buying SPIAs starting young

[neurosphere]

I know this topic has been covered extensively here, and the consensus/data/research indicate that SPIAs are not a good deal until later in life, when one benefits from mortality credits. And even then, one has to be in a "donut" hole of sorts, where there are no enough assets to "self insure" if you will, but also have enough assets that an SPIA will generate enough cash to cover a spending gap.

Despite this, there is something about buying an income stream that really appeals to me. So my question is likely more to do with the psychology of investing and of risk than anything else. But here is my situation, and here is the "strategy" that my mind desires, even though I am NOT seriously considering implementing such a plan.

Married, 40s, maxing out all tax available accounts with some money left over to invest (currently doing muni bonds and savings bonds). No children, and no desire to leave money for any heirs, although I do wrestle with leaving money to charity, but for now assume I don't desire that.

What I was thinking was to invest some taxable monies periodically into a joint spia, possibly inflation adjusted. Every so often (yearly, or every two years for example) I would purchase another SPIA with extra cash AND the income which has been paid out from previous SPIAs. Eventually when I retired, I would have several SPIAs of different amounts purchased at different times paying out monthly income. This would be in addition to the IRAs and 401ks.

This would be like an SPIA "ladder" or sorts, no? Assuming a long life span, why is this a bad idea? I like the (supposed) stability this provides. The ability to rely on an income stream which increases each year until retirement. As retirement approaches, I figure I'd be better able to figure out when I could retire, because I would know my SS payouts, and my SPIA payout. Thus I would be less reliant on determining a safe withdrawal rate on my stock/bond portfolio.

Anyway, something about this plan really appeals to me, even though I trust that the math makes this a losing bet. Maybe it means my risk tolerance is lower than I thought? But I consider myself to have a very high risk tolerance, so can't really figure out WHY the above plan is appealing. I think it's because, despite an appetite for risk, I also crave the ability to plan, and perhaps fear having to make a decision about when exactly I've reached my "number". With an income stream already in place, it would be easier to see how much of a spending gap I need my stock/bond portfolio to provide.

I also like the fact that should I die first, Mrs. Neurosphere has a somewhat easier situation than otherwise, where between SS and SPIA, has a steady income stream she can easily adjust her spending to. Also, there will be less of a pile of cash with which she can fall prey to unscrupulous advisors, etc. She has no head whatever for investments, but has an outstanding understanding of a sticking to a budget.

I don't think I'm describing this eloquently, and mostly I'm just thinking out loud and hoping that forcing myself to put my thoughts down "on paper" helps to give me insight into my motives. It may also be that I'm a tinkerer, and an SPIA is a "product" I don't have and I'm really just bored and looking to complicate, I mean, uh, enliven my portfolio.

Thoughts?

NS

[Easy Rhino]

First, I don't know what sort of SPIA you can buy in your 40's. If the insurance companies sell them, the payout is probably pitiably small.

Second, remember that you "lose" the bet if you (and your spouse) die relatively early. This would mainly affect your estate, of course, which brings up:

Third, if you have enough cash lying around to buy up SPIA's willy nilly in big chunks (like $100k a pop) then you probably will have a big nest egg to either self insure, or worry about the legacy of your estate.

[NYBoglehead]

It is a bad idea because the monthly income that the earlier SPIAs will provide will be much lower than the later ones because of the mortality credits. You will be needlessly forfeiting principal.

SPIAs can be great, but they are probably best used later in life when one wants the security of the monthly income. I'd spend the earlier years of retirement using your portfolio, and set a number in mind that you want to annuitize later on.

[dhodson]

Beyond the horrible payout, inflation would make purchasing power vanish.

[dickenjb]

If it makes you feel any better, I often have the same thoughts.

Then the rational side of my brain looks at the payouts for a 57 year old and what I would get at age 70 and realizes it would be downright stupid to buy at age 57.

I then remind myself of my plan to delay SS to age 70. Cheapest inflation adjusted annuity one can buy and backed by the US of A.

[englishgirl]

Wouldn't you have to pay income tax on the money you are receiving from the SPIA? It seems like a good tax-generating scheme - pay income tax when you earn the money, buy an SPIA, pay income tax on the payout, buy another SPIA out of the payout money, pay income tax on THAT payout, etc. With the SPIA, you're getting a return on principal in your payout, but it presumably is not neatly separated out so you can't only pay tax on the part that is just earnings. And we're talking income tax rather than capital gains tax, and in your peak earning years. Even if you left the money in a plain old savings account, you're paying income tax only on the interest earnings.

Instead, you could go and play around with the little calculator on immediateannuities.com and just see on screen what your money could buy, and use that for planning purposes. When you retire, you could always build yourself up a little SPIA "ladder" at that time, and you'll get much better payout rates if you START your buying at 67 or 70 or whatever than if you start at 45.

[neurosphere]

It seems like a good tax-generating scheme - pay income tax when you earn the money, buy an SPIA, pay income tax on the payout, buy another SPIA out of the payout money, pay income tax on THAT payout, etc.

That's a very good point about taxes being paid during prime earning years.

[ObliviousInvestor]

With the SPIA, you're getting a return on principal in your payout, but it presumably is not neatly separated out so you can't only pay tax on the part that is just earnings.

Actually that is what happens.

If you purchase an annuity, you get to receive your cost back, tax-free, over the period for which you're expected to receive payments (so, your lifetime if it's a simple lifetime annuity). For example if you pay $100,000 for a fixed lifetime SPIA, and your life expectancy at that time is exactly 20 years, $5,000 of each year's annuity income will be nontaxable ($5,000 being $100,000 divided by 20). After 20 years, the entire amount would be taxable.

IRS Publication 939 has more details: http://www.irs.gov/publications/p939/ar02.html

...though I still agree with your overall point that purchasing a lifetime SPIA at a young age may be a tax-inefficient way to go about things.

[rr2]

Can one buy SP Deferred Annuities instead at a young age to pay out starting 65?

[dhodson]

There are multiple deferred annuities that you can later annuitize.

[Watty]

About the only reason that can think of to buy a SPIA before you can use the income is that you expect interest rates and inflation to drop significantly and you want to lock in the SPIA to lock higher payments while interest rates are high.

I don't know what the future will bring but using the current low interest rates and low inflation as a guide now is the worst time in 20+ years to buy a SPIA.

[steadyeddy]

It sounds to me like you're describing a bond fund.

[555]

The longer time scale means more risk for the insurance company, which means more expense for you.

[The Wizard]

Some folks like to do this sort of thing with dividend-paying stock and bond funds...

[LH]

The default risk would be significant I would posit, its certainly very uncertain.

You are going to trust a private company to exist and pay you for 40years?

Contrapose this private company, to the largest financial entity in the world, US which has

1)power to tax
2)power to print money
3)most powerful military

that was telling me they were projecting ability to pay out only 67 percent of SS income stream, hmmmm, 22 years hence roughly???? I mean all that.... versus a private company, and the private company has "garaunteed" success???? (not that you said guaranteed that I recollect writing this, but it is bandied about usually.)

If you see the word "gaurantee" in reference to a time period of 20+ years, where you pay the money now, and purportedly get tsome benefit 20+ years hence, think long and hard about default risk. I mean, nation states with powers above companies default all the time, greece, etc. etc. etc., but again, a private company is good for it?????

How were enron bonds rated one year prior to default.....?

I think SPIA have some place near end retirement, if you need more return above 4 SWR than your portfolio can provide, but they have risk, and the longer you defer getting the money out of them, the greater the risk you bear.

[FinancialDave]

I'll say up front, that I am not a fan of annuities of any type in this interest rate environment, because basically their income is tied loosely to the 10 year treasury rate. The thought that the longer you wait makes the payout better, only signifies that you don't understand how they work. Sure the payout gets bigger, but the insurance company is still going to get their cut, which is substantial to other investments.

All that being said, your one criteria was to not leave anything behind, so a joint inflation adjusted SPIA is the way to go, but the time to buy it, or ladder into, as the case may be, is not until your retirement and all other income from work has stopped. Using deferred annuities or any other annuity prior to that IMO is a waste. If you want to start a program of saving to purchase the annuities you need to instead put these funds into a principal protected investment, such as I-bonds (you could do at least $25k a year for a married couple, if you buy another $5k with your tax refund,) or CD's.

fd

[FinancialDave]

The longer time scale means more risk for the insurance company, which means more expense for you.

I disagree. The risk to the insurance company over this time frame, is mostly that the interest rates on your investment will go down, which as you might imagine is mostly in the insurance companies favor. They would love for you to buy an annuity that has 40-45 years built into it at a 2% interest rate environment. In fact a 100% joint annuity not indexed for inflation for two 40 year olds is paying about 3.85% right now.

A little math on this might help:
Say you buy a $100,000 paying 3.85% for 45 years --- the payout will be $3850 per year x 45 = $173,250
To equal the same $173k in a compounded investment, the insurance company only needs to make 1.23% on their investment over 45 years.

fd

[dickenjb]

If you want to start a program of saving to purchase the annuities you need to instead put these funds into a principal protected investment, such as I-bonds (you could do at least $30k a year for a married couple, if you buy another $10k with your tax refund,) or CD's.

fd

Are you sure about $10K by tax refund? I have researched this and believe it is $5K per return - only by filing MFS could you get $10K and for most couples that would result in more tax. Note: the wiki says $5K per SSN but I believe this is in error.

[FinancialDave]

Are you sure about $10K by tax refund? I have researched this and believe it is $5K per return - only by filing MFS could you get $10K and for most couples that would result in more tax. Note: the wiki says $5K per SSN but I believe this is in error.

Yep, you are correct. I thought they had changed it but I just looked on the 8888 for this year and the limit is still $5,000.