Bogleheads

[nisiprius]

I'm going to retire next year at 62. It appears that it is appropriate for me to liquidate a big chunk of my assets and use the proceeds to buy one or more single premium immediate annuities, to generate a lifetime income stream. For purposes of discussion, please accept this premise. Also, please accept that this is all my own thinking; I'm not being "helped" by friendly insurance agents. (And I am not talking about variable annuities, so don't bother warning me about them. I'm talking about a simple transaction in which I make one big payment upfront and the insurance company pays me, according to a precisely specified contractual payment schedule, for life).

I'm tentatively planning to do is to do this "soon." That is, for the assets I'm planning to annuitize, I'm planning to liquidate and commit allof them within the next six to twelve months.

I'm trying to make one last reality check on doing this "all at once," versus the merits of doing only about half of it now, then waiting ten or fifteen years, then annuitizing more. My personal analysis is that waiting for any extended period of time doesn't work unless I am excessively optimistic about investment returns. I'd like to present my thinking and see what others think.

Assume that I have A in assets to annuitize, that I "need" to use those assets to generate I in annual income, and that annuitizing A would generate exactly I in annual income. Assume we will do all the calculations in constant, deflated, 2007 dollars. The alternatives are:

a) Annuitize all of A, receive annual income I, and live happily ever after.

b) Annuitize only half of A, invest the other half of A as best I can for fifteen years. During that time, receive half of I from the annuity and annually withdraw half of I from the invested assets. At the end of fifteen years, at age 77, take what remains from the invested assets and buy a second annuity.

The reasons for not wanting to do it all now is that it's a pretty scary thing to do. I'll be committing a good fraction of my life savings to an irrevocable proposition, even though it is a safe and conservative proposition. (I plan to use a mixture of annuities, one that is actually indexed to the CPI and one that are "graded," with a payout that increases by a specified percentage every year, which justifies doing all of my thinking in constant dollars and more or less ignoring inflation risk).

The chief arguments for waiting seem to me to be:

a) Cold feet. Unlike my house, this is literally a lifetime decision.

b) I'm locking in today's economics and might miss out on wonderful future possibilities. If the long-term interest rate were to rise dramatically, in hindsight I'll regret having gotten less income for the same premium than I could have. If we have another bull market like the 1990s, in hindsight I'll regret letting an insurance company effectively pay me the 2007 long-term treasury coupon rate when unannuitized money could be multiplying like rabbits.

c) If I die younger than expected, I or rather my heirs lose money. Not annuitizing now will give them more if I die young.

d) If inflation is much less than it is now, then I'll regret having the CPI-indexed annuity, as I could have gotten more. If it is much more than it is now, then I'll regret the graded-increase annuity even more, as it won't pay me enough to live on.

Now, my analysis is that waiting does not work, unless I'm insanely optimistic about my investment performance.

I set up a spreadsheet with one column giving the percentage of survivors in a population, based on a life table. I pretend everyone has bought an annuity with a $1000/month payout, calculate the total payout for the population, and calculate the net present value of that payout, based on the prevailing interest rate, as the price needed to purchase the annuity. And, lo and behold, the numbers I get are a) a bit larger than, but b) generally very darn close to the numbers I get from instant-quotation websites like http://www.brkdirect.com/spia/EZquote.asp or http://www.aigretirementgold.c....uestaQuote

Remember, I'm going to do this all in constant dollars. If I specify an real interest rate (i.e. above inflation) of 2.5%, my spreadsheet says that at age 62, a $200,000 purchase should yield a payout of $12,820.00 in annual income. (At age 77, a $200,000 purchase should yield a payout of $21,990 in annual income).

Scenario A: I purchase a $200,000 annuity and receive $12,820/year for life.

Scenario B, I purchase only a $100,000, generating only $6,410 in annual income. I invest the remaining $100,000 as best I can, and each year I need to withdraw $6,410 to make up my "needed" 12,820. For starters, if I assume a real rate of return 2.5% per year, 15 years later, $27,012.58 in assets remains.

I buy a second annuity with that $27,012.58 at age 77. It generates an income payment of only $2,968 per year; + $6410 from the original annuity = $9378, far short of the $12,820 I "need."

In order for that second annuity to generate the $6,410 payout I need, have to have about $62,000 for the initial premium. In order for that to happen if I start with $100,000 and withdraw $6,410 a year, I need to be earning a real return of about 4.75% above inflation. And that's only to get the same income I could have gotten by annuitizing everything now.

I'm pretty sure that I am not capable of reliably earning a real return of significantly more than 4.75% above inflation.

I think the fundamental explanation of why it works out this way is that in an annuity, the payouts for people who live "too long" are paid for by the people who "die young." In order to get a shot at post-life-expectancy income, I need to give the insurance company a shot at me-dying-early savings. To put it another way, at age 62 my life expectancy is 20.7 years, but at age 62 + 15 my life expectancy is not 20.7 - 15 years = 5.7 years, it is in fact 10.5 years.

[bob u.]

Hi Nisiprius--

I just wanted to make sure you've seen some of Gummy's figures. http://www.gummy-stuff.org/annuity-yes-no.htm Bob U.

Disclosure: I annuitized some monies at age 59 and have never regretted it. Gummy also annuitized some monies.

[dm200]

So many things can be different just a few years down the road, and your return will be a significantly higher percentage because you will be older.

So, if you can live ok for a few years on the income from the SPIA and from the investments, I lean towards waiting on part. I consider this a form of diversification.

Somehow, your numbers (getting the SPIA for half at age 77) don't look right, but if done properly, numbers don't lie, so I will take a look at these in some detail later when I have some time.

dan

[larryswedroe]

Following is from my upcoming book on alternative investments--though strictly speaking annuities are not investments but contracts

When to Purchase a Fixed Annuity

In general, the research indicates that it is preferable to delay annuitization until the mid 70s or early 80s. One study concluded that a sixty-five-year-old female has an 85 percent chance of being able to beat the rate of return from a life annuity until age eighty. For males the figure was 80 percent.3
There are two main reasons for this. The first is that the insurance company, in addition to covering its costs of marketing, underwriting and issuing the contracts, is building in a profit. The second is that the insurance companies that issue these policies are aware that they are being adversely selected—the most likely buyers of longevity insurance are those who have a good reason to believe that they will live a longer than average life. Thus, unless you are highly risk averse you should probably not buy an immediate fixed annuity until you approach age eighty. Similarly, if you are considering buying a deferred fixed annuity, you should consider delaying payments until age eighty.

Hope that helps

[dm200]

are you male or female?

[bobcat2]

Calculate the income you need in retirement to maintain your pre-retirement standard of living (SOL) during retirement. (I realize this calculation is the heavy lifting in this problem, but we will assume that difficulty away for now.)
Decide what percentage of your pre-retirement SOL (consumption) would be minimally acceptable during retirement. Annuitize at retirement the amount you need to meet this minimum goal. You have now locked in your minimum acceptable retirement SOL.

Example - You calculate you need $100,000 income/yr in retirement to meet your pre-retirement SOL of $80,000. You definitely do not want your retirement SOL to fall below $70,000, so you estimate you need $90,000/yr in retirement income to reach the acceptable min retirement SOL of $70,000.

Your pension is $46,000 and SS is $24,000.
$90,000-$46,000-$24,000=$20,000
You need to have an annuity of $20,000/yr to insure your min acceptable retirement SOL of $70,000.

Later in retirement you could decide to annuitize more of retirement income above this min level at retirement.

Bob K

[Ron]

Being that I just retired May 1st (Age 59) and purchased a fixed immediate annuity, I faced the same "challenges" of was it the "correct" thing to do. While I won't comment on the responses thus far, I just wanted to add a few other thoughts (based upon my situation).

You state as one option to use $200K to buy a revenue stream of $12,820/yr. If we use the "traditional rule" of a 4% withdrawal rate, you would have to have a portfolio value of $320,500 to generate ($12,820 x 25) generate the $12K+ per year (looks like you "saved" $120K). Yes, I know about the "end time value" that still may be there as an estate value, but nothing is "guaranteed".

As others have referenced in this (and other threads) it's good to delay purchase of an annuity till late '70's or '80's. That may be well and good (regardless of the longevity tables), but both my father and my wife's mother passed on in their mid '70's. Yes, we could live well beyond that, but our respective family histories do not support that possibility. Another reason why we converted/bought at an "early age". One thing we did to is to have a 28-year guarantee period (only reduced our monthly income by $20) to ensure that the money did not revert to the insurance company if we passed early (as expected). Even though our entire estate is going to charity (no other family) we still want to ensure that someone other than the insurance company/stockholders receive "value". If we live another 28 years - well, I guess that would be fine!

Another reason we purchased an annuity early is that even though we're 59 (my wife will also be retiring shortly), we plan (at this time) to take SS at age 66 (of course, 6.5 years is a bit of time, and that decision will be revisited on an ongoing basis).

It's a quandary, and we went back/forth several times before we bought the annuity, but I now feel it was a good decision. We expect to buy additional annuities in the future (if we do survive!) and did not want to "convert" more than 10% of our retirement portfolio at this "early time".

- Ron

[Prokofiev]

Ron,

" That may be well and good (regardless of the longevity tables), but both my father and my wife's mother passed on in their mid '70's. Yes, we could live well beyond that, but our respective family histories do not support that possibility"

Ron, I think you have it backwards. If you have a family history of short life spans you do NOT need longevity insurance. You would do much better spending down your nest-egg . . .
_________________
Everything should be made as simple as possible, but not simpler - Einstein

[nisiprius]

Just for laughs... and to make things easier for others to check... I did the calculation a different way. This doesn't depend on my homegrown life-table spreadsheet, taking my actuarial skills out of the equation, and I'll do the calculations with ordinary (inflated) dollars, assuming an inflation rate of 3% per year, and assuming I buy an annuity with a 3% annual graded increase in payout.

I got quotations online at this page: http://www.aigretirementgold.c....uestaQuote

I got quotations for a male, age 62, on 4/1/2008, living in Illinois, date of birth 4/1/2007, annuity to commence 4/1/2008, on an premium of 100,000. Then I got a similar quotation for age 77, to estimate what the situation would be 15 years later. For no good reason I specified a 15 year term certain for the first quotation but not the second. (It doesn't affect things much and it leans slightly the direction of favoring waiting, since it reduces the income from the first annuity). Here are the quotations I got:

Primary Annuitant -- Birth date: 04/01/1946   Sex: M
Benefit Commencement Date: 04/01/2008
State of Residence: IL
Payments per Year: 1
Total Premium Amount: $100,000.00
Initial Payment Amount for Fixed Single Life Annuity with 15 Years Guaranteed with 3% graded payment option: $5,531.04

Primary Annuitant -- Birth date: 04/01/1931   Sex: M
Quote Expiration Date: 08/14/2007
Benefit Commencement Date: 04/01/2008
State of Residence: IL
Payments per Year: 1
Total Premium Amount: $100,000.00
Initial Payment Amount for Fixed Single Life Annuity with 3% graded payment option: $9,692.16

Scenario 1, annuitize $200,000 and get income starting at $11,062.00 the first year and increasing 3% every year.

Scenario 2: annuitize $100,000 and get income starting at $5,531.04 the first year and increasing 3% every year. Set up a second column starting with $100,000 initially, and, each year, to make up the same income that I would have obtained under scenario 1, deduct 5,531.04 the first year, $5,696.93 the second year, and so forth, increasing 3% per year. Then add the assumed rate of return from the investment. Continue this for 15 years.

At the start of year 15, under scenario 1, I "need" and am receiving $17,234.24 from the annuity.

At the start of year 15, under scenario 2, if I get a 5% rate of investment return, my $100,000 (with income being withdrawn every year) has dwindled to $56,617.53, and when I buy the second annuity with it, it yields $2,520.02 per year. So my total income is $11,395.65, significantly less than the $17,751.26 I would have gotten if I had annuitized the entire $200,000.

If I get a 7.68% rate of investment return, my $100,000 has grown to $115,153.68, and when I buy the second annuity it yields $8,843.80, giving a total of $17,719.43, meaning I have done almost exactly as well as if I had annuitized the entire $200,000.

If I get a 9% rate of investment return, I have $159,335.55, the second annuity yields $14,340.20/yr, the total income is $23,215.83 or significantly better than $17,751.26 I would have gotten if I had annuitized the entire $200,000.

What this says to me is that... given my assumptions... things pivot on my degree of confidence that I can do better than 7.68% (i.e. a real rate of 4.68% since we're assuming 3% inflation) for the next 15 years, and that the outcome is, in fact, highly sensitive to market performance and inflation.

If I believe I can make about 7.5% or so--which is what I really believe-- then delaying annuitization increases my risk (i.e. the range of possible outcomes) without much affecting the average outcome.

[alec]

FWIW, here's a paper from Milevsky that discusses optimal ages to annuitize: Optimal Asset Allocation and The Real Option to Delay Annuitization: It's Not Now-or-Never

Interestingly enough, using low cost variable immediate annuities and increasing/graded annuities lowers the optimal ages.

- Alec

[pkcrafter]

Here is a link to a more recent paper on annuity optimization.

http://www.diehards.org/forum/viewtopic.php?t=4430

Try this link for annuity possibilities.
http://www.immediateannuities.....te_annuity

The amount an annuity will pay out is dependent on your age and the current interest rates. When you buy a fixed rate SPIA you lock in the current rate, so you will do better if rates are higher when you buy. Also, you get a better return the older you are. Rates vary too, so it pays to shop around, but only look at companies with very solid ratings.

One problem you have now is you are trying to squeeze too much out of your accumulated assets—WD of 6.4%. Any chance you can adjust your goals or do a little part time work for a few years? It would make a big difference.

Paul
_________________

[Taylor Larimore]

Hi:
I have been thinking about and studying immediate annuities for a long time. We are in our early 80s. We finally purchased two joint immediate annuities last year. I will share my thoughts:

1. Annuities provide the largest guaranteed lifetime income of any investment.

2. You should be in reasonably good health with prospects of living as long as average.

3. Try to avoid investing more than half your investment portfolio. You need cash for unforseen expenses (medical, nursing care, are big ones).

4. It is disconcerting to see your portfolio substantially reduced.

5. Most states guarantee only up to $100,000 if the insurance company goes bust.

5. Check out www.immediateannuities.com for highest income and company credit reports.

6. In general, I think it is best to avoid the "bells and whistles" that companies make available as add-ons. You can be sure they are padded for unexpected risks and extra profit. It also complicates comparisons (we did not get an inflation rider).

7. Annuities provide creditor protection.

8. Immediate annuities immediately reduce your estate for estate tax purposes.

9. Immediate annuities purchased with taxable funds turn capital-gains into taxable income.

--------------------------------------------------------------
In your situation, if you are considering a $200,000 purchase, I would be inclined to purchase half now and live with it for awhile. In addition to hedging against higher interest rates on which annuities are based, and achieving higher returns by waiting until you are older, you will get a better "feel" about your purchase You will also stay within the state's protective guarantee.

I hope these ideas are helpful.

Best wishes.
Taylor

[JDCPAEsq]

"Immediate annuities purchased with taxable funds turn capital-gains into taxable income."

Taylor - I'm not clear with what you mean by this. There would not be capital gains within the immediate annuity. Are you referring to when you annuitize a deferred annuity?
John

[Allan]

[SoonerSunDevil]

[SoonerSunDevil]

[Taylor Larimore]

[Allan]

[Ron]

[bobcat2]

I think Taylor's advice on annuities has been very sound with one major exception. If your life expectancy at the time of purchase is 15 years or greater, you need to very seriously consider purchasing an annuity with some sort of inflation protection. If you buy a $10,000/yr nominal annuity at age 61, and inflation averages 4% over the next 18 years, then at age 79 your annuity would be worth only $5,000 in today's dollars.

A younger retiree should consider purchasing either a graded payment annuity or an inflation-indexed annuity to protect against the erosion of the purchasing power of the annuity.

Bob K

[nisiprius]

[Ron]

[Ron]

[bobcat2]

I think a very reasonable strategy later on is to take some percentage of your annual gains in the equity portion of your portfolio (say 60% to 100%) and use those gains to purchase additional annuities, thereby locking in a higher floor standard of living. This seems to me to be a very sensible way to rebalance during the portfolio decumulation years of retirement.

Bob K

[bobcat2]

I agree with you. In your special case of a bridge period being the priority a nominal annuity makes perfect sense.

Bob K

[Ron]

[bob u.]

What an absolute delight to see such a thoughtful and sensible discussion of how to use immediate annuities.

Two years ago, and maybe even sooner, it was nearly impossible at most financial sites to have such a discussion. With gratitude, Bob U.[/u]

[LH]

In terms of the 100K insurance by the government:

I assume this is like the 100K bank deposit insurance, you will get your money back? I suppose in some sort of prorated form, say if you buy a lifetime annuity for 100k for whatever income stream it generates, and then 10 years later, the company defaults.

What does the government pay you? I assume a lump sum of cash prorated by some formula?

This is versus my admittedly limited understanding of the government insurance of private pension plans (say GMs), where there is a fixed amount of money backing it, and if enough pensions go down, one may get 50 cents on the dollar or worse back on ones pension.

So, to sum, as far as I have interpreted what I have read, there are two types of government "insurance" in these matters, one which is pretty solid(100k bank) and the other which could end up being dicey with loss of principle(government insurance of a private pension fund GM type).

This could be potentially highly important.

The Black Swan event of peoples life expectancy going dramatically up (think curing cancer, or finding the major ageing genes and turning them off, reversing them partly, finding something that dramatically reduces or eliminates pre-existing plaque systemwide in blood vessels... etc. etc.) in my lifetime certainly does not seem impossible.

what would happen to all these "guarenteed" private contracts/lifetime annuities under this scenerio, ie where will the money come from if the people simply do not die as expected? It would have to be from a government industry wide bailout.

LH

[nisiprius]

[Barry Barnitz]

TIAA-CREF has a paper dealing with this question:

Annuities: Now, Later, Never? by Benjamin Goodman, Director, Actuarial Consulting Services TIAA-CREF and Michael Heller, Vice President, Actuarial Consulting Services TIAA-CREF, October 2006

[nisiprius]

[mas]

[dm200]

[Taylor Larimore]

I wrote:

[bobcat2]

It goes almost without saying that I was referring only to your sound advice on this thread.

Bob K

[Valuethinker]

[LH]

http://www.pbgc.gov/

[Valuethinker]