The Annuity Puzzlement

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N52570
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The Annuity Puzzlement

Post by N52570 »

Why don't more people partially annuitize a portion of their portfolio?

Purchasing fees aside, and rough back of the envelope arithmetic. And at 55 years old It appears I can buy a SPIA the pays out 5.5 % for lifetime. Take 40% of a portfolio's value and purchase a guaranteed 5.5% SPIA ( given the insurance(s) companies stay in business) for life. Giving me a solid floor that then allows me to withdraw only 2% on the remaining 60% of the portfolio. Making me almost all but bullet proof. Whereas without the SPIA I would have to withdraw 3.4 % of the portfolio to produce the same revenue stream. And I'm assuming, with much greater risk of running out of money in the long run.

So what am I missing?

Or is the more prudent, conservative plan to stick with 100% of the portfolio early, seeing how the sequence of returns works out. Then purchase the SPIA if necessary when your much older( higher monthly payout) after having spent down the portfolio up to a target amount that will give you the desired income with the remainder of the portfolio.
Last edited by N52570 on Fri Sep 12, 2014 7:50 pm, edited 1 time in total.
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dhodson
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Re: The Annuity Puzzlement

Post by dhodson »

This has been discussed multiple times

You may wish to search spia

A few points though

That 5.5% you gave included return of principal

Likely you looked at a non inflation protected product


I plan to buy a spia at age 80 if in good health.
The Wizard
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Re: The Annuity Puzzlement

Post by The Wizard »

I think that some retirees like to live with lower income in retirement than they could have, while conserving their lump sum for an emergency of some sort.
I annuitized a hefty sum at age 63 and am happy with that...
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Jeff Albertson
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Re: The Annuity Puzzlement

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Garco
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Re: The Annuity Puzzlement

Post by Garco »

I think you've made a basic case for an SPIA. But there are numerous other considerations. Here are two that I think most people are likely to be concerned about.

1) If you have any bequest motive, then you may be reluctant to give up 40% of your wealth to an SPIA. Your calculation only talks about how to generate a certain level of income for yourself (and perhaps your spouse in a joint annuity). But at "the end," you would probably have less cash left over if you had initially put 40% of it into an SPIA.

2) Inflation is a serious concern, because most SPIA's offer nominal dollar payments, not real (inflation adjusted). In contrast, Social Security has a cost of living adjustment built in, and thus is more likely to keep up with inflation during your retirement lifetime. Without paying a premium cost for an inflation adjusted SPIA, some people propose addressing this issue by staggering SPIA's. Let's say divide the amount you want to annuitize into three pieces, and purchase an annuity at age 70, 75, and 80. In contrast, the 60% that you put into the market has a chance to keep up with inflation, and at the end if you follow an appropriate withdrawal rate you will probably have as much or more money when you pass as you do when you retire.
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Re: The Annuity Puzzlement

Post by flyingaway »

People here are talking about the possibility of market crashes every day, why has there been no talk about the possibility of SPIA going under? The market can crash at any time, bring down the SPIA insurance company with it. Is an SPIA insurance company stronger than many biggest U.S. banks?
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Re: The Annuity Puzzlement

Post by dhodson »

flyingaway wrote:People here are talking about the possibility of market crashes every day, why has there been no talk about the possibility of SPIA going under? The market can crash at any time, bring down the SPIA insurance company with it. Is an SPIA insurance company stronger than many biggest U.S. banks?
It has been mentioned

The insurance companies primarily invest in bonds and treasuries

Each state has a safety net of sorts usually up to 100k. It's not fool proof but in the padt works most of the time especially if below limits.
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Re: The Annuity Puzzlement

Post by flyingaway »

If the insurance companies buy bonds and treasuries and sell SPIA, the I can use the SPIA money to buy treasures and bonds (or the corresponding funds) and do not have to pay the middle man.
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N52570
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Re: The Annuity Puzzlement

Post by N52570 »

flyingaway wrote:If the insurance companies buy bonds and treasuries and sell SPIA, the I can use the SPIA money to buy treasures and bonds (or the corresponding funds) and do not have to pay the middle man.
However the Insurance Companies can pay a higher % payout because many who purchase an annuity die younger than the "average". Leaving more money in the "kitty". Strength in numbers, if you will.
Last edited by N52570 on Fri Sep 12, 2014 9:28 pm, edited 1 time in total.
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N52570
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Re: The Annuity Puzzlement

Post by N52570 »

flyingaway wrote:People here are talking about the possibility of market crashes every day, why has there been no talk about the possibility of SPIA going under? The market can crash at any time, bring down the SPIA insurance company with it. Is an SPIA insurance company stronger than many biggest U.S. banks?

Possibly. However many of the insurance companies offering annuities were founded in the late 1800's! For example Mass Mutual was started in 1851. Many others before the Great Depression. Having said that, your point is well taken and a concern, at least for me. One way to help mitigate some of that risk is to spread the amount out over several companies.
Last edited by N52570 on Fri Sep 12, 2014 9:32 pm, edited 1 time in total.
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technovelist
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Re: The Annuity Puzzlement

Post by technovelist »

N52570 wrote:Why don't more people partially annuitize a portion of their portfolio?

Purchasing fees aside, and rough back of the envelope arithmetic. And at 55 years old It appears I can buy a SPIA the pays out 5.5 % for lifetime. Take 40% of a portfolio's value and purchase a guaranteed 5.5% SPIA ( given the insurance(s) companies stay in business) for life. Giving me a solid floor that then allows me to withdraw only 2% on the remaining 60% of the portfolio. Making me almost all but bullet proof. Whereas without the SPIA I would have to withdraw 3.4 % of the portfolio to produce the same revenue stream. And I'm assuming, with much greater risk of running out of money in the long run.

So what am I missing?

Or is the more prudent, conservative plan to stick with 100% of the portfolio early, seeing how the sequence of returns works out. Then purchase the SPIA if necessary when your much older( higher monthly payout) after having spent down the portfolio up to a target amount that will give you the desired income with the remainder of the portfolio.
I don't think you are missing anything. I plan to annuitize a fair portion of my savings, enough to guarantee a reasonable standard of living. You can't get mortality credits any other way...
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Re: The Annuity Puzzlement

Post by Jeff Albertson »

The concerns related to inflation protection, solvency of the insurance companies and getting a fair rate can be minimized by using Thaler's suggestions in the second article (above). William Bernstein covers this in more detail in this book -

http://www.amazon.com/The-Ages-Investor ... e+investor
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wjo
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Re: The Annuity Puzzlement

Post by wjo »

N52570 wrote:
flyingaway wrote:People here are talking about the possibility of market crashes every day, why has there been no talk about the possibility of SPIA going under? The market can crash at any time, bring down the SPIA insurance company with it. Is an SPIA insurance company stronger than many biggest U.S. banks?

Possibly. However many of the insurance companies offering annuities were founded in the late 1800's! For example Mass Mutual was started in 1851. Many others before the Great Depression. Having said that, your point is well taken and a concern, at least for me. One way to help mitigate some of that risk is to spread the amount out over several companies.
A systemic crash so strong that it takes down a stable, highly rated insurance company will likely take down all of them. Spreading the money around multiple ones reduces the risk of account fraud and other idiosyncratic risks. From that perspective I think it is a good idea. My worry about annuities is the risk of systemic failure. Bill Bernstein, who has become quite conservative in his views about risk and likelihood of systematic failure has come out strongly in favor of building one's own annuity through a TIPS ladder as he is uncertain about the ability of insurance companies to withstand the next financial crisis. His thinking is 2008-09 might just be a speedbump compared to what was/is possible for systemic failure.

That said, I am a few years out from retirement withdrawals, but I reasonably plan to annuitize some of my funds, perhaps through a charitable remainder trust (which tend to have a lower payout rate than a commmercial annuity but meets my bequest motives).
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Re: The Annuity Puzzlement

Post by The Wizard »

Garco wrote:I think you've made a basic case for an SPIA. But there are numerous other considerations. Here are two that I think most people are likely to be concerned about.

1) If you have any bequest motive, then you may be reluctant to give up 40% of your wealth to an SPIA. Your calculation only talks about how to generate a certain level of income for yourself (and perhaps your spouse in a joint annuity). But at "the end," you would probably have less cash left over if you had initially put 40% of it into an SPIA...
Horse-pucky.
Let's say our retiree has $2M to start with and annuitizes $1M to provide for living expenses, in addition to SS.
The remaining $1M gets invested for the next 30 years of retirement and grows to some amount greater than that before being left to the recipients in the retiree's will.
How does this screw the recipients out of an inheritance?
Furthermore, have you ever heard of Looking Out For Number One?
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heyyou
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Re: The Annuity Puzzlement

Post by heyyou »

Wade Pfau has looked at annuities. His study showed that they extended portfolio longevity better than either 4% + inflation WD, or 4% of annual balance WD, but excluding lower rates. Some of the annuity benefit was from the mortality credits boosting the payout rate, and some was from living off the annuity while the remaining portfolio was all stock. That led to a second study to determine the proportions of those two benefits, and a study on spending bonds first, while equities grow, then looking at reducing stock allocation early in retirement and boosting it later to reduce exposure to a stock bust early in retirement. A later study used 50/50 stock/bond on the portfolio remainder after the annuity purchase. Then he found that deferred annuities are advantageous. Seems like most studies turn over another stone that needs more scrutiny.

I would like to see a diagram of stepped SPIAs that duplicate various inflation rates. The height and width (income and timing) of each step would vary to match inflation.
Without paying a premium cost for an inflation adjusted SPIA, some people propose addressing this issue by staggering SPIA's. Let's say divide the amount you want to annuitize into three pieces, and purchase an annuity at age 70, 75, and 80. In contrast, the 60% that you put into the market has a chance to keep up with inflation,
That is my intention. First annuity was no-COLA pension at 55, next is SS at 70, then SPIAs at 75 and 80, and maybe a deferred annuity anytime that interest rates are high. Mom lasted until age 92 with dementia, and my short term memory is fading at 64.
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Watty
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Re: The Annuity Puzzlement

Post by Watty »

So what am I missing?
Right or wrong, inflation is the reason that I am skeptical of annuities.

The typical person retiring today can remember double digit inflation in the late 1970's and early 1980's.

I'm not retired yet but I can still remember being excited when the interest rates dipped the day I locked in the rate and I got my first mortgage at 9.75% since I was sure I would be paying double digits.
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N52570
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Re: The Annuity Puzzlement

Post by N52570 »

Watty wrote:
So what am I missing?
Right or wrong, inflation is the reason that I am skeptical of annuities.

The typical person retiring today can remember double digit inflation in the late 1970's and early 1980's.

I'm not retired yet but I can still remember being excited when the interest rates dipped the day I locked in the rate and I got my first mortgage at 9.75% since I was sure I would be paying double digits.
I agree, inflation is the 800 lb Gorilla in the room. And each retirement scenario is so case specific it's hard to argue one way or the other without all the details. From my perspective, I'll have a Pension with cola that is around 40% of the income stream, well 40% initially before reaching SS age. The annuity would make up another 40% with the remainder coming from the portfolio with a projected SWR of 2%. So,there should be a little wiggle room there to help keep up with inflation before actually having to reduce spending drastically. I know, famous last words! :D Then SS kicks in at 67-70, preferably 70, if things go as planned. Specifically in my case, it's more about bridging the SS gap and using it as a small hedge against longevity. Then even if I'm forced to consume all the principal in the end before things recover, I'll have at least 2 of the 3 income streams with a cola. Well, at least in theory! :shock:
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Re: The Annuity Puzzlement

Post by letsgobobby »

I still think the tontine idea is more appealing since it addresses longevity risk specifically. Waiting for that product to come on line.
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Re: The Annuity Puzzlement

Post by Aptenodytes »

Garco wrote:I think you've made a basic case for an SPIA. But there are numerous other considerations. Here are two that I think most people are likely to be concerned about.

1) If you have any bequest motive, then you may be reluctant to give up 40% of your wealth to an SPIA. Your calculation only talks about how to generate a certain level of income for yourself (and perhaps your spouse in a joint annuity). But at "the end," you would probably have less cash left over if you had initially put 40% of it into an SPIA.
For people near the borderline of being able to live out a long life at a comfortable level of spending, SPIAs can improve bequest prospects, not degrade them. The net effect would be greatest for people living longer than average. Without a SPIA, such people run the risk of leaving no bequest, or possibly even a negative one as offspring are compelled to pitch in and support the ancient ones. With a SPIA, the bequest has a greater chance of remaining intact.

All this thinking is in the context of high uncertainty and competing risks. Nothing is deterministic here -- you make choices based on scenarios, implicit or explicit, that you use to manage your tradeoffs, never fully knowing what will turn out best.
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Re: The Annuity Puzzlement

Post by Wildebeest »

I am with Let's go Bobby as that I would love to invest in a Tontine. My preference would be to do this with Bogleheads even while as a group they will outlive the general population.

Like Vanguard started the low cost index funds, the John C Bogle Foundation for Financial Education IMHO would be the perfect vehicle for this Annuity and would draw lots of publicity to the Investing Advice inspired by Jack Bogle.

While I have money to put in a Tontine and have ideas as different Tontine funds ( 100 % TSM , 60 % TSM/40 % Total Bondfund, 100 % in SV and the other 4 in e.g, the Trev H Ultimately Buy and Hold), I am woefully short of any know how as to how to start this.
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Re: The Annuity Puzzlement

Post by Leeraar »

N52570 wrote:Why don't more people partially annuitize a portion of their portfolio?

Purchasing fees aside, and rough back of the envelope arithmetic. And at 55 years old It appears I can buy a SPIA the pays out 5.5 % for lifetime. Take 40% of a portfolio's value and purchase a guaranteed 5.5% SPIA ( given the insurance(s) companies stay in business) for life. Giving me a solid floor that then allows me to withdraw only 2% on the remaining 60% of the portfolio. Making me almost all but bullet proof. Whereas without the SPIA I would have to withdraw 3.4 % of the portfolio to produce the same revenue stream. And I'm assuming, with much greater risk of running out of money in the long run.

So what am I missing?

Or is the more prudent, conservative plan to stick with 100% of the portfolio early, seeing how the sequence of returns works out. Then purchase the SPIA if necessary when your much older( higher monthly payout) after having spent down the portfolio up to a target amount that will give you the desired income with the remainder of the portfolio.
OP, I agree.

I faced a big decision a few years ago when I was offered a high six-figure lump sum or an annuity from Prudential. I took the annuity. It is not indexed to inflation.

My intent is to supplement current cash flow from savings and to defer SS until age 70. Then, if need be, purchase an unindexed SPIA to cover the remainder of our base cash flow needs. If inflation erodes my annuities enough, purchase another SPIA as needed.

(In deferring SS you are purchasing an inflation-indexed annuity with survivor benefits that pays 8%. There is no better deal any where.)

When I last looked at this a couple of years ago, a 65-year old could get a nominal SPIA that paid 7% and an inflation-indexed one that paid 4%. That seemed to me to be a high price to pay. (Note the coincidental 4%!)
So what am I missing?
Other factors. People don't like insurance companies. Insurance companies may fail. When you die, the income stops and there is no legacy for your heirs.

L.
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Re: The Annuity Puzzlement

Post by CWRadio »

At what age should you buy a SPIA with the low interest rates we now have? Thanks
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Re: The Annuity Puzzlement

Post by dhodson »

CWRadio wrote:At what age should you buy a SPIA with the low interest rates we now have? Thanks
You dont get to pick interest rates. SPIAs do produce less at the moment but if you NEED a SPIA then you dont have a choice. Its pretty hard to "market time" interest rates and know interest rates and inflation going into the future.

You do get to pick at what age you purchase a SPIA (or not). The longer you wait, the better the mortality credits with for me the sweet spot being around age 80. If at age 80, im in bad health then i wont get one as originally planned.
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Re: The Annuity Puzzlement

Post by Garco »

Exactly, dhodson. The main reason to wait is for the mortality credits, not improved interest rates. Another reason is implicit in your comment about your health: facts about your life and financial situation change; you can make more informed decisions about your financial situation and needs after you've retired than before. At this time, on the verge or my retirement, I don't think I will need to annuitize. So I will build (mortality) credits for a while, then reassess the situation in a few years.
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Re: The Annuity Puzzlement

Post by Pizzasteve510 »

The Wizard wrote:
Garco wrote:I think you've made a basic case for an SPIA. But there are numerous other considerations. Here are two that I think most people are likely to be concerned about.

1) If you have any bequest motive, then you may be reluctant to give up 40% of your wealth to an SPIA. Your calculation only talks about how to generate a certain level of income for yourself (and perhaps your spouse in a joint annuity). But at "the end," you would probably have less cash left over if you had initially put 40% of it into an SPIA...
Horse-pucky.
Let's say our retiree has $2M to start with and annuitizes $1M to provide for living expenses, in addition to SS.
The remaining $1M gets invested for the next 30 years of retirement and grows to some amount greater than that before being left to the recipients in the retiree's will.
How does this screw the recipients out of an inheritance?
Furthermore, have you ever heard of Looking Out For Number One
Before you call a thoughtful post horse-pucky, you should know your topic and master basic math.

I think the answer is in your prior post
The Wizard wrote:I think that some retirees like to live with lower income in retirement than they could have, while conserving their lump sum for an emergency of some sort.
I annuitized a hefty sum at age 63 and am happy with that...
I realize you are happy with your decision, but you should not let your need to rationalize your annuity purchase lead you to react with posted comments that provide what is actually wrong information. There is no such thing as a free lunch. An annuity gives a perceived higher, safe return (in cash, less expenses) in exchange for loss of capital and perceived safety and predictability. Annuities rate of return is not the same as an investment rate of return that leaves capital intact. This is a sales trick used by insurance companies. 5% sounds better than 3%. However, if you don't get your principle back ever, you need to add time to the equation to know which is actually better for heirs. What you do with other money is not relevant (from purely an ROI and financial perspective....I grant it may make one feel emotionally more willing to take risks with the balance of ones assets from a emotional security perspective).
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Re: The Annuity Puzzlement

Post by Garco »

@PizzaSteve510: Exactly. Thank you for the corrective horse-sense.
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Re: The Annuity Puzzlement

Post by leonard »

Things can change over the term of the contract - do you really think an insurance company will necessarily stay viable for the 30 years or so it's paying out money? Are you really willing to bet on that up front?

Also, I have never understood - and will never understand - why people are willing to take market risk for decades to build up a portfolio. Then, give a big chunk of it away at the end in form of a risk premium payment to an insurance company. I don't understand what changes so drastically in someone's risk profile that one day - they are perfectly happy with whatever market risk they are taking - and the next they annuitize say 50% of their portfolio - drastically lowering their implied risk profile. I am almost positive nothing fundamentally changed in their need or desire for risk from before and after the annuitization.

Personally, I have no interest in saving my whole life for part of it to go to a risk premium for an insurance company.
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Re: The Annuity Puzzlement

Post by Leeraar »

I don't understand what changes so drastically in someone's risk profile that one day
Just a wild guess: They no longer have a salary and need a reliable stream of income to live on.

L.
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Re: The Annuity Puzzlement

Post by Aptenodytes »

leonard wrote:Also, I have never understood - and will never understand - why people are willing to take market risk for decades to build up a portfolio. Then, give a big chunk of it away at the end in form of a risk premium payment to an insurance company. I don't understand what changes so drastically in someone's risk profile that one day - they are perfectly happy with whatever market risk they are taking - and the next they annuitize say 50% of their portfolio.
Two reactions.

1) Yes, you do realize the thinking behind such moves. If you understand anything at all about risk, you understand this.

2) Virtually nobody does the thing you are talking about, so your faith in humanity can rest intact.

If you put 1 and 2 together you have what the OP references in the title -- the annuity paradox.
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Re: The Annuity Puzzlement

Post by CWRadio »

Leeraar wrote:
I don't understand what changes so drastically in someone's risk profile that one day
Just a wild guess: They no longer have a salary and need a reliable stream of income to live on.

L.
It missing the automatic pay check which a SPIA gives you and it makes my wife my comfortable if anything happens to me.
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Re: The Annuity Puzzlement

Post by LongerPrimer »

Been stuck here all morning because I can't find my wallet.
Found it. Thanky You, BHs. :P :D
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Re: The Annuity Puzzlement

Post by dhodson »

leonard wrote:Things can change over the term of the contract - do you really think an insurance company will necessarily stay viable for the 30 years or so it's paying out money? Are you really willing to bet on that up front?

Also, I have never understood - and will never understand - why people are willing to take market risk for decades to build up a portfolio. Then, give a big chunk of it away at the end in form of a risk premium payment to an insurance company. I don't understand what changes so drastically in someone's risk profile that one day - they are perfectly happy with whatever market risk they are taking - and the next they annuitize say 50% of their portfolio - drastically lowering their implied risk profile. I am almost positive nothing fundamentally changed in their need or desire for risk from before and after the annuitization.

Personally, I have no interest in saving my whole life for part of it to go to a risk premium for an insurance company.
There are people who NEED these products. Not as likely to be boglehead folks but people who's idea of retirement was that social security would be enough and then about 5 years before they retired, realized they needed to save. They dont have a bunch of money saved so they need to figure out how to live off what they got. For them a SPIA could easily be appropriate (although going back to work and other things might be useful if possible and nothing really fixes a lifetime of bad decisions). The problem is that these people are in the situation they are in partly bc they dont have a good grasp on finances. They windup going to a "free seminar" and are invested in either permanent insurance or a variable annuity. I find that 90% of insurance agents despise SPIAs and love variable annuities and permanent insurance instead. Then there are those who dont NEED it at all bc they got loads of money. For those, it probably doesnt make sense to put a lot into a SPIA. Putting a small portion isnt a bad decision for basic needs. At what age and what % can be debated for sure. I like the idea of putting a small part at age 80 IF im in great health at that time otherwise just deferring SS is what i plan to do.
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Watty
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Re: The Annuity Puzzlement

Post by Watty »

leonard wrote: Also, I have never understood - and will never understand - why people are willing to take market risk for decades to build up a portfolio. Then, give a big chunk of it away at the end in form of a risk premium payment to an insurance company. I don't understand what changes so drastically in someone's risk profile that one day - they are perfectly happy with whatever market risk they are taking - and the next they annuitize say 50% of their portfolio - drastically lowering their implied risk profile. I am almost positive nothing fundamentally changed in their need or desire for risk from before and after the annuitization.
The thing that changes is that up until the day you retire most people have the option of working a bit longer if their investments are not doing as well as they would have liked.

This would not only allow them to save more but it would give them time for their investments to grow and possibly recover from a bear market. If there are a few bad years, like 2008, then someone that is still working also has a pretty good chance of just keeping their money invested until the market recovers. Someone that was retired in 2008 and was withdrawing funds at the market lows would have had a smaller portfolio when the market eventually did recover.

Working a few more years would also shorten the length of retirement which would help a smaller than hoped for portfolio cover the expenses better.

There is also the point of view that once you have enough that you have "won the game" there is no reason to keep taking risks since you don't need to.

The time frame also changes. Someone that is 75 and looking at an annuity only has about a 20 year time frame until they are 95. Someone that is 35 has 60 years.
Last edited by Watty on Sat Sep 13, 2014 3:24 pm, edited 1 time in total.
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Re: The Annuity Puzzlement

Post by Ron »

leonard wrote:I don't understand what changes so drastically in someone's risk profile that one day - they are perfectly happy with whatever market risk they are taking - and the next they annuitize say 50% of their portfolio - drastically lowering their implied risk profile. I am almost positive nothing fundamentally changed in their need or desire for risk from before and after the annuitization.
Sure it did (in my case).

One day I was a "wage slave"; the next I was retired. My (investment) risk profile changed in 24-hours.

Before, I had a salary that I could count on, to pay my bills and to allow me to live life in the (financial) manner that I wished.

The day after, I had no salary (nor pension or SS) to live on. I had put all my "risk" in one bucket - my portfolio. That was to be the product that I was going to depend on until the end of my life (aided by SS at age 70, some eleven years later).

My primary goal was to have a base income that acted as the company defined benefit plan (e.g. pension) that was eliminated in the early 80's and over time, replaced with a 401(k) and cash balance plan (e.g. lump sum distribution). My second goal was to draw down a good portion of my (and wife's) 401(k) holdings before we were forced to starting at age 70.5. While we had/have a good amount invested in TIRA's, Roth IRA's (which we have some) were not available for a good part of our investing life and Roth 401(k)'s were not available at all. Lastly, I/we wished to delay SS until age 70 (which will be our largest retirement income producer) rather than have to take it at age 62 or even at our joint FRA age of 66.

A major concern at the time was the idea of runaway inflation (been there, done that). But guess what happened? Since we purchased our SPIA in mid-2007, inflation has held mostly steady (at least the published rate :wink: ) and fixed investment interest rates, such as bank accounts and CD's have actually gone down. It makes us look good to have that just under 5% IRR return (does not include return of principal).

We're in the seventh year of our eleven year plan (retirement to SS) and everything is going actually better than plan (no accounting for dumb luck :mrgreen: ).

Inflation has not been rampant; our SPIA has been joined by my wife's two small pensions, and my wife started receiving 50% of my FRA SS a few months ago (I filed/suspended in January). Those payments will continue until she gets her full SS in 3.5 years.

The SPIA has turned out to be a good decision - in our case. And no, we didn't "invest" 50% of our joint portfolio; in our case it was just 10% at the time we purchased the SPIA. You don't have to throw a good deal of money in the pot to make a plan viable.

One last thing. A lot of folks like to point out that you can do better investing in the broad market. While I agree with that statement, I don't agree that SPIA's should be looked at in the same manner. SPIA's are income vehicles - not investment vehicles. Often folks confuse the issue with "wait till you are 80 - you get a better payout". Sure, you get a better payout but as has been mentioned in this thread, it's just a higher rate of return of your own money since you have fewer years in which to receive that money. Interest rates have little to do with the size of the payout at an advanced age. And then there is the question of income risk. Would you rather bet on the market or bet on an SPIA to provide you with a somewhat guaranteed (we could debate that one all day) income/subsistence level of income.

And when (or if?) we reach age 70 - in just over three years, that continuing SPIA income will just provide enough income to be "icing on the cake" to our other existing retirement income streams. And if we don't reach age 70, remaining payments (until our joint computed age of 87) will go to our estate.

FWIW,

- Ron
Last edited by Ron on Sat Sep 13, 2014 3:28 pm, edited 1 time in total.
Johno
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Re: The Annuity Puzzlement

Post by Johno »

N52570 wrote:Why don't more people partially annuitize a portion of their portfolio?

Purchasing fees aside, and rough back of the envelope arithmetic. And at 55 years old It appears I can buy a SPIA the pays out 5.5 % for lifetime. Take 40% of a portfolio's value and purchase a guaranteed 5.5% SPIA ( given the insurance(s) companies stay in business) for life. Giving me a solid floor that then allows me to withdraw only 2% on the remaining 60% of the portfolio. Making me almost all but bullet proof. Whereas without the SPIA I would have to withdraw 3.4 % of the portfolio to produce the same revenue stream. And I'm assuming, with much greater risk of running out of money in the long run.

So what am I missing?
As mentioned, the fixed annuity might make your portfolio more vulnerable to high inflation, though that depends of course of what you would have invested the money in if not the annuity. If you'd have invested in similarly long term fixed rate bonds, then the inflation risk profiles isn't changed. But if as is possible (would be true in my case, for example) one would favor shorter term fixed income investments (highest paying 5 yr CD's for example are a sweet spot of today's FI market IMO) or TIPS (I have TIPS in longer maturities than I'd put fixed rate money in today's market) then the fixed annuity is a serious increase in risk to high inflation.

Earlier this year I got quotes for annuities from age 70 (as immediate annuity, putting in birth date as if I was 70, on Vanguard's thing) for couple (70 and 68) with 100% survivor's benefit that were 6.3% fixed and 4.5% CPI adjusted. Even if one were to actually get the fixed annuity, I believe the CPI adjusted quote is the more realistic one to use for planning and comparison purposes.

Then there's pricing. It seems that immediate fixed annuities are priced in the mid-high 80%'s of actuarial value based on the Social Security Admin's actuarial table. It seems that any other bell or whistle (deferred annuity, inflation adjustment) reduces that %, perhaps significantly. When discussing the related choice of when to take to Social Security, some insist the SSA's table is too pessimistic (in the general sense, ie understates likely lifespan), at least for them. So one factor that might be important but hard to nail down is personal longevity expectation. But in any case, a legitimate source of resistance to annuities is the fact that you are paying an insurance company's expected return on capital, which you aren't if you rely on market growth of your assets without the annuity. By the same token, it's highly likely the Social Security itself is priced more favorably than the annuity, so it would probably make little sense to buy an annuity except after first deciding to postpone SS til age 70.

But at the other end of the spectrum from mainly relying on SS as longevity protection, if one has enough assets relative to expenses that the main question is how much will be left to heirs, then paying the relatively high 'load' of the insurance co's profit is probably less attractive than if one is in a situation where running out of non-SS money is a higher probability, again assuming also that SS alone covers a pretty small % of expenses. For people in that range private annuities seem worth exploring, with still the problem of inflation risk for the fixed variety, and perhaps less sharp pricing and fewer providers (for credit diversification) of the CPI adjusted variety.
Last edited by Johno on Sat Sep 13, 2014 3:27 pm, edited 1 time in total.
Harold
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Re: The Annuity Puzzlement

Post by Harold »

There's also the reality that people are very bad at assessing risk.

Without their risk profile changing, they could go from a starry-eyed assessment of the returns from risky investments -- to a panicked assessment of how they could possibly live if something were to happen to those risky investments. Probably neither assessment was correct.

(Though the one resulting in transferring risk to the insurer was probably more prudent.)
Leeraar
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Re: The Annuity Puzzlement

Post by Leeraar »

Things can change over the term of the contract - do you really think an insurance company will necessarily stay viable for the 30 years or so it's paying out money? Are you really willing to bet on that up front?
Yes. Prudential was established in 1875. They have my pension whose NPV is low seven figures, far greater than any state SPIA guarantee. I firmly believe they are too big to fail.

SPIAs are a very good idea for many people, particularly those in danger of depleting their savings while they are still alive.

I actually think that SPIAs should be a mandatory available choice for owners of IRAs, 401ks and similar defined contribution savings plans.

By the way, I have not done the research, but I have read that buying such an annuity only later (age 80) is not the best strategy.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
LongerPrimer
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Re: The Annuity Puzzlement-Why Not.

Post by LongerPrimer »

Anyway, Got some annuities, VAs, high fee GLWBs.
Just did a retirement funds inventory. Why do I have cash in a Roth? Why in a tIRA?
Got some property. Had planned to plant houses but should have bought CDs.
Got some IRAs. Wish they were Roths.
Got some Stock. Keeps me occupied.
Got a wife that makes things interesting.
Got some body parts that used to function well, I least I thought they worked well, and now they don't.
Got some siblings that I want to ignore and have caused me ulcers.

At least we can have a discussion here. I was briefly on another Retirement forum where the mods were vehemently against anytype of annuities favoring Vanguard bond funds only for risk management.

You know what scared me to annuities: In 2007-2008, I got a bro with phD, Ivys Econ. Risk management. BigBank. Well connected. But his type never gets out onto the street and see the real world. If the big money institutions want to buy risk. I am happy to sell it. I didn't get the real good deals then, but they are better than what is offered 6 years later. :annoyed
LongerPrimer
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Re: The Annuity Puzzlement

Post by LongerPrimer »

Harold wrote:There's also the reality that people are very bad at assessing risk.

Without their risk profile changing, they could go from a starry-eyed assessment of the returns from risky investments -- to a panicked assessment of how they could possibly live if something were to happen to those risky investments. Probably neither assessment was correct.

(Though the one resulting in transferring risk to the insurer was probably more prudent.)
+100 to Harold.
bsteiner
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Re: The Annuity Puzzlement

Post by bsteiner »

wjo wrote:...I am a few years out from retirement withdrawals, but I reasonably plan to annuitize some of my funds, perhaps through a charitable remainder trust (which tend to have a lower payout rate than a commercial annuity but meets my bequest motives).
A charitable remainder trust is a trust that provides "income" to one or more individuals for life (or for a term of up to 20 years), after which the balance goes to charity.

The payments are a fixed percentage of the value of the trust. The trust can be either an annuity trust (in which the percentage is applied to the initial value of the trust), or a unitrust (in which the percentage is applied to the current value of the trust each year). For example, if the trust is $1 million, and the selected percentage is 5%, in an annuity trust, the payments will be $50,000 a year. In a unitrust, the payments will be 5% of the then value of the trust each year.

In general, you can select any percentage you want, so long as it's at least 5% but not more than 50%, and so long as the actuarial value of the charity's interest is at least 10% of the initial value of the trust. For example, for one person age 60, a charitable remainder unitrust could have a payout between 5% and about 16%. If the payout rate exceeds the investment return, the annual payments will decrease over time as the value of the trust decreases.

A charitable remainder trust is exempt from income tax. However, the distributions are generally taxable, as ordinary income to the extent the trust has ordinary income, and then as capital gain to the extent the trust has capital gain. The main purpose of a charitable remainder trust is to enable someone to diversify out of a concentrated position, or to sell an appreciated asset, without incurring a large current capital gains tax. (The tax is deferred rather than eliminated.)

The other choices are to sell the asset and pay the tax, hold the asset until death for the basis step-up (with the risk of holding the concentrated position), or hedging (which has some cost and isn't always possible). When the capital gains tax rate was 15%, we weren't creating very many charitable remainder trusts. Now that the capital gains tax rate is effectively 23.8% (including the 3.8% net investment income tax), we'll probably be creating more charitable remainder trusts.

State income taxes also have to be considered. In some states, it's possible to create a trust for your own benefit that can be a separate taxpayer, in a way that will avoid state income tax. As of this year, New York residents can no longer do this, though New Jersey residents still can. California residents can also do this, except if the accumulated income and gains are ever payable to a beneficiary in California, the tax becomes due at that point. However, these trusts are complicated, and someone in a high income tax state may prefer the charitable remainder trust.
Dandy
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Re: The Annuity Puzzlement

Post by Dandy »

Basically, people don't understand annuities and even when they do don't want to part with substantial assets. They have saved/invested for decades and have $1 million and then are asked to pony up $400k for an annuity. Quite a decision. Many believe they can do better investing. Assets that are not annuitized are available to husband and wife. Unless the annuity is a joint annuity then that would not apply. Also, there is a well earned distrust of insurance companies and sales people.

The fact that the basic immediate annuity is usually a pretty sound product is often offset by the various "bad" annuity products that carry the same name,a higher commission and are over sold.
Leeraar
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Re: The Annuity Puzzlement

Post by Leeraar »

Dandy wrote:Basically, people don't understand annuities and even when they do don't want to part with substantial assets. They have saved/invested for decades and have $1 million and then are asked to pony up $400k for an annuity. Quite a decision. Many believe they can do better investing. Assets that are not annuitized are available to husband and wife. Unless the annuity is a joint annuity then that would not apply. Also, there is a well earned distrust of insurance companies and sales people.

The fact that the basic immediate annuity is usually a pretty sound product is often offset by the various "bad" annuity products that carry the same name,a higher commission and are over sold.
Yes.

I will continue to hammer away that an SPIA is a very sound choice for those needing some base level of assured income.

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
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cfs
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Re: The Annuity Puzzlement

Post by cfs »

Rick Ferri's article on annuities.

Here is a good article by Rick Ferri on this subject.

http://www.rickferri.com/blog/investmen ... -everyone/
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Austintatious
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Re: The Annuity Puzzlement

Post by Austintatious »

I came across this MarketWatch article this morning and thought it would worth a read to those following this thread. Annuity specialist (their description of the author) Stan Haithcock advises us regarding the coming annuity renaissance that's just around the corner. I'd like to think he has it right since I, too, have become a fan of the annuity, at least, the simple and straightforward ones.

ttp://www.marketwatch.com/story/hate-annuitie ... -16?page=1

I'm especially interested in the recent federal decision authorizing an investor to have a so called longevity annuity in her 401(k) and/or IRA. QLACs (qualified longevity annuity contracts) will become, according to Haithcock, the most popular of annuities in a short 5 years, and this makes sense to me. This new option may make annuities so popular that Haithcock's perdictions of simplicity, federal oversight and lower commissions might actually come true.
Leeraar
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Re: The Annuity Puzzlement

Post by Leeraar »

Austintatious wrote:I came across this MarketWatch article this morning and thought it would worth a read to those following this thread. Annuity specialist (their description of the author) Stan Haithcock advises us regarding the coming annuity renaissance that's just around the corner. I'd like to think he has it right since I, too, have become a fan of the annuity, at least, the simple and straightforward ones.

ttp://www.marketwatch.com/story/hate-annuitie ... -16?page=1

I'm especially interested in the recent federal decision authorizing an investor to have a so called longevity annuity in her 401(k) and/or IRA. QLACs (qualified longevity annuity contracts) will become, according to Haithcock, the most popular of annuities in a short 5 years, and this makes sense to me. This new option may make annuities so popular that Haithcock's perdictions of simplicity, federal oversight and lower commissions might actually come true.
There have been threads on this. Also, check out Mike Piper's blog and newsletter. (Oblivious Investor)

L.
You can get what you want, or you can just get old. (Billy Joel, "Vienna")
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Frugal Al
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Re: The Annuity Puzzlement

Post by Frugal Al »

Most of the studies that claim an SPIA increases portfolio survival and income have the non SPIA portion of the portfolio in 100% stocks, which can be a behavioral challenge for many even with the regular income from the SPIA. Still, if one can get by that challenge, SPIAs at a relatively young age can make some sense.

As others have said, these things are insurance, not investments. Why buy expensive insurance if you're not sure you need it--especially since it actually (actuarially) gets cheaper the longer one waits. Some people like the comfort of knowing something is guaranteed. That's OK, whatever gets you by. The problem is that these guarantees don't amount to much at today's payout rates. With IRRs equal to the historical inflation rate over average longevity periods, we're basically paying the insurance company to send our money back to us in small monthly increments. If we die in the interim, they get to keep it. Sounds like a great deal...for the insurance company. The only annuity puzzlement I see is that many push these things at relatively young ages without considering alternatives which offer significant upside potential. I'll take TIPS, CDs, Treasuries, Stocks, and implement the VPW. I'll evaluate things annually between age 75 and 80 to see if I need an SPIA.
letsgobobby
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Re: The Annuity Puzzlement

Post by letsgobobby »

Yes for the average investor annuities appear underbought. But for those who can afford to self insure, be it LTC, inflation, longevity, total home loss, etc, buying any for of insurance may be unwise. That probably will include include a number of Bogleheads, but not all.
Austintatious
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Re: The Annuity Puzzlement

Post by Austintatious »

Frugal Al wrote:Most of the studies that claim an SPIA increases portfolio survival and income have the non SPIA portion of the portfolio in 100% stocks, which can be a behavioral challenge for many even with the regular income from the SPIA. Still, if one can get by that challenge, SPIAs at a relatively young age can make some sense.

As others have said, these things are insurance, not investments. Why buy expensive insurance if you're not sure you need it--especially since it actually (actuarially) gets cheaper the longer one waits. Some people like the comfort of knowing something is guaranteed. That's OK, whatever gets you by. The problem is that these guarantees don't amount to much at today's payout rates. With IRRs equal to the historical inflation rate over average longevity periods, we're basically paying the insurance company to send our money back to us in small monthly increments. If we die in the interim, they get to keep it. Sounds like a great deal...for the insurance company. The only annuity puzzlement I see is that many push these things at relatively young ages without considering alternatives which offer significant upside potential. I'll take TIPS, CDs, Treasuries, Stocks, and implement the VPW. I'll evaluate things annually between age 75 and 80 to see if I need an SPIA.
What about that Mel Lindauer EE bond build-it-yourself annuity?

http://www.forbes.com/sites/theboglehea ... n-annuity/

I've liked this idea since the first time I read of it which, unfortunately, was later in my investing career. Assuming that one thinks about it early enough to get the 20 years in, it relieves one from having to rely on an insco, a good thing IMO. Certainly, it offers as meaningful a guarantee as one could have, and the investor always has access to the funds, if getting to them becomes necessary. I consider that a fair trade off for the lower returns. And one could always do the same with I bonds, with their inflation protection feature, as an alternative or in addition to the EE bond version.
robertf57
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Re: The Annuity Puzzlement

Post by robertf57 »

Interesting discourse; but, I feel that many miss the true value of an annuity for retirement planning as a risk management strategy. They give lip service to the concept without really grasping it. At the risk of offending everyone by going over concepts that are well understood, let me develop the argument akin to Otar’s chapter in “Retirement Income Redesign” (1). A non-annuity approach to retirement income involves creation of a portfolio of different assets with the expectation (hope?) of a specific return from which a cash flow is withdrawn to support the retiree’s life style. A “Safe Withdrawal Rate” (SWR) is assumed that is expected to support the retiree throughout their life. The fly in the ointment of this approach is uncertainty. If we knew our moment of death and the exact returns our investment would generate this would be a plug and chug math problem. But returns and our life span (and therefore a SWR) are all probabilistic events.

The uncertainty around an individual’s life span is quite large. For an individual to manage that risk from his portfolio of investments, a lower SWR is required. The uncertainly around the average life expectancy of a pool of people is much smaller and consequently a higher actuarially sound payout is possible from a pool... This is precisely what an annuity or a pension is. So, an annuity allows the individual to trade off their longevity risk and increase the cash flow from a portion of the annuitant’s portfolio, depending on the costs the insurer adds. ( you can't out live the cash stream and the cash stream should be greater than your safe cash stream without the annuity)

Whether an annuity makes sense for you depends on the withdrawal rate required to support your retirement lifestyle, the theoretical SWR, and how much the annuity will pay you. If your required withdrawal rate is less than the SWR, Otar’s chapter would say you don’t need an annuity. However, an annuity may allow you to have a higher standard of living by being able to spend a higher cash flow from your portfolio than you could safely draw without it.

The default risk, loss of liquidity of the corpus of the annuity, unanticipated inflation, and the potential reduction in ultimate bequests are separate issues (although the guaranteed cash flow may allow at least partial mitigation of the bequest issue through investment strategies during the payout phase).

It seems that this board generally maligns annuities as a component strategy for retirement and contributes to the Ops annuity paradox statement that started this thread. I, for one, think to logic behind annutization of a portion of one’s assets is sound and they can be an excellent strategy in some circumstances. But one size does not fit all

1)Otar J. Lifelong Retirement Income: How to Qualify and Eliminate Luck in Retirement Income Redesigned. Evansky H, Katz D. Bloomberg 2006
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Clearly_Irrational
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Re: The Annuity Puzzlement

Post by Clearly_Irrational »

1) Inflation
2) I tend not to trust things with lots of fine print
3) Insurance companies can fail

Annuities make sense for a narrow range of individuals with specific needs.
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