Why an Annuity vs Wellesley

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Why an Annuity vs Wellesley

Postby Hexdump » Sun Feb 24, 2013 1:06 pm

I have been playing around with numbers trying to make an annuity purchase make sense to me.
I liked them a lot better a few years ago when interest rates were higher, but here we are.
I was thinking of buying a $100,000.00 SPIA, Joint Spousal, 100%, Life only.
The annuity would provide a $440.00 monthly benefit
Whereas the same $100,000.00 invested in VWIAX, Wellesley Admiral would provide close to the same amount considering dividends and capital gains.
Selling Wellesley shares once a quarter to fill the budget and I would still have most of all the shares left at the end of the year.
At least that is what my test model shows for the past 5 years, Plus something to leave to my heirs if I am so inclined.

So, for me, what advantage is there to an annuity. A guaranteed income stream fairly painless.

Thanks
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Re: Why an Annuity vs Wellesley

Postby grabiner » Sun Feb 24, 2013 1:40 pm

The difference is that the income stream from Wellesley is not guaranteed. Wellesley lost about 20% of its value in 2007-2009; if you were taking out $5280 of an initial $100,000 balance every year, you lost more than 30%. If you live long enough or the market returns are poor, you might run out of money.

The $5280 per year from a $100,000 annuity is guaranteed by the annuity provider (and possibly by your state if the annuity provider goes broke), regardless of how long you live or what happens to the markets. Therefore, the annuity is better if you need a fixed amount of money for the rest of your life and don't care what happens after your death.

One risk with either strategy is inflation; unless you have an inflation-adjusted annuity (and your quote presumably isn't), you don't know what your payments will buy in 20 years. Withdrawing 5.28% and allowing withdrawals to grow with inflation is possible with mutual funds, but is even riskier than withdrawing a fixed-dollar amount; a normal recommendation is that 4% growing with inflation is sustainable.
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Re: Why an Annuity vs Wellesley

Postby Default User BR » Sun Feb 24, 2013 2:11 pm

A great deal of the past capital gains for Wellesley was on the back of the long bull market in bonds. That's unlikely to continue with that sort of results going forward, and in fact bond components might show some losses over the coming years, although offset with increased yields.

There's nothing magic about that fund. It holds some stocks and some bonds. Either of those could show losses over the coming years. You can't buy past performance.


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Re: Why an Annuity vs Wellesley

Postby wshang » Sun Feb 24, 2013 3:00 pm

This is not an either or proposition. You could buy a little annuity now, and essentially dollar cost average in over the next couple of years. The payout is related to the 10 year Treasury, which right now - downright stinks!
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Re: Why an Annuity vs Wellesley

Postby Professor Emeritus » Sun Feb 24, 2013 3:29 pm

Interestingly we are using Wellesley as a parking space for the money we need to defer social security. Which is the equivalent of course of buying a little annuity every month. I expect to draw it down over the next 8 years.
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Re: Why an Annuity vs Wellesley

Postby Khanmots » Sun Feb 24, 2013 3:33 pm

grabiner wrote:a normal recommendation is that 4% growing with inflation is sustainable.

This comes with the caveat that it's sustainable for at most 30 years... which is fine for most retirements.

If you plan on retiring early and/or living to a ripe old age, then 2-3% becomes more realistic.
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Re: Why an Annuity vs Wellesley

Postby IlikeJackB » Sun Feb 24, 2013 5:25 pm

For your consideration, with the usual caveats (past performance, etc.): http://socialize.morningstar.com/NewSoc ... ID=2800078
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Re: Why an Annuity vs Wellesley

Postby jeffyscott » Sun Feb 24, 2013 5:30 pm

Another comparison, assuming the annuity is a fixed amount, with no inflation adjustment...

Using the SEC yield of 4.27%, $100,000 in Vanguard Long Term Investment Grade Bond Fund would generate about $356 per month. If you instead pulled out $440 per month out it would still last about 40 years.
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Re: Why an Annuity vs Wellesley

Postby Hexdump » Sun Feb 24, 2013 5:36 pm

grabiner wrote:The difference is that the income stream from Wellesley is not guaranteed. Wellesley lost about 20% of its value in 2007-2009; if you were taking out $5280 of an initial $100,000 balance every year, you lost more than 30%. If you live long enough or the market returns are poor, you might run out of money.

The $5280 per year from a $100,000 annuity is guaranteed by the annuity provider (and possibly by your state if the annuity provider goes broke), regardless of how long you live or what happens to the markets. Therefore, the annuity is better if you need a fixed amount of money for the rest of your life and don't care what happens after your death.

One risk with either strategy is inflation; unless you have an inflation-adjusted annuity (and your quote presumably isn't), you don't know what your payments will buy in 20 years. Withdrawing 5.28% and allowing withdrawals to grow with inflation is possible with mutual funds, but is even riskier than withdrawing a fixed-dollar amount; a normal recommendation is that 4% growing with inflation is sustainable.


Grabiner, what period would you think would be a stress test for my theory ? You mentioned 2007-2009, so if I took the numbers from say, 9/2008 thru 3/2010, would that be a fair sampling ?
Using Yahoo finance numbers what I did was buy $100,000 of VWIAX at the close of business on the same day that the Yahoo started tracking the fund, I think early in 2004.
Then every 3 months, reinvested the dividends and cap gains, and after reinvesting the distributions, I sold enough shares to equal $1,320.

At the end, I still had plenty of shares left.

I was thinking that the 34% equity position of Wellesley would help with the inflation. Isn't that the theory at least ?

Do you see any glaring errors in my reasoning or any not so glaring ? :D

Thanks
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Re: Why an Annuity vs Wellesley

Postby EternalOptimist » Sun Feb 24, 2013 5:50 pm

Hexdump wrote:I have been playing around with numbers trying to make an annuity purchase make sense to me.
I liked them a lot better a few years ago when interest rates were higher, but here we are.
I was thinking of buying a $100,000.00 SPIA, Joint Spousal, 100%, Life only.
The annuity would provide a $440.00 monthly benefit
Whereas the same $100,000.00 invested in VWIAX, Wellesley Admiral would provide close to the same amount considering dividends and capital gains.
Selling Wellesley shares once a quarter to fill the budget and I would still have most of all the shares left at the end of the year.
At least that is what my test model shows for the past 5 years, Plus something to leave to my heirs if I am so inclined.

So, for me, what advantage is there to an annuity. A guaranteed income stream fairly painless.

Thanks



I tend to agree. I think there are many ways to get an income stream without releasing your principal.
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Re: Why an Annuity vs Wellesley

Postby rj49 » Sun Feb 24, 2013 5:59 pm

IlikeJackB wrote:For your consideration, with the usual caveats (past performance, etc.): http://socialize.morningstar.com/NewSoc ... ID=2800078


That's a big caveat, with 30 years of declining interest rates and a fund with 65% in bonds. If you want the greater stability of an annuity, I'd make a safer version of Wellesley, with Equity Income for the stock allocation, which is similar to Wellesley, but with more diversification. Then for the fixed income part, use CDs and ibonds, so you won't suffer from regret if interest rates and inflation rises (at least not as much). Then if annuity rates and/or Wellesley's yield improves after a number of years, move into those. If you want a one-fund equivalent, I'd probably go with TR income, which has international stocks, TIPS, foreign bonds, and a 30% stock allocation, so you have more diversification and less manager risk, and I believe the duration of its bond funds is shorter than for Wellesley.
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Comparing an Annuity with Wellesley

Postby Taylor Larimore » Sun Feb 24, 2013 6:14 pm

Hexdump:
The annuity would provide a $440.00 monthly benefit hereas the same $100,000.00 invested in VWIAX, Wellesley Admiral would provide close to the same amount considering dividends and capital gains.

We cannot fairly compare a mutual fund with a lifetime annuity:

* A mutual fund return is not guaranteed. Annuity return is guaranteed.

* A mutual fund can lose money (Wellsley lost -4.2% in 1999). Annuity income is always positive.

* Withdrawals from Wellsley might exhaust the portfolio. SPIA lifetime annuity income is forever.

* Mutual Fund principal is always available. SPIA principal is not (with few exceptions).

Past performance does not guarantee future performance.

Despite its drawbacks, a life annuity provides the largest lifetime guaranteed income of any security.

Best wishes.
Taylor
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Re: Comparing an Annuity with Wellesley

Postby Hexdump » Sun Feb 24, 2013 8:26 pm

Taylor Larimore wrote:Hexdump:
The annuity would provide a $440.00 monthly benefit hereas the same $100,000.00 invested in VWIAX, Wellesley Admiral would provide close to the same amount considering dividends and capital gains.

We cannot fairly compare a mutual fund with a lifetime annuity:

* A mutual fund return is not guaranteed. Annuity return is guaranteed.

* A mutual fund can lose money (Wellsley lost -4.2% in 1999). Annuity income is always positive.

* Withdrawals from Wellsley might exhaust the portfolio. SPIA lifetime annuity income is forever.

* Mutual Fund principal is always available. SPIA principal is not (with few exceptions).

Past performance does not guarantee future performance.

Despite its drawbacks, a life annuity provides the largest lifetime guaranteed income of any security.

Best wishes.
Taylor


Thank you Taylor and I have a few comments. I agree that these are really 2 different critters so take my comparison for what it's worth.
Where did you get your numbers for 1999 ? The funds inception was 2001 and the 1st I could find was 2003.
Additionally, it looked like 2008 was the worst year with the fund being down 9.79%.
Nonetheless, I ran the 2008 numbers through my model and still wound up with more shares than I started with.
I used a buy-in price of 52.88 as of 12/31/2007 which yielded 1891 shares.
Taking these 1891 shares forward through 2008, reinvesting dividends and selling shares each quarter to get the $1,320 (440x3), I wound up with 1918 shares. So even though the fund lost money, I still funded my budget and retained the principal.
It's tough to predict but if the future continues like the past 10 years, I don't think I will exhaust the fund.

Past history is no guarantee, but it's all I have.
Mutual funds do go broke and the principal is lost, so that is a risk
I appreciate all your comments and take them to heart.

Thanks again.
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Re: Why an Annuity vs Wellesley

Postby momar » Sun Feb 24, 2013 8:29 pm

Khanmots wrote:
grabiner wrote:a normal recommendation is that 4% growing with inflation is sustainable.

This comes with the caveat that it's sustainable for at most 30 years... which is fine for most retirements.

If you plan on retiring early and/or living to a ripe old age, then 2-3% becomes more realistic.

No, it comes with the caveat that it has been sustainable for at least 30 years.

4% was the maximum safe withdrawal rate in that study; in other words, it was the worst case scenario.

Of course, no one knows what will happen going forward.
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Comments

Postby Taylor Larimore » Sun Feb 24, 2013 8:43 pm

Hexdump:
Where did you get your numbers for 1999 ?

From Morningstar:

http://performance.morningstar.com/fund ... on?t=VWIAX


Never forget:

"Using past performance numbers as a method for choosing mutual funds is such a lousy idea that mutual fund companies are required by law to tell you it is a lousy idea." -- Bill Schultheis, author and adviser.

Best wishes.
Taylor
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Re: Comparing an Annuity with Wellesley

Postby jeffyscott » Sun Feb 24, 2013 9:10 pm

Hexdump wrote:Where did you get your numbers for 1999 ? The funds inception was 2001 and the 1st I could find was 2003.


The fund's inception date was in 1970, the admiral share class was apparently created in 2001.
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Re: Why an Annuity vs Wellesley

Postby bdpb » Mon Feb 25, 2013 1:00 am

The comparison may look good today but that's probably because of your age. Wait 10 years and make this comparison again. Certainly the SPIA will look better the older you are when you purchase it.
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Re: Why an Annuity vs Wellesley

Postby MN Finance » Mon Feb 25, 2013 1:17 am

This is obviously not a question that has anything to do with Wellesly. You are asking if you should annuitize money or invest and take withdrawals. That decision is based on a host of factors that you haven't mentioned. The investment you use if you choose option B is a far secondary choice. If you have 100k to live on and you need 500/mo, yes you probably need a SPIA. If you have 1M and you need 20k/yr, then no, you don't need a SPIA. If leaving a legacy is important then that changes the game. If you annuitize a small or large percent of your portfolio, that's a factor. If you have some reason to believe your lives will be longer or shorter than the average, that's a huge piece of information. Again, this has nothing to do with a fund. It has to do entirely with other considerations.

The original question is not any different than posting, should I buy a prius or a suburban, without saying how many miles you drive, what you'll use the vehicle for, do you go camping or to starbucks on the weekend, etc.
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Re: Why an Annuity vs Wellesley

Postby Johm221122 » Mon Feb 25, 2013 4:34 am

EternalOptimist wrote:
Hexdump wrote:I have been playing around with numbers trying to make an annuity purchase make sense to me.
I liked them a lot better a few years ago when interest rates were higher, but here we are.
I was thinking of buying a $100,000.00 SPIA, Joint Spousal, 100%, Life only.
The annuity would provide a $440.00 monthly benefit
Whereas the same $100,000.00 invested in VWIAX, Wellesley Admiral would provide close to the same amount considering dividends and capital gains.
Selling Wellesley shares once a quarter to fill the budget and I would still have most of all the shares left at the end of the year.
At least that is what my test model shows for the past 5 years, Plus something to leave to my heirs if I am so inclined.

So, for me, what advantage is there to an annuity. A guaranteed income stream fairly painless.

Thanks



I tend to agree. I think there are many ways to get an income stream without releasing your principal.

There are just check wiki for safe withdraw rates, but SPIA are an option and in some instances good one
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Re: Why an Annuity vs Wellesley

Postby Khanmots » Mon Feb 25, 2013 10:27 am

momar wrote:
Khanmots wrote:
grabiner wrote:a normal recommendation is that 4% growing with inflation is sustainable.

This comes with the caveat that it's sustainable for at most 30 years... which is fine for most retirements.

If you plan on retiring early and/or living to a ripe old age, then 2-3% becomes more realistic.

No, it comes with the caveat that it has been sustainable for at least 30 years.

4% was the maximum safe withdrawal rate in that study; in other words, it was the worst case scenario.

Of course, no one knows what will happen going forward.

If I'm remembering correctly 4% was (the roundish number) that gave a 95% confidence interval for a 30-year period given historical data. If you wanted to truly remove the worst case scenarios, it'd require a lower withdraw rate.

From some number crunching I did (although admittedly not with the same level of rigor), in order to obtain a 95% confidence for a 40 year horizon you're at roughly a 3% SWR, and for a 50 year horizon you're at roughly a 2.5% SWR. Any longer, or if you have concerns about the sustainability of the rate of return seen in the last hundred years of return history, and you're talking closer to a 2% SWR.
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Re: Why an Annuity vs Wellesley

Postby midareff » Mon Feb 25, 2013 11:00 am

Professor Emeritus wrote:Interestingly we are using Wellesley as a parking space for the money we need to defer social security. Which is the equivalent of course of buying a little annuity every month. I expect to draw it down over the next 8 years.


Interesting... I am using it as a parking place and a quarterly stipend until I hit RMD in first quarter of 2019. Lately I am starting to think I like a similar combination of VYM and Int Term Tax Ex for a bit shorter duration, slightly less cost, better AA control and a slight tax advantage.
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Re: Why an Annuity vs Wellesley

Postby Hexdump » Mon Feb 25, 2013 11:56 am

MN Finance wrote:This is obviously not a question that has anything to do with Wellesly. You are asking if you should annuitize money or invest and take withdrawals. That decision is based on a host of factors that you haven't mentioned. The investment you use if you choose option B is a far secondary choice. If you have 100k to live on and you need 500/mo, yes you probably need a SPIA. If you have 1M and you need 20k/yr, then no, you don't need a SPIA. If leaving a legacy is important then that changes the game. If you annuitize a small or large percent of your portfolio, that's a factor. If you have some reason to believe your lives will be longer or shorter than the average, that's a huge piece of information. Again, this has nothing to do with a fund. It has to do entirely with other considerations.

The original question is not any different than posting, should I buy a prius or a suburban, without saying how many miles you drive, what you'll use the vehicle for, do you go camping or to starbucks on the weekend, etc.


These are excellent points to consider MN, thank you. And I agree it has nothing to do to with which fund for option B. I picked Wellesley as it is a one fund solution (important), and has our AA mix. Past performance hasn't been bad either.
The $100,000 represents 9.5% of our portfolio.
From the 100K we will need $4,445 annually and it must not run out.
Leaving a Legacy is not important.
Ages are very significant. I am 73 and wife is 56 with longevity being common in her genetics. We are planning for 40 years.
As an aside, the Vanguard annuity with a 1% growth factor would yield 389, 392, 396, 400, and 404 for the 1st 5 years.

Would you say that the probability of Mutual of Omaha or Wellesley going broke , are equally likely ? I think that they can't be compared, though, for me, the safety feeling is the same with Mutual of Omaha slightly ahead due to the state guarantee.

Would Wellesley at 34% equities, or Mutual of Omaha at 1% growth, keep up with inflation ? Again, I have no idea how to figure it out.

Thanks again
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Re: Why an Annuity vs Wellesley

Postby scone » Mon Feb 25, 2013 2:33 pm

I just can't wrap my head around annuities. For one, there's the "guarantee." Essentially, this only holds as long as the insurance company does not blow up. But what might cause an insurance company to blow up? Maybe bad investment decisions, colliding with a bad market, and too-low reserves? Maybe toxic mortgages? Maybe derivatives, which Buffett once compared to WMDs? Maybe all of the above?

The insurance company is supposed to have a big fat reserve to cushion itself if the market dies. How big is the reserve? How many customers does the insurance company have, and is the reserve keeping pace with the number of customers? Low long would that cushion last, if tens of thousands of annuitants had to be paid over a very prolonged Japanese-style bear market?

If the company does blow up, how do you really know the state backup insurance fund will pay off in a timely manner? What if many insurance companies blow up at the same time, using up all the state funds? What if the whole system ends up in legal wrangling for months or years? Could you ride out the loss of income for months or years?

And there's this idea that you are somehow transferring market risk from yourself to the insurance company. How can that be? The insurance company takes your money and invests it in the market-- the money is not sitting in an FDIC-insured checking account. You are still "in the market" by proxy. You're just letting someone else handle the details of the investments for you.

But that's what Wellesley does! And unlike the annuity, you can sell Wellesley, or use it for collateral, or will it to your heirs.

Maybe I'm missing something really important here, but I just don't see the appeal of the annuity. Once I start to think about it, all I'm really buying is an insurance contract on top of a mutual fund. Am I missing something? :confused
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Re: Why an Annuity vs Wellesley

Postby rj49 » Mon Feb 25, 2013 2:59 pm

scone wrote:I just can't wrap my head around annuities. For one, there's the "guarantee." Essentially, this only holds as long as the insurance company does not blow up. But what might cause an insurance company to blow up? Maybe bad investment decisions, colliding with a bad market, and too-low reserves? Maybe toxic mortgages? Maybe derivatives, which Buffett once compared to WMDs? Maybe all of the above?

The insurance company is supposed to have a big fat reserve to cushion itself if the market dies. How big is the reserve? How many customers does the insurance company have, and is the reserve keeping pace with the number of customers? Low long would that cushion last, if tens of thousands of annuitants had to be paid over a very prolonged Japanese-style bear market?

If the company does blow up, how do you really know the state backup insurance fund will pay off in a timely manner? What if many insurance companies blow up at the same time, using up all the state funds? What if the whole system ends up in legal wrangling for months or years? Could you ride out the loss of income for months or years?

And there's this idea that you are somehow transferring market risk from yourself to the insurance company. How can that be? The insurance company takes your money and invests it in the market-- the money is not sitting in an FDIC-insured checking account. You are still "in the market" by proxy. You're just letting someone else handle the details of the investments for you.

But that's what Wellesley does! And unlike the annuity, you can sell Wellesley, or use it for collateral, or will it to your heirs.

Maybe I'm missing something really important here, but I just don't see the appeal of the annuity. Once I start to think about it, all I'm really buying is an insurance contract on top of a mutual fund. Am I missing something? :confused


I think insurance companies fund immediate annuities through investing in long-term Treasuries, or at least used to, when they yielded much better. That's why immediate annuity rates are so tied to long-term interest rates, rather than stock returns. Their generous, guaranteed payments also take advantage of the simple fact that many people will die earlier than expected, so that benefits them and those who live longer. Also, since most immediate annuities aren't adjusted for inflation, they don't have to invest as aggressively to achieve the same payment. I think of immediate annuities more like social security, which also invests in government bonds, and which retirees depend on for safety and a basic standard of living. I know that I treasure my military retirement pay, also an annuity, because it means I don't have to worry about stock/bond market losses ruining my basic standard of living.

If you want to learn a lot about annuities, read Moshe Milevsky, a Canadian academic who writes books and articles about them. Jim Otar also recommends annuities as a necessity for those who don't have sufficient assets to ensure a safe retirement. Forbes has a lot of articles on annuities as well, telling both the pros and cons of them. It's understandable why people distrust them, though--we all hate the idea of surrendering a big chunk of money that we can't get back, and annuities have been linked with high fees, shady sales practices, and pushy salesmen, although now investors have them available through VG, which I imagine results in higher quality and lower cost.
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Re: Why an Annuity vs Wellesley

Postby MN Finance » Mon Feb 25, 2013 3:19 pm

scone wrote:I just can't wrap my head around annuities. For one, there's the "guarantee." Essentially, this only holds as long as the insurance company does not blow up. But what might cause an insurance company to blow up? Maybe bad investment decisions, colliding with a bad market, and too-low reserves? Maybe toxic mortgages? Maybe derivatives, which Buffett once compared to WMDs? Maybe all of the above?

The insurance company is supposed to have a big fat reserve to cushion itself if the market dies. How big is the reserve? How many customers does the insurance company have, and is the reserve keeping pace with the number of customers? Low long would that cushion last, if tens of thousands of annuitants had to be paid over a very prolonged Japanese-style bear market?

If the company does blow up, how do you really know the state backup insurance fund will pay off in a timely manner? What if many insurance companies blow up at the same time, using up all the state funds? What if the whole system ends up in legal wrangling for months or years? Could you ride out the loss of income for months or years?

And there's this idea that you are somehow transferring market risk from yourself to the insurance company. How can that be? The insurance company takes your money and invests it in the market-- the money is not sitting in an FDIC-insured checking account. You are still "in the market" by proxy. You're just letting someone else handle the details of the investments for you.

But that's what Wellesley does! And unlike the annuity, you can sell Wellesley, or use it for collateral, or will it to your heirs.

Maybe I'm missing something really important here, but I just don't see the appeal of the annuity. Once I start to think about it, all I'm really buying is an insurance contract on top of a mutual fund. Am I missing something? :confused


You are simply pooling risk. It's the same concept with all insurance products. I pay life insurance premiums each year under the same premise. The mathematics work out actuarially so that the insurance co neutralizes the individual risks by creating the pool and then enough to cover costs and make a profit.

All the questions you've asked are what the ratings agencies use to rate the providers. Without talking about the ratings being suspect or not, that's why the matter. You can always find cheaper insurance or a higher SPIA payout, but at what cost. Now, the reality is that if an insurance co had trouble, you'll likely see another company buy up the portfolio since the risk on something like this is generally pretty quantifiable (life expectancy); granted it would sell at an appropriate discount and the losing insurer loses money, but the investors would end up being pooled with a larger, presumably more sound base. And the money is not in the market. It's invested in the insurance company's general fund. The annuity payments are not a direct pass through investment the way mutual funds are, but rather a promise to pay, backed by the firms security, which rests on the reserves and underlying investments. Most general funds are a huge pool of investments, some illiquid, and invested for the long term (since redemptions and cash requirements are extremely predictable). There are typically large amounts of investment grade bonds, private loans, and small amounts of things like real estate, timber, agriculture, private equity, etc. Generally not equity based investments (at least not nearly to the extent of Wellesley)
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Re: Why an Annuity vs Wellesley

Postby MN Finance » Mon Feb 25, 2013 3:30 pm

Hexdump wrote:These are excellent points to consider MN, thank you. And I agree it has nothing to do to with which fund for option B. I picked Wellesley as it is a one fund solution (important), and has our AA mix. Past performance hasn't been bad either.
The $100,000 represents 9.5% of our portfolio.
From the 100K we will need $4,445 annually and it must not run out.
Leaving a Legacy is not important.
Ages are very significant. I am 73 and wife is 56 with longevity being common in her genetics. We are planning for 40 years.
As an aside, the Vanguard annuity with a 1% growth factor would yield 389, 392, 396, 400, and 404 for the 1st 5 years.

Would you say that the probability of Mutual of Omaha or Wellesley going broke , are equally likely ? I think that they can't be compared, though, for me, the safety feeling is the same with Mutual of Omaha slightly ahead due to the state guarantee.

Would Wellesley at 34% equities, or Mutual of Omaha at 1% growth, keep up with inflation ? Again, I have no idea how to figure it out.

Thanks again


These are not trivial pieces of additional information. First, as just posted, an insurance co going "broke" is not likely (at least the way you're thinking about it - money's gone, you're all out of luck, sorry). It would be assumed by someone else. Secondly, Wellesley can't "go broke" (again, not in the way your thinking about it), but it can certainly lose value.

You said you "need" $4500/year off of $100k and it "must not run out". That statement alone clearly lends toward a SPIA vs. assuming your own risk with a mutual fund. Though, since it's 1/10th of your portfolio, I'm not sure I'd agree that it must not run out since you have other resources. Sometimes people compartmentalize their investments, which is fine, by you should consider it in context of everything you own. A lot of people will buy a SPIA to cover a fixed cost for piece of mind, something like mortgage payments. Again, that's fine, but not the only way to look at it.

You also said that your wife is 56. Investing in traditional investments for 40 years certainly posses a risk of the asset being depleted at some point. The dispersion of potential future outcomes over 40 years is very wide (ie, the 100k could grow to 1M, or it could be zero). Shorter periods are more predictable, even with market volatility.

If there is indeed some expectation of longer life, while not predictable, certainly lends toward the SPIA as well.

You are trading off uncertainty for certainty in an annuity. You know you will get that payment to the end of your life, no more or less, and then it's gone. In an investment your 100k could grow many times the original amount even if you take out money, or it could run out.
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Re: Why an Annuity vs Wellesley

Postby scone » Mon Feb 25, 2013 3:40 pm

Thanks for your reply-- I've commented on your comments (yours in italics and bold).

I think insurance companies fund immediate annuities through investing in long-term Treasuries, or at least used to, when they yielded much better. That's why immediate annuity rates are so tied to long-term interest rates, rather than stock returns.

I just got a SPIA quote from Berkshire Hathaway. They are paying 2.89% and current 30 year Treasury rates are 3.15% (from this chart http://www.treasury.gov/resource-center ... data=yield). That's .26% difference, which is pretty slim. It seems to me you would have to move out into riskier investments just to cover your costs and give the growth BRK investors are expecting.

Their generous, guaranteed payments also take advantage of the simple fact that many people will die earlier than expected, so that benefits them and those who live longer. Also, since most immediate annuities aren't adjusted for inflation, they don't have to invest as aggressively to achieve the same payment.

Even with the mortality credits, the cash flow in an ultra-low interest rate environment has got to be problematical. I would like to be assured that the insurance company is not reaching for yield by engaging in dangerous investment shenanigans.

I think of immediate annuities more like social security, which also invests in government bonds, and which retirees depend on for safety and a basic standard of living. I know that I treasure my military retirement pay, also an annuity, because it means I don't have to worry about stock/bond market losses ruining my basic standard of living.

Personally, I would never compare Social Security, which is effectively backed by the Federal government, with a private annuity, which is backed by a state-run pool, up to a certain limit. There is no Federal back-up for private annuities, AFAIK. As I understand it, if the insurance company goes bankrupt, you have lost any monies you have put in, less what you can get out of the state pool, plus (I assume) whatever you recover from bankruptcy proceedings, which can take years. I'm not even sure where the annuitant stands in BK proceedings-- is it before or after the bond holders, or the stock owners? I really don't know.

It's understandable why people distrust them, though--we all hate the idea of surrendering a big chunk of money that we can't get back, and annuities have been linked with high fees, shady sales practices, and pushy salesmen, although now investors have them available through VG, which I imagine results in higher quality and lower cost.

That's the thing-- if you're going to get this thing through Vanguard, why not buy W & W and cut out the middle man? If I have to trust some sort of financial institution, I'd rather trust Vanguard and Wellington Management than any insurance company I can think of, including one that's part of a holding company run by Warren Buffett. I suppose that attitude comes from living through the recent crash, where Vanguard and Wellington came through very well, but one of our major insurance companies, AIG, nearly crashed had to be bailed out. I'm just saying, "look upon this and upon that." :shock:
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Re: Why an Annuity vs Wellesley

Postby Johm221122 » Mon Feb 25, 2013 3:53 pm

Scone,
Think about some one 75-80 with limited means that needs maximum income, say 9% a year.Which would you choose?
John
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Re: Why an Annuity vs Wellesley

Postby scone » Mon Feb 25, 2013 3:53 pm

MN Finance wrote:And the money is not in the market. It's invested in the insurance company's general fund. The annuity payments are not a direct pass through investment the way mutual funds are, but rather a promise to pay, backed by the firms security, which rests on the reserves and underlying investments. Most general funds are a huge pool of investments, some illiquid, and invested for the long term (since redemptions and cash requirements are extremely predictable). There are typically large amounts of investment grade bonds, private loans, and small amounts of things like real estate, timber, agriculture, private equity, etc. Generally not equity based investments (at least not nearly to the extent of Wellesley)

Thanks for responding. Honestly, to me some of the investments you describe above sound like a hedge fund, especially "private loans, and small amounts of things like real estate, timber, agriculture, private equity, etc." If this is true, the only thing these investments have in common with Wellesley are the investment grade bonds. The lack of transparency and liquidity in these investments, especially "private loans," really turns me off, I must say. Who supervises these guys, and how can I find out what's really under the hood?

(BTW, I hope my house insurance premiums aren't invested like that. But then again they aren't asking me to fork over a huge sum all at once. Just saying.)
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Re: Why an Annuity vs Wellesley

Postby scone » Mon Feb 25, 2013 3:58 pm

Johm221122 wrote:Scone,
Think about some one 75-80 with limited means that needs maximum income, say 9% a year.Which would you choose?
John

You are running away from a tiger, and you come to a cliff. What to do?

Seriously, if tens of millions of Americans are eventually "forced" to buy an annuity, the questions I'm asking become that much more important, don't you think?
"Sometimes you eat the bear and sometimes the bear eats you." -- Preacher Roe
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Re: Why an Annuity vs Wellesley

Postby Johm221122 » Mon Feb 25, 2013 4:05 pm

scone wrote:
Johm221122 wrote:Scone,
Think about some one 75-80 with limited means that needs maximum income, say 9% a year.Which would you choose?
John

You are running away from a tiger, and you come to a cliff. What to do?

Seriously, if tens of millions of Americans are eventually "forced" to buy an annuity, the questions I'm asking become that much more important, don't you think?

You are asking good questions but insurance companies are a necessary function for some.I have faith in U.S. finance system, it will work even if we have to borrow or tax are way there
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Re: Why an Annuity vs Wellesley

Postby scone » Mon Feb 25, 2013 4:29 pm

Johm221122 wrote:
scone wrote:
Johm221122 wrote:Scone,
Think about some one 75-80 with limited means that needs maximum income, say 9% a year.Which would you choose?
John

You are running away from a tiger, and you come to a cliff. What to do?

Seriously, if tens of millions of Americans are eventually "forced" to buy an annuity, the questions I'm asking become that much more important, don't you think?

You are asking good questions but insurance companies are a necessary function for some.I have faith in U.S. finance system, it will work even if we have to borrow or tax are way there
Kohn

Here's how I see the worst case scenario. There are currently about 62,015,000 people receiving Social Security. (http://www.ssa.gov/policy/docs/quickfac ... _snapshot/) This is a heavily scrutinized, public program, backed and administered by the Federal government. According to the Census, there will be about "88.5 million people 65 and older in 2050. People in this age group would comprise 20 percent of the total population at that time." (http://www.census.gov/newsroom/releases ... -ff07.html)

If (let's just imagine this for a second) 60 million of these 88.5 million people are forced to buy some sort of an annuity, then a group of insurance companies are covering a population roughly comparable in size to the entire Federal Social Security system, which is already strained. So-- let's imagine an "insurance industry perfect storm." If the insurance industry as a whole blows up massively, the way the mortgage and banking industry blew up in 2008, and there are no insurance companies strong enough to buy up the weaklings, then what happens to all those tens of millions of annuitants who are now holding worthless contracts? Do they get a bailout?
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Re: Why an Annuity vs Wellesley

Postby jeffyscott » Mon Feb 25, 2013 6:20 pm

Hexdump wrote:The $100,000 represents 9.5% of our portfolio.
From the 100K we will need $4,445 annually and it must not run out.


Why? What about the other 91.5%?

Do you need a flat nominal $4445 or does it need to keep up with inflation or grow at some other rate?

Would Wellesley at 34% equities, or Mutual of Omaha at 1% growth, keep up with inflation?


30 year TIPS yield is 0.54% real and 30 year nominal bond yield is 3.08%, so expected inflation is more like 2.5%. If ends up being 1% TIPS will turn out to have been a very poor investment compared to nominal bonds.

After 40 years at 1%, the $4445 will be $6618, but if you need to keep up with 2.5% inflation then $11,935 will be needed.
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Re: Why an Annuity vs Wellesley

Postby Default User BR » Mon Feb 25, 2013 7:39 pm

scone wrote:I just got a SPIA quote from Berkshire Hathaway. They are paying 2.89% and current 30 year Treasury rates are 3.15% (from this chart http://www.treasury.gov/resource-center ... data=yield). That's .26% difference, which is pretty slim. It seems to me you would have to move out into riskier investments just to cover your costs and give the growth BRK investors are expecting.

Part of the payout of an SPIA is return of capital.

You seem to not getting the risk pooling part. Some people will get all of their capital returned and then some. Others will die soon after starting the annuity and never get back anywhere near the full amount.


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Re: Why an Annuity vs Wellesley

Postby scone » Mon Feb 25, 2013 8:19 pm

Default User BR wrote:
scone wrote:I just got a SPIA quote from Berkshire Hathaway. They are paying 2.89% and current 30 year Treasury rates are 3.15% (from this chart http://www.treasury.gov/resource-center ... data=yield). That's .26% difference, which is pretty slim. It seems to me you would have to move out into riskier investments just to cover your costs and give the growth BRK investors are expecting.

Part of the payout of an SPIA is return of capital.

You seem to not getting the risk pooling part. Some people will get all of their capital returned and then some. Others will die soon after starting the annuity and never get back anywhere near the full amount.
Brian

Of course I get the "risk pooling" part. That's trivial. What you don't get is the systemic risk, i.e., "reaching for yield and profit to make the guarantee, eventually causes massive losses and bankruptcy" part. The trigger could be a Katrina-like event or two, running down the reserves, and the insurance industry as a whole could repeat the disaster of the subprime crisis. If the individiual insurance companies are bankrupt, and the industry is too weak to pick up the outstanding contracts, the annuitants are up the creek, no matter what the math says. Simple as that.
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Re: Why an Annuity vs Wellesley

Postby Default User BR » Mon Feb 25, 2013 8:27 pm

scone wrote:Of course I get the "risk pooling" part. That's trivial. What you don't get is the systemic risk, i.e., "reaching for yield and profit to make the guarantee, eventually causes massive losses and bankruptcy" part. The trigger could be a Katrina-like event or two, running down the reserves, and the insurance industry as a whole could repeat the disaster of the subprime crisis. If the individiual insurance companies are bankrupt, and the industry is too weak to pick up the outstanding contracts, the annuitants are up the creek, no matter what the math says. Simple as that.

I've never seen such paranoia about such a conservative product as an SPIA.


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Re: Why an Annuity vs Wellesley

Postby careytilden » Mon Feb 25, 2013 8:59 pm

Default User BR wrote:
scone wrote:Of course I get the "risk pooling" part. That's trivial. What you don't get is the systemic risk, i.e., "reaching for yield and profit to make the guarantee, eventually causes massive losses and bankruptcy" part. The trigger could be a Katrina-like event or two, running down the reserves, and the insurance industry as a whole could repeat the disaster of the subprime crisis. If the individiual insurance companies are bankrupt, and the industry is too weak to pick up the outstanding contracts, the annuitants are up the creek, no matter what the math says. Simple as that.

I've never seen such paranoia about such a conservative product as an SPIA.


Brian


Especially strange, to me, is the explicit alternative--a mutual fund with equity holdings--doesn't seem to cause nearly the same amount of concern. By the way, there's another thread going on with a similar discussion. In that one, the actual restrictions of an SPIA provider are detailed. This post in particular may be relevant to scone's concerns:

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Re: Why an Annuity vs Wellesley

Postby nisiprius » Mon Feb 25, 2013 9:01 pm

Just to throw some gasoline on this fire, why Wellesley rather than Managed Payout Growth & Distribution? :)
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Re: Why an Annuity vs Wellesley

Postby Default User BR » Tue Feb 26, 2013 2:14 am

careytilden wrote:
Default User BR wrote:I've never seen such paranoia about such a conservative product as an SPIA.

Especially strange, to me, is the explicit alternative--a mutual fund with equity holdings--doesn't seem to cause nearly the same amount of concern.

Right. If we postulate a series of black swan events that effectively brings down the insurance industry, what will be happening with stocks? Chugging along merrily? I think not.


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Re: Why an Annuity vs Wellesley

Postby fidelio » Tue Feb 26, 2013 7:23 am

nisiprius wrote:Just to throw some gasoline on this fire, why Wellesley rather than Managed Payout Growth & Distribution? :)



wow! now we're talkin' .... but not everybody at vanguard is a m.p.f. fan.

as the poster stated somewhere that the money had to last, and a legacy was not a concern, it has to be a spia, even given scone's worries (fwiw, i was in "risk management" for 32 years, and i would say if the ins. industry "blows up," we're all pretty screwed in the general sense). but i like wellesley, in that even though it is an active fund, it follows a pretty rigid income/equity formula, and has low expenses. really "semi-passive," given its formula.

playing the end against the middle, why not split your 100 between both - 50 in wellesley gets you admiral, and you'll always have your spia for those seasons in which wellesley falters for whatever reason -- and wellesley's equities should help keep up w/ inflation in the longer run. it seems it should "even out" over 30+ years ....
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Re: Why an Annuity vs Wellesley

Postby Trev H » Tue Feb 26, 2013 8:05 am

VWINX (Wellesley) perhaps a humble offering from Vanguard, but man it has kicked some serious Total Market Booty !

1970-2012

Wellesley Income

10K Growth
$610,212.16
CAGR
10.03
StDev
8.98
Sharpe
0.57
Bear Market
1973...-3.49
1974...-6.43
2000...16.17
2001....7.39
2002....4.64
2008...-9.84

A similar stock/bond mix of Total Market Funds

30% TSM
05% Total Intl
65% Total Bond
(annual rebalancing)

10K Growth
$395,417.72
CAGR
8.93
StDev
7.75
Sharpe
0.51
Bear Market
1973...-4.18
1974...-4.98
2000....3.45
2001....1.18
2002...-1.67
2003..-10.03

Wellesley may have been a bit more volatile, but well worth it per CAGR and Sharpe ratio.

Even if you switch to a more agressive mix of Total Market Funds...

50% TSM
10% Total Intl
40% Total Bond

10K Growth
$490,941.93
CAGR
9.48
StDev
11.28
Sharpe
0.43
Bear Market
1973....-9.39
1974...-13.33
2000....-2.29
2001....-4.13
2002....-8.68
2009...-20.91

You fall way short of Wellesley returns and Sharpe and realy up the volatility

Ok.. well lets try again with Total Market Funds (even more agressive mix)...

60% TSM
20% Total Intl
20% Total Bond

10K Growth
$561,282.00
CAGR
9.82
StDev
14.47
Sharpe
0.39
Bear Market
1973...-13.38
1974...-19.78
2000....-7.19
2001....-8.93
2002...-13.94
2008...-30.03

I would consider Wellesley over the Annuity myself (just as you are)... and it would not be a bad idea to split it up - half annuity, half wellesley.

You could always commit the other half later on if the annuity starts to feel a little better once worn a while..

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Re: Why an Annuity vs Wellesley

Postby Hexdump » Tue Feb 26, 2013 10:07 am

nisiprius wrote:Just to throw some gasoline on this fire, why Wellesley rather than Managed Payout Growth & Distribution? :)


Ok, the fire is well and truly lit. To answer your question, there were reasons that I chose Wellesley and not Managed Payout.
I believe that at the time, Wellesley more closely fit our AA and had a growth and distribution rate that was better than what else I was considering as a one-fund solution.

Actually, I had not known about Managed Payout so I guess I had better get busy and see how it works.
I guess I say thanks Nis. :?
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Re: Why an Annuity vs Wellesley

Postby Hexdump » Tue Feb 26, 2013 10:24 am

jeffyscott wrote:
Hexdump wrote:The $100,000 represents 9.5% of our portfolio.
From the 100K we will need $4,445 annually and it must not run out.

Why? What about the other 91.5%?

It is invested in Wellesley and has to provide for the balance of our budget.


jeffyscott wrote:Do you need a flat nominal $4445 or does it need to keep up with inflation or grow at some other rate?

The $4445 will need to keep up with inflation
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Re: Why an Annuity vs Wellesley

Postby Bustoff » Tue Feb 26, 2013 10:55 am

MN Finance wrote: If you have 1M and you need 20k/yr, then no, you don't need a SPIA.


WHY ?
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Re: Why an Annuity vs Wellesley

Postby Johm221122 » Tue Feb 26, 2013 11:03 am

Bustoff wrote:
MN Finance wrote: If you have 1M and you need 20k/yr, then no, you don't need a SPIA.


WHY ?

One reason would be 2% is an extremely safe withdraw rate, even over long time frames
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Re: Why an Annuity vs Wellesley

Postby MN Finance » Tue Feb 26, 2013 11:23 am

I can understand the concern about illiquid or non-market based investments in a general fund, but in practice, they shouldn't concern investors any more than conventional investments (and should be less concerning). If someone said, hey, here's 100B, you need to invest it with a 50 year time horizon, keep it conservative, but still generate a decent yield given today's world, it has to be investing in something. In the 2008 collapse, most of these general funds lost billions but still maintained their standard payouts in both the accumulation and distribution products. And the primary reason is that they were not forced to sell anything. I'm not saying anybody can predict the future, but if they owed an A quality commercial real estate building and the valuation they put on the books showed a 50% decline, it wasn't a stretch for them to say, hey, we're not selling this thing and there's no way it really just lost 50% and since we are going to hold it for 50 years, everyone just relax. Of course we can/will seem something equal to 2008 and maybe beyond, but if these insurers didn't fold then, that has to show something to the uncertain investor. And after all, how they manage this portfolio is how they get the ratings. Those ratings matter. I wouldn't be worried if I bought a SPIA from a A co, but I'd rather buy from a AA or AAA co even if they payout is slightly less.

It's not really a question about what backs the guarantees. As has been mentioned a few times, it's about pooling risk. That in itself is a pretty simply concept to grasp.

For all those people on the "edge" financially, this is a critical option. In essence, what they're saying, is "yes, I know I can invest myself, have more control, draw income, and if the markets are good actually make money and leave a legacy, but I'm willing to give all that up to know that I have payments guaranteed forever and won't have to deal with the downside of investing myself which is running out of money."
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Re: Why an Annuity vs Wellesley

Postby MN Finance » Tue Feb 26, 2013 11:32 am

Johm221122 wrote:
Bustoff wrote:
MN Finance wrote: If you have 1M and you need 20k/yr, then no, you don't need a SPIA.


WHY ?

One reason would be 2% is an extremely safe withdraw rate, even over long time frames
John


Yes, because you don't need to surrender your potential future upside to protect against the downside (which is the money running out). You can probably run a monte carlo that shows that taking 20k off a 1M comes out better in aggregate for the family finances (income and legacy) 97% of the time vs. using a SPIA (made up percentage; I have no idea what it is). And most rational investors would say, yes, I'll assume that risk because 3% is a small chance for the SPIA being better. If the required w/d rate is higher, then the probability numbers start to tip the other way, certainly being more favorable for the annuity especially given any risk of living too long. And in this case, the impact of the risk showing up (running out of money) is far worse than the upside of the risk not showing up... for ex, even if the probability is 50/50, rational investors will still choose the annuity, because in aggregate the absolutely utility value of running out is greater than hitting it big in the market and having more later or leaving a bigger legacy (not sure if "absolutely utility value" is a term, but idea should make sense).
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Re: Why an Annuity vs Wellesley

Postby Bustoff » Tue Feb 26, 2013 11:40 am

Maybe this is one of those periods where Gerald Loeb is correct.
"Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival."
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Re: Why an Annuity vs Wellesley

Postby Bustoff » Tue Feb 26, 2013 11:47 am

Johm221122 wrote:
Bustoff wrote:
MN Finance wrote: If you have 1M and you need 20k/yr, then no, you don't need a SPIA.


WHY ?

One reason would be 2% is an extremely safe withdraw rate, even over long time frames
John


At 2% annual inflation wouldn't you need a 4% withdraw rate ?
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Re: Why an Annuity vs Wellesley

Postby Johm221122 » Tue Feb 26, 2013 11:55 am

You increase your withdraw by 2%, so 2% of 20k is $400 more the next year.But if you were planning on buying a 20k annuity payment it most likely would not be indexed for inflation
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