Is there a way to provide for inflation ?

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Hexdump
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Is there a way to provide for inflation ?

Post by Hexdump »

This is probably a dumb idea/question but here goes anyway.
I am 75 DW is 58.
We have a Joint Life annuity which provides about $1,500/month but it does not allow for inflation.
Would it be possible to fund another annuity to provide for the missing inflation component ?
My no doubt, screwed up math, says that the $1,500/month ($18,000/year), if it were to track say 3% inflation, should increase to ($18,000 x 1.03) for next year/etc. So, $540.00 would cover the inflation.
If I were to fund another annuity which provided the $540.00 annually, would it somewhat provide for the missing inflation provision of the original annuity ?

If not and it probably doesn't, what would I need to do ?

thanks
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ResearchMed
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Re: Is there a way to provide for inflation ?

Post by ResearchMed »

One suggestion is to have a ladder of small deferred annuities, one to kick in every couple/three/etc., years.

Those are much less expensive than SPIA's, due to mortality credits, especially the further out they go.

Then every few years, you'd get your own "inflation adjustment" that would continue for life.

RM
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Tamales
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Re: Is there a way to provide for inflation ?

Post by Tamales »

If I understand your proposal, since it is a fixed $540 amount, it wouldn't be compounded. So if inflation is 3% every year, that would only be an inflation compensation for 1 year, and would begin to lag behind going forward.
Sagenick48
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Re: Is there a way to provide for inflation ?

Post by Sagenick48 »

I must be dense, but what does "DW" stand for? I see the abbreviation used all the time and assume in means the spouse.
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furwut
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Re: Is there a way to provide for inflation ?

Post by furwut »

DW = dear wife
DH = dear husband

DD = damn divorce :wink:
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Re: Is there a way to provide for inflation ?

Post by Hexdump »

Tamales wrote:If I understand your proposal, since it is a fixed $540 amount, it wouldn't be compounded. So if inflation is 3% every year, that would only be an inflation compensation for 1 year, and would begin to lag behind going forward.
Yes, I see what you mean about the compounding and it seems that maybe the idea of periodic delayed annuities might be able to help.
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Re: Is there a way to provide for inflation ?

Post by Hexdump »

ResearchMed wrote:One suggestion is to have a ladder of small deferred annuities, one to kick in every couple/three/etc., years.

Those are much less expensive than SPIA's, due to mortality credits, especially the further out they go.

Then every few years, you'd get your own "inflation adjustment" that would continue for life.

RM
This is quite a good idea RM and sounds like what I am looking for.
dbr
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Re: Is there a way to provide for inflation ?

Post by dbr »

How do you impose an inflation index on deferred annuities? Wasn't one of the points in the discussion about those that even if the deferred annuity is inflation indexed, the indexing would only apply after the annuity is realized and not in the time intervening. I may have misread those conversations.

Anyway, it is correct that to index up a fixed annuity it would be necessary to invest additional money every year to increase the income stream for inflation. The dilemma in this is to identify the source of the capital needed to make the investment. This can only be drawn down from some other investment which itself more than paces inflation.
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ResearchMed
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Re: Is there a way to provide for inflation ?

Post by ResearchMed »

dbr wrote:How do you impose an inflation index on deferred annuities? Wasn't one of the points in the discussion about those that even if the deferred annuity is inflation indexed, the indexing would only apply after the annuity is realized and not in the time intervening. I may have misread those conversations.

Anyway, it is correct that to index up a fixed annuity it would be necessary to invest additional money every year to increase the income stream for inflation. The dilemma in this is to identify the source of the capital needed to make the investment. This can only be drawn down from some other investment which itself more than paces inflation.
This plan does NOT assume any "inflation adjustment" in the deferred annuities themselves.

Adding an extra income chunk every few years (and for life) *IS* the "inflation adjustment".

Obviously it isn't tied precisely to an Inflation index.

But the point is that if inflation is likely to occur over decades, then getting a permanent income bump every few years is sort of like a step-wise adjustment.

RM
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dbr
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Re: Is there a way to provide for inflation ?

Post by dbr »

ResearchMed wrote:
Obviously it isn't tied precisely to an Inflation index.
Isn't that the crux of the OP's question? Otherwise, for example, one can deal with the issue of having a fixed annuity plus an investment portfolio by just modelling how secure the outcome would be if we take the annuity as income and look at withdrawing from the portfolio by amounts increasing by more than inflation. That takes away from the world of SWR studies, but there is nothing wrong with that. Any probalilistic model, even FireCalc can run a scenario like that and produce some chances of failure. Codging up a system to start with a fixed annuity and actually index future annuity income for inflation is a much more difficult problem to implement technically. Whether on needs to do that is a different question.
furwut
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Re: Is there a way to provide for inflation ?

Post by furwut »

In his book Unveiling the Retirement Myth author Cecil Otar recommends dedicating an investment bucket to offset inflation on non-indexed (and partially indexed) annuities.

In Chapter 33 a table shows a requirement for a $109,000 bucket (50% S&P 500 and 50% fixed income) to provide inflation protection for each $10,000 of non-indexed annuity income for 30 years. OP then would need $196,200.

My interpretation is that you would withdrawal from this bucket only to the extent to make up for inflation from the previous year. For example if, after year one, inflation had been 5% one would withdrawl $900 from the bucket ($18,000 annuity income * .05) NOT 5% of the bucket ($196,200 * .05 = $9810).
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DG99999
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Re: Is there a way to provide for inflation ?

Post by DG99999 »

I am coming up with the following lump sums needed to fund the inflation payments for 30 years, based on an expected return. These figures, however, are probably on the low side since they do not account for fees, taxes, or sequence of return risk - so they represent more of a theoretical minimum. I believe this actually may help to validate the higher $196k figure. (i.e. these figures would work, as is, if you were pulling the inflation payment from a Roth 401k each year invested in a GIC account paying the given rate of return)

Return....NPV
..3%.......$176,608
..5%.......$123,736
..7%........$88,970
I am not a financial professional. My posts are only my opinion on the topic. You need to do your own due diligence and consult with a professional when addressing your financial questions.
ourbrooks
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Re: Is there a way to provide for inflation ?

Post by ourbrooks »

You can certainly withdraw from an investment account each year to compensate for the effects of inflation, keeping in mind that every year you will be withdrawing more money.

A better scheme is periodically, say, every five years, buy another SPIA whose payments would make up for the loss in purchasing power over the previous five years. Why is this better? Because, per dollar of payment, SPIAs get cheaper the older you get, particularly after age 70 or so. SPIA payouts have two components, one from interest earned on the annuity purchase and one from "mortality credits," money paid to the insurance company by other people who died earlier. By age 70 or so, the mortality credits become far and away the largest part of the payout.

From some rough spreadsheet calculations, the money that you have invested for future inflation protection only has to grow at the rate of inflation. Because of the effect mentioned above, the payout rate will increase faster than inflation.
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Hexdump
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Re: Is there a way to provide for inflation ?

Post by Hexdump »

These are interesting ideas.
When we were shopping for an SPIA last year, the difference between an inflation indexed and a non-inflation-indexed annuity were significant. I don't remember the exact numbers but we bought the non-indexed.
There were other % increase options that we took a hard look at before saying no. 1%, 2%, 3%, etc.
So, here we are today, trying to provide for the future inflation.
Rather than tie the increase to an inflation index of some kind, I would be perfectly happy to get a guaranteed inflation adjustment of say 2%-3%.
I like the idea of an annuity in that the payments are for lifetime and pretty much guaranteed. Investing in an equity/bond vehicle has some risk so I was trying to come up with something more like an annuity. Admittedly, the guarantor could go into default but I tend to ignore that.
In addition to the present annuity that we own, 100% of the balance of our investable assets are in Vanguard Wellesley and if I look at its lifetime return, it has been stellar, so it is providing for inflation.
TIPs are a puzzlement to me so I stay away.
Perhaps some sort of a CD ladder or just leave the $$$ in Wellesley.
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Re: Is there a way to provide for inflation ?

Post by flyingaway »

furwut wrote:DW = dear wife
DH = dear husband

DD = damn divorce :wink:

I thought: DD = Dear (or Darling) Daughter
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BL
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Re: Is there a way to provide for inflation ?

Post by BL »

Have you also considered buying I-Bonds since they are tied to inflation? You could each do $10k/year (double that with 2 very simple trusts) for a few years to build up to whatever you choose, then withdraw each year. Nothing exact here, but it is inflation adjusted every 6 months.
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Re: Is there a way to provide for inflation ?

Post by Hexdump »

BL wrote:Have you also considered buying I-Bonds since they are tied to inflation? You could each do $10k/year (double that with 2 very simple trusts) for a few years to build up to whatever you choose, then withdraw each year. Nothing exact here, but it is inflation adjusted every 6 months.
Thank you for another good idea. I like IBonds a lot and building a sorta ladder of them makes sense.
Another consideration that I prefer about annuities is that they are essentially on auto-pilot. DW doesn't want to and refuses to do any, reading/learning about where the $$$ comes from. Additionally she tends to be reactive. Whenever one of her compatriots are talking about "now is the time" to buy (stocks, bonds, S&P500, etc), she corners me and tells me to do it. I have been able to avoid it one way or the other but I want to provide something that is bullet proof, steady and reliable with no involvement from her.
She is likely to outlive me since I am 18 years her senior. She understands CD ladders so maybe that's a start.
Perhaps I will try and get her interested in this discussion.
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Re: Is there a way to provide for inflation ?

Post by The Wizard »

Assuming one has sufficient assets, there are various ways to deal with inflation.
Partial annuitization is fine and is what I've done.
Possibly annuitize an additional sum every 5-7 years depending on how things are going. Or just supplement with portfolio withdrawals.

Separately, it sounds like a balanced fund might good for the OP, if his wife has no desire to learn about this stuff..
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Re: Is there a way to provide for inflation ?

Post by inbox788 »

My understanding is that TIPS and Ibonds are used for capital preservation and inflation protection, while annuities are insurance against excess longevity.

With limited funds, you're going to have to compromise and optimize one or the other. You're going to have to use some assumption about survival age and if you exceed it, you may run out of funds no matter what.

Where are the funds coming from? Annuities generally require a lump sum payment.

I would probably take my chances and put some of the annuity stream or the lump sum cash into a balanced fund and I'd expect the return to beat inflation in most cases in the long run.
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Re: Is there a way to provide for inflation ?

Post by Hexdump »

inbox788 wrote:My understanding is that TIPS and Ibonds are used for capital preservation and inflation protection, while annuities are insurance against excess longevity.

With limited funds, you're going to have to compromise and optimize one or the other. You're going to have to use some assumption about survival age and if you exceed it, you may run out of funds no matter what.

Where are the funds coming from? Annuities generally require a lump sum payment.

I would probably take my chances and put some of the annuity stream or the lump sum cash into a balanced fund and I'd expect the return to beat inflation in most cases in the long run.
I agree that the lump sum into a balanced fund would mostly beat inflation long term yet I would prefer the guarantee of an annuity.
The funds will be from either of our traditional IRAs or from my Roth. Hmmm, well DW is not eligible to begin withdrawals yet due to her age, so that will need to be thought about a bit more. For right now our spending comes from our annuity and my IRA. Her IRA is also 100% in Wellesley.

I had this discussion with DW and she is comfortable with, and had some knowledge of how to manage a CD ladder.
So, given the two choices of either Wellesley (or perhaps a different Vanguard fund), or a CD ladder, which would you choose ?
And I think that I might be beating a dead horse in that similar discussions have probably been had already under different guidelines but with essentially the same question.
CDs, annuities, or a basket of funds.

thanks again
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Re: Is there a way to provide for inflation ?

Post by The Wizard »

The answer to the OP's question is likely an optimal MIX of annuities plus a basket of funds.
(I'm not much a fan of CDs...)
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Re: Is there a way to provide for inflation ?

Post by lack_ey »

The Wizard wrote:The answer to the OP's question is likely an optimal MIX of annuities plus a basket of funds.
(I'm not much a fan of CDs...)
If by "funds" you mean mostly stock funds, I agree. CDs are good for some things, but fixed income is not very strong for trying to stretch out money and not have it run out (as opposed to preserving capital and being able to pass money on if you pass earlier than expected). Single premium immediate or deferred annuities are better, as are stocks in the long run (most likely) if broadly diversified and not withdrawn from during market crashes.

With deferred annuities, you could build up a base of increasing cash flow, but you still might be in trouble if inflation is much higher than you anticipate. Then again, with the current annuity, you're in even more trouble if inflation spikes.

There are annuity options out there with inflation adjustments, but given expected levels of inflation, on average they are a raw deal compared to the non-adjusted type. And my very limited understanding is that nobody currently offers deferred types that inflation adjust between now and the time payout starts.

As always with annuities, check the conditions of the state guarantee organization and spread money across multiple very stable companies to reduce the risk of insurance company defaults.

It depends on spending levels and many assumptions and what else is bought, but I disagree with Wellesley Income in the wife's IRA (and also with a CD ladder there too), at least for the majority of the funds. Anyway, it's a difficult optimization problem even if all the details are known. Good luck.
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Re: Is there a way to provide for inflation ?

Post by ResearchMed »

lack_ey wrote:
The Wizard wrote:The answer to the OP's question is likely an optimal MIX of annuities plus a basket of funds.
(I'm not much a fan of CDs...)
If by "funds" you mean mostly stock funds, I agree. CDs are good for some things, but fixed income is not very strong for trying to stretch out money and not have it run out (as opposed to preserving capital and being able to pass money on if you pass earlier than expected). Single premium immediate or deferred annuities are better, as are stocks in the long run (most likely) if broadly diversified and not withdrawn from during market crashes.

With deferred annuities, you could build up a base of increasing cash flow, but you still might be in trouble if inflation is much higher than you anticipate. Then again, with the current annuity, you're in even more trouble if inflation spikes.

There are annuity options out there with inflation adjustments, but given expected levels of inflation, on average they are a raw deal compared to the non-adjusted type. And my very limited understanding is that nobody currently offers deferred types that inflation adjust between now and the time payout starts.

As always with annuities, check the conditions of the state guarantee organization and spread money across multiple very stable companies to reduce the risk of insurance company defaults.

It depends on spending levels and many assumptions and what else is bought, but I disagree with Wellesley Income in the wife's IRA (and also with a CD ladder there too), at least for the majority of the funds. Anyway, it's a difficult optimization problem even if all the details are known. Good luck.
We feel the same, as mentioned above in part.

We don't yet know what proportions we'll use for each category yet, of course.
(I'm not using the term "bucket", because our "categories" aren't intended for the typical short/medium/long term. We can figure that out month to month/year to year without labels.)

But it's meant for the different usage and protections.

Some will be SPIA's, along with Social Security. We'll probably figure that as somewhat close to minimal needs.

Then we'll probably later add a couple of small laddered deferred annuities for extra inflation protection, as only the SS above will already include that.

And we'll also be planning for long term care, perhaps in part with proceeds from our house if we haven't already sold and moved to a place with no stairs, etc. Maybe that *will* be the start of the long term care.

So much is impossible to predict.

The rest, we'll probably split into some lower risk, easily accessible money, and then equities for growth.
Sure, we'd rather not end up meeting only "minimal needs", but that will be above the "cat food" level.
So the "growth" category will also be spent on extras like more travel.

We may end up annuitizing more, because we don't have any legacy desires.
We just can't figure out a way to have that final check bounce on the day the last of us heads off...

RM
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