needed to generate a baseline level of income to meet mandatory expenses, (ii) simply generating that baseline level of income to meet mandatory expenses, where there is zero income volatility (or perhaps only volatility in the sense of a fixed annual percentage increase in SPIA that is known at time of purchase), or other objectives.

Much like a low-cost mutual fund is not inherently good or bad but is rather a tool in a much wider toolbox that can be used for specific applications if those applications meet the specific objective(s) of the individual, an IVA shares this same characteristic.

As damjam correctly points out, “… no one can know for sure what is the optimal strategy because the future is unknown.” If one knew exactly how long he would live, the task of planning retirement income for a precisely specified number of years would be much easier. Given that none of us do, the task becomes one of planning in the face of uncertainty, especially uncertainty as to longevity. Thus, a reasonable course of action might be to allocate a portion of one’s retirement assets to financial vehicles that contain characteristics that are geared to mitigate longevity risk.

IVAs are not a widely used or even commonly understood product today. Yet if an individual meets conditions where an IVA is a potential tool for achieving that individual’s objective, compare it to alternatives (e.g., VA with GLWB, mutual fund withdrawals, etc.). It’s challenging to invent as efficient a retirement income generator, one that starting with the same amount of money will also last a lifetime with 100% probability and produce higher monthly income. Give it a try and please share your ideas or results with readers of this forum.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Quant » Mon Jun 17, 2013 9:05 pm

As Bogleheads appear to seek to achieve a specific result at least cost (e.g., index funds for asset accumulation), this notion can apply to generating retirement income from a given nest egg. An individual can allocate, say, $250,000 to an IVA and receive a guarantee of lifelong income, where the level of that income depends on the performance of the investment choices that individual makes. That same individual would need to allocate approximately $500,000 to generate an identical stream of monthly income using identically invested mutual funds—and even then would still have a small probability of running out of money in retirement by outliving the income the mutual funds could generate. This holds true even if the annual fee on the mutual funds is 0.20% and the annual fee on the IVA is 0.80%.

The reason for this is that an IVA is designed for the express purpose of retirement income generation. In contrast, stocks and bonds (or mutual funds made up of a collection of stocks and bonds) are asset accumulation vehicles where one can grow wealth by either lending money at interest (bond) or by taking partial ownership in a business (stock). Such mutual funds can also try to serve as a means of generating income by simply spending them down, but they were not designed with this specific objective in mind and offer no particular advantage in doing so. They leave the individual with uncertainty as to the “right” spend down speed and unnecessarily expose the individual to the risk of prematurely exhausting these assets while still alive.

Without further information or education, it almost certainly seems at first illogical that one product with a 0.20% annual fee ends up vastly more expensive than another product with an 0.80% annual fee. Indeed, it takes roughly twice as much money at the time one starts to generate retirement income using the 0.20% annual fee product (mutual funds) as when using the 0.80% annual fee product (IVA). This is because they are dissimilar products intended to perform dissimilar functions.

The main message I thought might be helpful to Bogleheads who seek to achieve a specific financial objective at least cost is to provide information about a way to generate lifelong income at half the cost (i.e., starting with only half as much money) as the way most individuals might otherwise do so.

When people ask “What’s my number? How much do I need to save for retirement?” a crucial factor in answering that question is “How are you planning on generating retirement income from your nest egg?” “I can show you one way to do it where you need to start with $1 million. I can show you another way to generate the identical monthly income where you need to start with $2 million.”

The less costly approach leaves more other funds available for other purposes such as legacy purposes. The more costly approach may leave no other funds available for other purposes. Under the more costly approach, there is no assurance of any legacy but rather continued uncertainty whether anything will be left to bequeath. Whether there will be anything to bequeath is up in the air until the person dies, and even then the amount will be uncertain, depending on how long one lives. Of course, now we’re starting to mix retirement income objectives and bequest objectives, whereas the inquiry that began this line of messages was one dealing solely with the retirement income objective.

In sum, there’s more to the less expensive approach to doing things than just looking at the level of an annual product fee. If one truly wants to achieve a certain financial result in the least expensive, most efficient manner possible, one needs to probe deeper.

The emphasis here has been to communicate information about an approach to retirement income generation that may be of particular interest to those seeking to achieve this in perhaps the least cost manner among the various alternative approaches. IVA mechanics have not been addressed in great detail. In general, though, one selects a target return such as 3.5%. To the extent the portfolio of investment funds you choose exceeds 3.5% in any year, your annuity income increases. For example, in a year where the collective return of your investment choices nets 7.5%, your income increases by approximately 4%.

Best wishes to all whether you choose to use this information for part of your financial affairs in retirement or go a different route.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Wed Jun 19, 2013 7:16 am

Quant wrote: IVA mechanics have not been addressed in great detail. In general, though, one selects a target return such as 3.5%. To the extent the portfolio of investment funds you choose exceeds 3.5% in any year, your annuity income increases. For example, in a year where the collective return of your investment choices nets 7.5%, your income increases by approximately 4%.

Wow, that is a fairly simplified example. I suspect the mechanics aren't addressed because they can be confusing and obfuscatory. These are bad deals for most people that have planned appropriately and have properly utilized their tax advantaged space. In rare instances they might be appropriate in high tax situations, or for people that are very risk averse. Most people can do better with a balanced portfolio, and possibly the addition of a fixed SPIA.

Every day there's another story on VAs, including insurance companies changing terms, companies getting out of the business, companies concerned about disintermediation and worried they've over hedged with their bond holdings in the midst of rising interest rates and lapsing policies. Even low fee versions are marginal at best. If most people that bought these things had to understand them, there would be few customers. There is no free lunch, and when some customers thought they got one, the insurance companies wanted them back (i.e., changed the terms).
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby cjking » Wed Jun 19, 2013 8:38 am

I haven't read the whole thread, and I'm not in the US so my experience may not be applicable, but when I've looked at annuities (SPIAs) closely I've found that insurance company additional costs offset the benefit from mortality credits below about age 70, so I agree there's no advantage to annuitising before about that age.

Edit: essentially the component of income that was due to underlying investment returns was, after charges, 0.5% - 1% per year lower within a SPIA than I could get by investing in similar assets directly, so the mortality credits had to be worth that much just to break even, and for someone below roughly 70, they weren't. The more I was below the break-even age the more I would lose by annuitising too early.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby House Blend » Wed Jun 19, 2013 10:52 am

Here's a simple way to think about the should-I-wait question in the specific case of a fixed-income SPIA.

Say I want to purchase $1000/mo of extra income. (These are nominal dollars, not inflation-adjusted dollars.)

Say I'm a 60yo male, but might wait until 65 or 70. A quick trip to an online quote generator gives these lump sum costs for today:

Age 60: $203874
Age 65: $176454
Age 70: $154050
Age 75: $129894

So I can spend $204K today and get the income now, or spend down that $204K at the rate of $1000/mo for 5 years and hope that I still have $176K left in order to purchase that same level of income at age 65. I could get lucky and discover that interest and payout rates have gone up during those 5 years so I might need less than $176K for that purchase.

But in any case, it seems to me that the key question to ask is: with a withdrawal rate of $1000/mo, what rate of return on $203,874 is needed in order to have at least $176,454 after 5 years?

Answer: about 0.286%/mo, or 3.49% annualized.

For waiting 10 years, the break even rate of return is 3.97%. For 15 years, it is 4.24%.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Wed Jun 19, 2013 2:15 pm

Thanks, House Blend. I hadn't actually run the numbers at the various levels. Those returns aren't too onerous at all to justify waiting to buy a fixed SPIA.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Quant » Thu Jun 20, 2013 12:19 am

A quick trip to the online quote generator Vanguard’s web site directs to for an instant IVA quote reveals the following. The same information House Blend located for a fixed SPIA is shown for comparison:

Age ------- Fixed SPIA ------ IVA

Age 60: ... $203,874 ... $191,152
Age 65: ... $176,454 ... $170,862
Age 70: ... $154,050 ... $150,053
Age 75: ... $129,894 ... $126,782

Both the fixed SPIA and IVA provide a first monthly payment of $1,000. The fixed SPIA stays at that level forevermore. The IVA benefit increases each month the investment return exceeds 3.50% on an annualized basis. The IVA benefit stays the same as the prior month if the investment return equals 3.50% on an annualized basis. The IVA benefit decreases from the prior month’s level if the investment return is less than 3.50% on an annualized basis.

So if one purchases the fixed SPIA at age 65, at age 85 he will still receive a monthly benefit of $1,000. If one purchases the IVA at age 65, at age 85 he will receive a monthly benefit of $2,038 if his investment return is 7.25% per year along the way.

And recall that you control the investment allocation, so whether 7.25% is achieved is somewhat in your hands.

House Blend’s analysis regarding rate of return needed to end up with sufficient funds to purchase a fixed SPIA 5, 10, or 15 years in the future while taking withdrawals in the interim is appropriate if one can earn that rate of return uniformly during the withdrawal period. It does not account for “sequence-of-returns” risk. If the asset portfolio from which withdrawals are made declines in the early years and rises in the later years such that the rate of return House Blend calculates is realized on average for the full deferral period, there won’t be sufficient assets to purchase the SPIA.

Additionally, mortality improvement will cause SPIA premiums to be higher to fund the same level of monthly income 5, 10, or 15 years from now if interest rates remain where they are today.

Frugal Al wrote:

"Wow, that is a fairly simplified example. I suspect the mechanics aren't addressed because they can be confusing and obfuscatory. These are bad deals for most people that have planned appropriately and have properly utilized their tax advantaged space. In rare instances they might be appropriate in high tax situations, or for people that are very risk averse. Most people can do better with a balanced portfolio, and possibly the addition of a fixed SPIA.

Every day there's another story on VAs, including insurance companies changing terms, companies getting out of the business, companies concerned about disintermediation and worried they've over hedged with their bond holdings in the midst of rising interest rates and lapsing policies. Even low fee versions are marginal at best. If most people that bought these things had to understand them, there would be few customers. There is no free lunch, and when some customers thought they got one, the insurance companies wanted them back (i.e., changed the terms).”


Actually, for an IVA, the mechanics in the example are the extent of the mechanics.

Frugal Al is instead referring to deferred variable annuities with a Guaranteed Lifetime Withdrawal Benefit (GLWB) rider. With these, one starts with an accumulated value such as $100,000 and is guaranteed to be able to take withdrawals of a certain percentage like 5% or $5,000 per year for life, even if the account value should go down to zero during that time.

These do have high costs, can be confusing and obfuscatory, and tend to be for people that are very risk averse. Frugal Al has his facts straight—it’s just that they pertain to a different product.

Frugal Al is also correct that insurance companies that engaged in the VA “living benefits wars” of the 2000-2010 period offered too generous benefits that were difficult to hedge or simply went unhedged or were improperly hedged. For certain of these, a bear stock market combined with a lower interest rate environment was the perfect storm of disaster. (Guess what happened near the end of that decade?!) Consequently, some VA-writing insurance companies exited the business. Others reduced terms on newly issued policies, such as introducing investment restrictions and lowering the 5% in the above example to something less. Others offered deals to try to buy back these VA “living benefits.”

Again, all these things Frugal Al correctly remembers apply to VA deferred annuities with so-called living benefits. His observations about those are nearly universally shared: high costs, confusing, appeal to very risk averse, etc.

None of those observations apply to an IVA. They aren’t for people who are very risk-averse. No insurer has changed the terms on these. To my knowledge, no insurer has gotten out of this business. An IVA is simply the variable equivalent of a fixed SPIA.

All the bad press on deferred VAs tends to taint anything with the name “annuity” in it. (VAs have been used as asset accumulation vehicles for the much larger demographic of baby boomers still accumulating retirement wealth, and so there’s been a lot of press about VAs. There’s been virtually no press about IVAs, because of the relatively fewer baby boomers taking retirement income relative to those still accumulating wealth and because of the lesser amount of IVA sales relative to deferred VAs. The fact that IVA commissions are significantly lower than deferred VA commissions also plays a role in the relative levels of sales.)

Take an objective look at an IVA (of any company, but take an especially strong look at those with lowest cost). House Blend, if you’re willing to buy a fixed SPIA, would you be willing to buy a variable SPIA that both costs less and has the capacity to significantly increase your income level over time? Would you be willing to buy both?

I’m just an (old) student of retirement income, who took an interest in this subject starting with the 1965 paper by Yaari. People are too quick to dismiss an IVA. The mechanics of an IVA are unchanged from when CREF (of TIAA-CREF) introduced it in 1952. Insurance companies can offer these safely, without any need to buy derivatives or be concerned with where interest rates or the stock market are going—in significant contrast to more recent, less well conceived product designs.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Thu Jun 20, 2013 9:30 am

Quant, perhaps I misunderstood some of your previous posts, but as soon as you start with guarantees and lifetime payments with regard to IVAs you are entering territory that has expenses associated with it. The simplest bare bones IVA can be relatively low cost, but offers none of the bells and whistles. As soon as you start comparing fixed SPIAs to the IVA variant you need to consider those expenses and the associated complexity. In Wade Phau's studies he consistently points out IVAs are not generally effective in a retirement portfolio. As far as fixed SPIAs, I think many here only disagree on when to buy them and what percent of one's portfolio--assuming there's a need, say, something below about 30x retirement expenses and a long lifespan is anticipated. What am I missing? I believe Moshe Milevsky has also pointed out that VAs are just too expensive once riders are added. Once again, beware the high cost of guarantees.
Last edited by Frugal Al on Thu Jun 20, 2013 9:45 am, edited 1 time in total.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby ndchamp » Thu Jun 20, 2013 9:41 am

Frugal Al wrote:Quant, perhaps I misunderstood some of your previous posts, but as soon as you start with guarantees and lifetime payments with regard to IVAs you are entering territory that has expenses associated with it. The simplest bare bones IVA can be relatively low cost, but offers none of the bells and whistles. As soon as you start comparing fixed SPIAs to the IVA variant you need to consider those expenses and the associated complexity. In Wade Phau's studies he consistently points out most shouldn't consider IVAs in their retirement portfolio. As far as fixed SPIAs, I think many here only disagree on when to buy them and what percent of one's portfolio--assuming there's a need, say, something below about 30x retirement expenses and a long lifespan is anticipated.


Perhaps you could read the Vanguard IVA Contract Prospectuses and point out all these extra expenses and complexities. I seem to have missed them.
http://www.agincome.com/iva/IVAController?page=Prospectus
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Thu Jun 20, 2013 10:12 am

I've already read it. It guarantees variable income for life. It's not an apples to apples comparison. An optional rider would be needed. More guarantees=more expenses. And VAs don't keep up with inflation either, as some might think or be told in a sales pitch. There's no free lunch. If you like it and are happy with it--great. I'll pass.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby House Blend » Thu Jun 20, 2013 11:33 am

Quant wrote:House Blend’s analysis regarding rate of return needed to end up with sufficient funds to purchase a fixed SPIA 5, 10, or 15 years in the future while taking withdrawals in the interim is appropriate if one can earn that rate of return uniformly during the withdrawal period. It does not account for “sequence-of-returns” risk. If the asset portfolio from which withdrawals are made declines in the early years and rises in the later years such that the rate of return House Blend calculates is realized on average for the full deferral period, there won’t be sufficient assets to purchase the SPIA.

I agree--I left that detail out for the sake of brevity. :wink:

Given that you generally can't earn 3.5% risk-free today (although I'm getting more than that now from TIAA Traditional), you'll need to take some risk with the lump sum. So even if you manage an internal rate of return of 3.5% on the lump, a poor sequence of returns could leave you with less than you need.

Correction: an internal rate of return of 3.5% is exactly what you need to break even in my example. Where sequence-of-returns risk is hidden is in the fact that if you have a fund that returns 3.5% annualized, but with fluctuations, then your internal rate of return will be less than 3.5% if bad years precede good years while making withdrawals.

Take an objective look at an IVA (of any company, but take an especially strong look at those with lowest cost). House Blend, if you’re willing to buy a fixed SPIA, would you be willing to buy a variable SPIA that both costs less and has the capacity to significantly increase your income level over time? Would you be willing to buy both?

Too early to make that call. But because half of my portfolio is tax-deferred and at TIAA-CREF, I will at least be looking at using their Traditional and variable annuities to generate retirement income. And Traditional (perhaps with the graded payout schedule) would be my first choice among those options.
Last edited by House Blend on Fri Jun 21, 2013 10:08 am, edited 1 time in total.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Thu Jun 20, 2013 12:02 pm

Here's an interesting analysis comparing Vanguards GLWB with a Cash Refund Fixed SPIA at age 65. It offers some support to Quant's position http://www.advisorperspectives.com/news ... arison.pdf. Still, I think fixed SPIAs trailed here because they are more interest rate sensitive (to buy) and when this was written in 2012 rates were obviously low like today.

Three other aspects of IVAs is that all income gains are taxed as ordinary income, there's no step-up of cost basis for inheritance, and a few states have premium taxes on the products. Only time will tell if other cash strapped states follow suit. These things are still complex and hard to compare. And there's enough wiggle room contractually for the insurance companies to change the investment portfolios if they think there's a need. Even Vanguard doesn't go out of their way to push these things, but it's good to have a low fee alternative to 1035 into.
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby House Blend » Thu Jun 20, 2013 1:02 pm

Frugal Al wrote:Three other aspects of IVAs is that all income gains are taxed as ordinary income,...

Not if you annuitize from a Roth.

That said, I do think that interactions with the tax code (RMDs, taxation of SS benefits, quirks of state taxation, etc) make the annuity decision more complicated.

Another reason I can see for delaying the start of a SPIA is to wait until after you've filed for SS benefits. (Granted for most non-Bogleheads this is moot--there is no period between retirement and commencing SS.) At this point you now have an inflation-adjusted income stream, and are in a better position to decide how much more income you want/need. In the years before that, without these income streams filling up the low brackets, you can convert tax-deferred accounts to Roth at low tax cost. (Assuming you have other sources-- such as a taxable account-- to rely on during that period.)
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby Frugal Al » Thu Jun 20, 2013 2:34 pm

House Blend wrote:Not if you annuitize from a Roth.

Oh, such sacrilege. I know people do it, but I don't think I could to that to my carefully cultivated sacred ground. :oops:
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Re: Are safe bonds safe enough & why wait on SPIA Annuity?

Postby ndchamp » Fri Jun 28, 2013 6:07 pm

Quant wrote:Take an objective look at an IVA (of any company, but take an especially strong look at those with lowest cost). People are too quick to dismiss an IVA. The mechanics of an IVA are unchanged from when CREF (of TIAA-CREF) introduced it in 1952. Insurance companies can offer these safely, without any need to buy derivatives or be concerned with where interest rates or the stock market are going—in significant contrast to more recent, less well conceived product designs.

Other than Vanguard's online quote generator from AIG, is there any other online site offering IVA quotes? :?:
It seems that there is really no way to compare SPIVA contracts.
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