Is the 'SWR' of an SPIA really around 3.8% ?......

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Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Sun Mar 10, 2013 5:26 pm

I just logged on to Vanguard and they transferred me to some other site and I filled out a form to get an instant quote.
I used an example of a 70 year old man married with a 62 year old woman. With inflation protection and 100% benefit of the survivor.
got 1 quote back that was about 3.8% of the money invested. This would be the 'apples to apples' comparison of a portfolio invested.
This seems to be low to me, unless I did something wrong.
It's like you are guaranteeing yourself of the 'worst case' withdrawal amount, with no chance of anything better.

I must have done something wrong......What should the payout be in percentage of investment numbers?
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby furwut » Sun Mar 10, 2013 6:08 pm

Sounds about right to me. You were quoted inflation protection AND joint survivorship so that is really going to reduce the payout. I think if you did a straight single life for the 70 year old man you might well get double that figure.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby nisiprius » Sun Mar 10, 2013 6:13 pm

Well, interest rates have been falling.

It's hard to find quotations for inflation-adjusted SPIAs, but compound-3%-annual-increasing SPIAs are pretty easy to find, and when I was shopping, I found Vanguard--or, rather, Vanguard's insurance partner--to be reasonably competitive. So whatever Vanguard quoted should be reasonably representative of what you'd find elsewhere.

Remember, the traditional SWR assumes a single person aged 65. Life expectancy at age 65 is in the ballpark of 20 years, so simply reducing the age to 62, would, back-of-the-envelope, mean paying out for 23 years instead of 20, so you'd expect the payout to be 20/23 = 87% or 13% less than for someone age 65. Throwing joint survivorship in, even for a partner age 70, cuts it some more.

OK, I just tried it for a single person aged 65:

Annuity type: Single Life Only Annuity
Annuitant's date of birth: 1/1/1948
Annuitant's gender: M
Annuitant's state of residence: IL
Annuitant will be depositing: $100,000.00
Source of funds: Non-qualified (after-tax) Assets.
Annuitant's spouse is the sole beneficiary: N/A
Annuitant will be receiving inflation adjusted quotes linked to changes in the CPI-U Index and separate quotes with a fixed annual increase of 3%
Quotes will be based on an estimated deposit date of: 4/9/2013
Annuitant elected to begin receiving payments on (commencement date): 5/1/2013
Annuitant elected not to be contacted by the service center.

For inflation-adjusted annuities, the average quote was for a payout of about $373/month, i.e. 4.48% of the premium per year.
For 3%-compound-increasing, about $390/month, i.e. 4.68% of the premium per year.
For a level, not-increasing payout, about $535/month, i.e. 6.42%

If you start at the same payout, an inflation-adjusted annuity is going to be paying out a lot more, so it's not surprising that it costs a lot more. As you see, it's very much in the same ballpark as one that pays out 3% every year. Well, again, back-of-the-envelope: if you assume the 65-year old is going to live 20 years, by year 10 the payout will be, oh, 30% more than when it started, so figure maybe 30% more average over the life of the annuity. So you'd expect that for the same premium they can only afford to pay you oh, 30% less. And, guess what? $535/month - 30% = $374.5/month. Actually that's amazingly good agreement considering all the approximations and rounding and ignoring compounding, etc.

Point is, a 30% smaller payout for an inflation-adjusted or 3%-increasing payout is definitely in the ballpark of what you'd expect. And so is a 13% reduction for age 62 versus age 65.
Last edited by nisiprius on Sun Mar 10, 2013 6:34 pm, edited 3 times in total.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Sun Mar 10, 2013 6:21 pm

furwut wrote:Sounds about right to me. You were quoted inflation protection AND joint survivorship so that is really going to reduce the payout. I think if you did a straight single life for the 70 year old man you might well get double that figure.


So, if you were to compare someone investing in a Target Retirement Fund......The worst case SWR would be about 3.8% Historically. This is with Full survivor ship and Inflation protection for a couple. The SPIA offers to take all your money off of your hands and guarantees that you will get the worst case Historical SWR of 3.8% and gets to keep all your money when you die. While the Investment portfolio offers the potential of a higher withdrawal (If the markets do well) and maybe some assets left to your heirs.

Can someone explain the advantage of this? Why would a couple do this? I could see where it would make sense for a single male with no significant other. But for a couple investing in a Vanguard Retirement fund, it seems like a real loser to buy an SPIA.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby JW Nearly Retired » Sun Mar 10, 2013 6:56 pm

The inflation adjustment is expensive. H age 70/survivor wife age 62 with 100% to survivor at http://www.immediateannuities.com/
gives 5.28% payout. (7.79% if single life only).
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Sun Mar 10, 2013 7:02 pm

JW Nearly Retired wrote:The inflation adjustment is expensive. H age 70/survivor wife age 62 with 100% to survivor at http://www.immediateannuities.com/
gives 5.28% payout. (7.79% if single life only).
JW


Yes, but that is what all SWR studies are based on.....So if you want an apples to apples comparison, you cannot leave out the inflation adjustment.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby nisiprius » Sun Mar 10, 2013 7:07 pm

Because history is a reasonable guide to averages, but not to extreme events. "Hasn't happened yet" isn't a guarantee. New records in sports are broken every Olympics, and new extremes in investment performance are set almost as often.

It's just like the difference between a stock and a bond. A bond is promise to pay specific numbers of dollars on specific days, a stock is not. The bond's promise may or may not be kept, but there is a promise. Someone may opine that Exxon's or AT&T's or GM's dividends are just as reliable as bond interest, but that's just an opinon.

An SPIA is a promise. An SWR is an opinion.

If you take 4%-initial-than-COLAed withdrawals from a portfolio, and it doesn't work, exactly what is William P. Bengen going to do for you? Pay you the difference? No. Even you a nice personal letter of apology? I doubt it.

If the SPIA doesn't pay out as scheduled, the State Guaranty association is going to do more for you than William P. Bengen will do if it turns out that a portfolio doesn't support 4%-rule payouts.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Sun Mar 10, 2013 7:12 pm

nisiprius wrote:If the SPIA doesn't pay out as scheduled, the State Guaranty association is going to do more for you than William P. Bengen will do if it turns out that a portfolio doesn't support 4%-rule payouts.


Oh, I understand that! But, to guarantee you the worst case historical SWR by taking all your money up-front, is way to high a price for me to pay!

Just sayin, I won't be going down the SPIA path, if these are the facts.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby dhodson » Sun Mar 10, 2013 7:26 pm

You are purchasing insurance and not investing

Insurance is never a good bet as an investment

A non inflation spia at age 70 or 80 won't look as bad.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Sun Mar 10, 2013 7:30 pm

dhodson wrote:You are purchasing insurance and not investing

Insurance is never a good bet as an investment

A non inflation spia at age 70 or 80 won't look as bad.


So, you are buying insurance that your SWR will be never be lower in any time in U.S. History over the last 100 years?

And a Non-Flation SWR won't look as bad either! I just ran Firecalc and with No Inflation my SWR is over 5.5% ! :D
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby nisiprius » Sun Mar 10, 2013 8:00 pm

Cut-Throat wrote:So, you are buying insurance that your SWR will be never be lower in any time in U.S. History over the last 100 years?
Yes. Exactly.

The house I live in is just about 100 years old. It has never burned down in the last 100 years. Yet I carry insurance on it.

In the 2007 edition of Stocks for the Long Run Professor Jeremy Siegel wrote that
never in any of the past 175 years would a buyer of newly-issued 30-year bonds have outperformed an investor in a diversified portfolio of common stocks held over the same period.
That was true for 175 years, and then in 2009 it ceased to be true. (Does anyone have a copy of the current edition? Can anyone look up the precise language he uses in it now?) That does not mean that 2008-2009 was fatal to a safe withdrawal rate--it was followed by a quick recovery--but it does show that things that have not happened in 100 years can happen.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Sun Mar 10, 2013 8:04 pm

nisiprius wrote:
Cut-Throat wrote:So, you are buying insurance that your SWR will be never be lower in any time in U.S. History over the last 100 years?
Yes. Exactly.

The house I live in is just about 100 years old. It has never burned down in the last 100 years. Yet I carry insurance on it.



And if I could buy Portfolio Insurance for the same cost as Fire Insurance, I would also. However, I would not surrender my entire house Ownership to the Ins. Company to insure that it would not burn down, so I could live in it.

All I was trying to do here was keep an open mind about SPIAs and was assessing their costs. I could see for a Single Male that had no heirs, it could be a possibility. I just plugged in my situation and wanted to make sure I had the numbers right.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby ourbrooks » Sun Mar 10, 2013 8:20 pm

If the 5.5% figure is from Firecalc, then you probably should subtract about 2% going forward. Historically, interest rates have rarely been as low as they are now and low stock returns tend to go with low bond returns. You might look at the studies Wade Pfau has done in which he assumed lower interest rates; he's suggesting that 4% is a number of the past.

Also, the 5.5% is probably for a 30 year period. You have about a 10% chance of outliving your money. Heaven forbid, you should be married to someone of the same age. Then, the chance of at least one of you living beyond 30 years is even higher. Try running Firecalc again, this time, for a more realistic 40 year period.

If you are planning on a leaving a bequest, then an SPIA has even better advantages. You can purchase the SPIA to cover your income needs and give the bequest to your heirs while you're still alive. Alternately, you can invest the bequest in 100% stocks; worse case, if the market is down when you die, they can wait until it recovers before spending the money.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby EDN » Sun Mar 10, 2013 8:28 pm

Cut-Throat wrote:
furwut wrote:Sounds about right to me. You were quoted inflation protection AND joint survivorship so that is really going to reduce the payout. I think if you did a straight single life for the 70 year old man you might well get double that figure.


So, if you were to compare someone investing in a Target Retirement Fund......The worst case SWR would be about 3.8% Historically. This is with Full survivor ship and Inflation protection for a couple. The SPIA offers to take all your money off of your hands and guarantees that you will get the worst case Historical SWR of 3.8% and gets to keep all your money when you die. While the Investment portfolio offers the potential of a higher withdrawal (If the markets do well) and maybe some assets left to your heirs.

Can someone explain the advantage of this? Why would a couple do this? I could see where it would make sense for a single male with no significant other. But for a couple investing in a Vanguard Retirement fund, it seems like a real loser to buy an SPIA.


There are some benefits to SPIAs, but like anything, you are paying to offload risk. And the more risk you offload, the more expensive it gets. I agree, for the average investor who has discipline, a balanced and diversified asset class portfolio is a much better option, followed by a balanced total market portfolio. A SPIA would be a ways down the list.

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby dickenjb » Sun Mar 10, 2013 9:10 pm

IIRC Bengen's study was for a 65 year old and looking for 30 year portfolio survival.

It is entirely possible for a 65 year old to live beyond age 95.

In fact, this link from Vanguard's website says there is an 18% chance that at least one of a married couple will survive past 95.

https://personal.vanguard.com/us/insigh ... ement-tool

The SPIA would look pretty good then.

And the insurance company does not "keep your money" if you die before your life expectancy. They use it to pay off those who live longer than their life expectancy. Of course they also are in business to make money, but SPIA margins are thin which is why they don't get pushed like variable annuities.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby bobcat2 » Sun Mar 10, 2013 9:43 pm

SWR studies based on history do not include times when real interest rates are as low as they are today. We are now in a very low real interest rate environment. So not only are the payouts from life annuities low, but 'safe withdrawal rates' from portfolios are also much lower than the historical averages suggest. A 'safe' SWR from a 35/65 portfolio when 10 year real rates are zero or slightly less has to be significantly lower than a 'safe' SWR when 10 year real rates are 2% or 3%. :(

The news here is that the SPIA low payout rate is explicit, where with SWRs from portfolios we like to ignore this hard truth. Nor can we get around this hard truth by having a higher exposure to more risky equities. The equity risk premium does not magically expand when real interest rates are low. :(

Taking into consideration the current level of real interest rates is extremely important when developing an investment strategy, because the higher real interest rates are, then the higher the income stream that can be supported by any particular level of wealth. Because the goal of retirement planning is income in retirement, setting a retirement target of a given level of wealth at retirement is faulty retirement targeting, because the amount of retirement income that wealth will support is conditional, among other things, on the level of real interest rates at retirement age.

link - http://www.bogleheads.org/forum/viewtopic.php?f=10&t=105487&hilit=learned#p1531366

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby bobcat2 » Sun Mar 10, 2013 10:07 pm

In many ways this gets back to Bob Merton's question that he often asks an audience member when he is making a presentation on retirement issues. Merton will ask a particular member of the audience whether at the end of the presentation she would rather have Merton give her ten million dollars or five million dollars. After some hesitation to consider whether this is a trick question, the audience member replies that she would rather have the ten million.

Then Merton asks what if the ten million can only be invested at a guaranteed 1% real rate, while the five million can be invested at a guaranteed 8% real rate. Now it is not so clear which is the better deal, because it depends on the length of the investment horizon. Typically we face a long investment horizon when beginning retirement. So the level of real interest rates when entering retirement makes a very big difference to the relative success of our retirement plans.

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Mon Mar 11, 2013 7:13 am

bobcat2 wrote:SWR studies based on history do not include times when real interest rates are as low as they are today. We are now in a very low real interest rate environment. So not only are the payouts from life annuities low, but 'safe withdrawal rates' from portfolios are also much lower than the historical averages suggest.
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No but the studies do include the Great Depression and Severe Inflation of the 1970s.

And there is no way that you can definitively say that what the 'Safe withdrawal rates' are.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby EDN » Mon Mar 11, 2013 7:43 am

bobcat2 wrote:SWR studies based on history do not include times when real interest rates are as low as they are today. We are now in a very low real interest rate environment. So not only are the payouts from life annuities low, but 'safe withdrawal rates' from portfolios are also much lower than the historical averages suggest.
BobK


If they cover the market history from 1928-2012 they do. Depending on the choice of bonds, 20YR (long-term) did not produce a real return from 1926-1981. Even 5YR bonds had a negative real return from 1941-1981. But a 60/40 portfolio of $1M, with equities split S&P 500, large value, and small value with bonds 5YR and taking $40K per year adjusted for inflation, over this 41 year period grew to over $30M (how's that for the right tail of a distribution?). After 40 years, that $40K had grown to $270K, owing to the power of compounding.

A simple 60% TSM, 40% TBM (5YR T-Notes prior to 1976) would have "worked" as well, producing almost $6M by 1981. Of course, it's up to you to decide if "worked" is the apt description given the spread of $24M in ending portfolio value between the TSM and Asset Class versions of this story.

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby ObliviousInvestor » Mon Mar 11, 2013 9:39 am

Cut-Throat wrote:Can someone explain the advantage of this? Why would a couple do this? I could see where it would make sense for a single male with no significant other. But for a couple investing in a Vanguard Retirement fund, it seems like a real loser to buy an SPIA.


Cut-Throat wrote:There is no way that you can definitively say that what the 'Safe withdrawal rates' are.


You answered your own question. :)
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby tfb » Mon Mar 11, 2013 10:10 am

Cut-Throat wrote:I used an example of a 70 year old man married with a 62 year old woman. With inflation protection and 100% benefit of the survivor.
got 1 quote back that was about 3.8% of the money invested. This would be the 'apples to apples' comparison of a portfolio invested.
This seems to be low to me, unless I did something wrong.
It's like you are guaranteeing yourself of the 'worst case' withdrawal amount, with no chance of anything better.

I must have done something wrong......What should the payout be in percentage of investment numbers?

I heard insurance companies are only allowed to invest in bonds to back up their obligations (SPIA experts, is this true or not?). If you were to use a 100% bonds portfolio to satisfy your SWR, I would worry about the 3.8% rate to be more like an average case than a worst case. So maybe give up your bonds to the insurance company for a SPIA and keep your stocks for the upside.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Levett » Mon Mar 11, 2013 10:44 am

tfb,

I have an SPIA guaranteed by the General Account of TIAA.

As of December 31, 2012, this is what the Account's portfolio looks like:

https://www.tiaa-cref.org/public/pdf/performance/retirement/profiles/TIAA_Gen_Act_Fin_Strength.pdf

So, no, it's not just bonds--unless there is some dedicated bond subaccount to support the SPIA.

I'm not an expert.

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby tfb » Mon Mar 11, 2013 10:53 am

Levett wrote:tfb,

I have an SPIA guaranteed by the General Account of TIAA.

As of December 31, 2012, this is what the Account's portfolio looks like:

https://www.tiaa-cref.org/public/pdf/performance/retirement/profiles/TIAA_Gen_Act_Fin_Strength.pdf

So, no, it's not just bonds--unless there is some dedicated bond subaccount to support the SPIA.

I'm not an expert.

Lev

Thank you Lev. From the PDF:

44.99% Corp./Govt. bonds/Preferred stock
35.63% Structured finance
06.08% Commercial mtgs.
06.30% Equity/Other
03.41% Real Estate
03.59% Cash/Other

About 10% in equity and real estate. The other 90% looks bonds-like to me.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby bobcat2 » Mon Mar 11, 2013 11:36 am

Even 5YR bonds had a negative real return from 1941-1981. But a 60/40 portfolio of $1M, with equities split S&P 500, large value, and small value with bonds 5YR and taking $40K per year adjusted for inflation, over this 41 year period grew to over $30M
The equity risk premium from 1940-79 for equities vs bonds was 7.9%. So if you think the ERP going forward will be about 8%, then a 60/40 portfolio in retirement with a SWR of 4% might work well, assuming there is no sequence of returns problem caused by stocks tanking in the first few years of retirement. :wink:

By way of comparison the global ERP for stocks vs bonds was 3.2% from 1900-2012.
Over the 113 years from 1900 to 2012, the middle chart shows that the real return on the world index was 5.0%
per year for equities, and 1.8% per year for bonds.

Source - Credit Suisse Global Investment Returns Yearbook 2013
http://www.investmenteurope.net/digital_assets/6305/2013_yearbook_final_web.pdf

Do you feel lucky? Well, do ya, punk? - with apologies to Harry Callahan.

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby bobcat2 » Mon Mar 11, 2013 12:05 pm

By way of comparison on real SPIA quotes, I very well remember looking for real life annuity prices in the spring of 2007 (nearly six years ago) for a 65 year old male. The two payout quotes I got were for 6.0% and 6.4%.

I would guess that in the last nearly six years the life expectancy for males at age 65 has increased by about 6-9 months so that accounts for a small amount of the difference. But more importantly back in May of 2007 the yield on 10 year TIPS was about 2.5%. Last Friday's ten year TIP yield was -0.67%. That 3% change in real interest rates makes a significant difference.

A quick and dirty formula for life annuity payouts is the following.
payout = (1/life expectancy) +(interest rate)/2


So assuming life expectancy of 20 at age 65 in 2007 and 20.7 in 2013 we get the following -

2007 payout = 1/20 +.025/2 = 5%+1.25% = 6.25% vs quotes of 6.0% and 6.4%

2013 payout = 1/20.7 -.0067/2 = 4.76% -.34% = 4.42% vs Nisi quote of 4.48%

Looked at thru the above simple formula we can see how slightly longer life expectancy and dramatically lower interest rates have greatly lowered the payouts on real life annuities since 2007 - with most of the impact coming from lower interest rates.

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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Mon Mar 11, 2013 3:46 pm

I guess that if you believe that we are in a worse position today than we have ever been in 100 years of investing history, you should probably buy an annuity and lock up that worst case SWR of 3.8%. This would be a point in time like September 1929 and you have just retired and started to draw down your accumulation. This would be quite a point history. We'll see.

I know which route I'm betting on.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Taylor Larimore » Mon Mar 11, 2013 4:04 pm

Cut Throat:

In my opinion, it is usually best to wait until around 80 years old before purchasing an Immediate Lifetime Annuity (SPIA).

A SPIA purchased today for a man age 80 will have a guaranteed lifetime payout of $11.42% of the one-time premium.

http://www.immediateannuities.com/

Best wishes.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby bobcat2 » Mon Mar 11, 2013 5:33 pm

Cut-Throat wrote:I guess that if you believe that we are in a worse position today than we have ever been in 100 years of investing history, you should probably buy an annuity and lock up that worst case SWR of 3.8%. This would be a point in time like September 1929 and you have just retired and started to draw down your accumulation. This would be quite a point history. We'll see.

I know which route I'm betting on.

We are in a situation of extremely low interest rates. We in the US only have good stock market, bond market, and inflation data going back to about 1900. There's not a lot of 30 year independent sample periods going back just 110 years or so, thus I wouldn't put a lot of faith on what has happened in the financial marketplace of just the US to reach general conclusions. But certainly given that today the real bond interest rate is below zero and the historical equity risk premium of stocks over bonds is only 3.2% globally, things don't look particularly fortuitous going forward from this point.

Here's a couple of things people now in their 60s can do to help mitigate retiring in this low interest rate world. Both Social Security and DB pensions are predicated on historical average or typical levels of real interest rates, rather than the current very low real and nominal interest rates. When real interest rates are much lower than the historical average, as they are now, the net present value (NPV) gain from delaying starting SS and pension benefits is much greater than when real interest are close to average. Conversely, when real interest rates are much higher than the historical average, the NPV gain from delaying beginning benefits is lower than when real interest rates are close to average. So now when interest rates are extremely low is an excellent time to delay taking SS and DB pension benefits. In other words, by far the best real life annuity deal you can purchase currently is to delay taking your SS benefits. You should also at least also look into seeing what are the potential advantages of delaying any DB pension benefits you have.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
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Re: Is the 'SWR' of an SPIA really around 3.8% ?......

Postby Cut-Throat » Mon Mar 11, 2013 5:55 pm

Taylor Larimore wrote:Cut Throat:

In my opinion, it is usually best to wait until around 80 years old before purchasing an Immediate Lifetime Annuity (SPIA).

A SPIA purchased today for a man age 80 will have a guaranteed lifetime payout of $11.42% of the one-time premium.

http://www.immediateannuities.com/

Best wishes.
Taylor


Now you're talking!
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