SPIA and Inflation Interview

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winski58
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SPIA and Inflation Interview

Post by winski58 »

Would anyone care to explain to me what Lew Mandell is trying to convey in this interview?

The following is from a PBS interview.
Paul Solman: But suppose I put all my savings into a life annuity and inflation skyrockets?

Lew Mandell: I hope that a major contribution of my book is its focus on minimizing uncovered inflation-related expenses in retirement. This is done by having a fully-paid, age-in-place home and no other consumer debt as well as by maximizing Social Security retirement payments by waiting until age 70 to begin drawing them. Therefore, if your uncovered-for-inflation core expenses amount to, say, 10 percent of your total core expenses after you purchase the nominal life annuity, the impact of inflation on your standard of living is just a tenth of the level of inflation. A 20 percent rate of inflation would impact your living standard by just 2 percent per year.
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bertilak
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Re: SPIA and Inflation Interview

Post by bertilak »

winski58 wrote:Would anyone care to explain to me what Lew Mandell is trying to convey in this interview?

The following is from a PBS interview.
Paul Solman: But suppose I put all my savings into a life annuity and inflation skyrockets?

Lew Mandell: I hope that a major contribution of my book is its focus on minimizing uncovered inflation-related expenses in retirement. This is done by having a fully-paid, age-in-place home and no other consumer debt as well as by maximizing Social Security retirement payments by waiting until age 70 to begin drawing them. Therefore, if your uncovered-for-inflation core expenses amount to, say, 10 percent of your total core expenses after you purchase the nominal life annuity, the impact of inflation on your standard of living is just a tenth of the level of inflation. A 20 percent rate of inflation would impact your living standard by just 2 percent per year.
Seems to be saying that if the non-indexed annuity provides a small amount of your income and all your other income is inflation-indexed, then inflation will have a trivial effect. In other words, a non-answer.

MY answer would be that you need other investments - ones that have a tendency to track inflation, even if only loosely. Those can be used to fill in or bump up your income when inflation has chipped away at you. In other words, the premise of the question reflects a bad choice. Don't put all your savings in a non-indexed annuity!
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nisiprius
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Re: SPIA and Inflation Interview

Post by nisiprius »

Just as it is bizarre to me to read people fulminating at length over the inflation risks of "bonds" without ever mentioning, even in an aside, that TIPS exist, it is bizarre to me to read people fulminating at length over the inflation risks of level-payment SPIAs without ever mentioning that inflation-indexed SPIAs exist. I mean, they exist. They really do exist. And while there are issues (only a few companies issue them and their financial strength ratings are no more than sorta OK), there are quite a lot of companies that issue SPIAs with payouts that increase by a fixed percentage, e.g. 3%, compounded, annually.
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Re: SPIA and Inflation Interview

Post by bertilak »

nisiprius wrote:Just as it is bizarre to me to read people fulminating at length over the inflation risks of "bonds" without ever mentioning, even in an aside, that TIPS exist, it is bizarre to me to read people fulminating at length over the inflation risks of level-payment SPIAs without ever mentioning that inflation-indexed SPIAs exist. I mean, they exist. They really do exist. And while there are issues (only a few companies issue them and their financial strength ratings are no more than sorta OK), there are quite a lot of companies that issue SPIAs with payouts that increase by a fixed percentage, e.g. 3%, compounded, annually.
Even so, there is a need to deal with non-indexed annuities. For example, my defined benefit pension (the major portion of my income) is not inflation indexed.
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livesoft
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Re: SPIA and Inflation Interview

Post by livesoft »

I think he's saying that most of one's core expenses have no inflation component. If you have a paid off home, then rent and mortgage cannot affect you. If you have bought all the durable goods you need to live, then no affect of inflation on you. You don't borrow money, so loan interest rates don't affect you. For the items that have some inflation, you use SS benefits which are inflation-linked.

So if SS benefits pay a substantial fraction (0.9 or 90%) of your core expenses (food, utilities, property taxes, health care), then that leaves only 10% of core expenses that you need to cover with an inflation-linked product. Or you ignore it.

For non-core expenses, the quoted passage doesn't say anything about their inflation component.
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bertilak
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Re: SPIA and Inflation Interview

Post by bertilak »

livesoft wrote:... If you have a paid off home, then ... mortgage cannot affect you.
I guess it depends on your situation. The more of your expenses that are a mortgage payment, the less inflation affects you. The mortgage payments are not subject to inflation.

This is my case. I have a big mortgage. I kept moving from house to house and taking out a new 30-year mortgage each time and then refinancing at 30 years whenever rates were favorable. So, here I am retired with 25+ years left on my mortgage. My only consolation is that this big chunk of my expenses is not subject to inflation (the property taxes are).
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lawman3966
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Re: SPIA and Inflation Interview

Post by lawman3966 »

In an attempt to supplement what I saw above, I have provided an example below.

The following identifies assets on the left, and the expense the asset is directed to pay on the right.

(1) Paid-off home: 40% of expenses. (The paid off home liability-matches the 40% of total cost ($1200 of the total $3000) that would be paid by a non-home-owner)
(2) Social security: 50% of expenses. (adjusted for inflation by law; liability matches the cost and rate of inflation of the goods the SS payment is directed toward.
(3) non-inflation adjusted (nominal) annuity: 10% of expenses (for groceries and the like). Matches only the initial, uninflated cost. Does not match up with the inflated cost after the first year.

Let's further assume that your lifestyle would cost $3000 for someone without a paid-off home, without SS, and without the annuity. Let's assume there is 10% inflation across the board in year 1. (We have to assume that the 10% inflation rate would be applied to the rental value of your home for someone who did not own a home).

Thus, the total cost of living for our house-less and SS-less hypothetical person would rise to $3300/mo, consistent with our 10% inflation rate.
However, for the homeowner only item (3) (the groceries etc) is subject to a greater expense that is not covered by the home/SS/annuity package. Item (3) started out at $300/mo (since it's 10% of your total expense basis). There was 10% inflation, thus this cost rises to $330/mo.
Now, your total monthly cost increase is $30/month, which represents a 1% inflation rate (over the $3000 amount), rather than the 10% inflation rate that would apply to someone paying for all of the above costs out of a lump sum of assets instead of the package of three assets listed above.

-Edited for clarity-.
Last edited by lawman3966 on Thu Jun 26, 2014 3:33 am, edited 1 time in total.
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bertilak
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Re: SPIA and Inflation Interview

Post by bertilak »

lawman3966 wrote: Let's assume the following proportions of total cost of your various expenses:
(1) Paid-off home: 40% of expenses. (inherently adjusted for home price inflation, since there are no remaining payments).
I don't understand. If the home is paid off and there are no remaining payments how can that be 40% of expenses? Looks looks zero percent to me.
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lawman3966
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Re: SPIA and Inflation Interview

Post by lawman3966 »

bertilak wrote:
lawman3966 wrote: Let's assume the following proportions of total cost of your various expenses:
(1) Paid-off home: 40% of expenses. (inherently adjusted for home price inflation, since there are no remaining payments).
I don't understand. If the home is paid off and there are no remaining payments how can that be 40% of expenses? Looks looks zero percent to me.
I think I expressed my ideas poorly. I am going to edit my post in an attempt to clarify.

The paid-off home liability-matches the 40% of total expenses that the home cost would represent if the person did not own the home.

Thus, the lump sum invested in the home precludes the possibility of rent increases that would confront a non-home-owner.
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Frugal Al
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Re: SPIA and Inflation Interview

Post by Frugal Al »

First and foremost, if possible, one should maximize the best inflation indexed annuity there is: Social Security.
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