Bogleheads

[larryswedroe]

Just finished reading Milevsky on this and here is what he advises
Should not annuitize before 65-70. And certainly by 85.
He also suggests a strategy of start buying at 65-70 and then diversify the interest rate risk by buying small amounts each year until say 85 when the full amount you want to annuitize is done.

[Rick Ferri]

My post is a bit off topic, but one that index providers should embrace.

The industry has many 'accumulation indexes' such as target date indexes and the like. What is needed, and what Larry is poking at, is the need for 'distribution indexes'.

IMO, accumulation indexes and distribution indexes need to work hand and hand to create a life-time plan for retirement. That is not yet happening in the investment industry, but needs to.

Rick Ferri

[Raybo]

[bob90245]

Well, I'm just a nobody with a website, but my analysis differs from Milevsky. Once the age 65 retiree starts tapping his or her nest egg, there is also risk of waiting to purchase an an immediate annuity.

Immediate Annuities in Retirement

[bobcat2]

I don't think whether you begin annuitization at age 64 or age 67 makes much difference. What is important is that the annuities be real and not nominal. If you buy a nominal annuity at age 64 and inflation averages only 3% over the next 24 years, then by the time you are 88 the annuity will have lost half its value.

Whether to buy a real annuity at age 63 vs age 66 or 67 partially depends on the level of interest rates when you are 63. If a 63 year old can get a real annuity yielding 5.8% or better why not take it. It's tough to beat a guaranteed real return near 6%. For instance last summer from Elm Income a 65 year old male could get a real annuity yielding slightly more than 6.4%. Pull up the truck.
I don't know the return today on Elm real annuities for 65 year old males, but I am sure it is less than 6.4%.

The other consideration of when to start annuitization is gender. Men get about the same deal at 63 as women get at 65. This is both good news and bad news for the boys.

Bob K
_________________
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it.

[bob u.]

Rick and Bob:

Rick: I hope you do some published work on distribution indexes. That would tie in nicely with life cycle accumulation/decumulation.

Bob: Don't underestimate your contribution. I've seen Milevsky make a number of comments in a number of venues. Bottom line, though: I'm awfully glad I did my SPIA in 2000 (just because the payout suited my needs) and I did it at age 58. A lot depends on payout rates at the time, right?

And, anyway, an SPIA doesn't have to be a onetime event, and a nice payout rate enables unannuitized monies to be left alone until the feds say it's drawdown time. I'll revisit the matter as I approach RMD five years hence. Perhaps an inflation-indexed annuity will appeal if the payout is right. Bob U.

The "Bob" I was addressing was Bob 90425, but I also pay close attention to Bobcat2!

[mephistophles]

Since annuitization is irreversible and ends all future flexibility how does one measure in the risk factor for doing exactly that?

How much of the purchase price of an IIA goes to marketing expenses? I know the agent gets several percent of the premium and I think that higher levels in the marketing distribution also get their share.

ole meph

[4th&Goal]

How about a ladder of 7-10 year Single Payment Immediate Annuities (SPIA) until much later (perhaps 75-80) and then a lifetime SPIA?
_________________
"I advise you to go on living solely to enrage those who are paying your annuities. It is the only pleasure I have left."
(Voltaire)

[frank_davis]

[bilperk]

Are not the new VG funds that offer 3,5,and 7% payouts, somewhat of an indexed distribution vehicle?

best,
_________________
Bill

[nisiprius]

[bob90245]

[nisiprius]

An annuity gradually morphs from one kind of thing into another kind of thing as the age of the annuitant increases. What kind of thing it is depends on the magnitude of what Milevsky calls "mortality credits," the money that goes into the pool from annuitants who pay their premium and die early.

It slowly changes from an ultraconservative investment-like thing into an insurance-like thing.

In the beginning the size of the mortality credits is small. For the first years, the annuity behaves very much as if you'd irrevocably handed over a chunk of money to an insurance company, which invests it in something like Treasury bonds or TIPS and makes monthly payments back to you, after raking off some profit.

It is investment-like, except that you've irrevocably locked a chunk of your asset allocation into an ultraconservative investment. And it resembles something that an annuitant could do for himself.

Incidentally, if the annuity has (say) a ten-year term certain, then for the first ten years of the annuity it is exactly like an irrevocable investment; there's no insurance component at all.

As the annuitant's age increases, the size of the mortality credits increases, and the annuity becomes more and more insurance-like. It becomes less and less like something an annuitant could do for himself. It requires a pool of people, so that the shorter-lived annuitants can pay for the longer-lived annuitants. As the annuitant's age increases, the uncertainty of future lifespan increases, too. That is, the ratio between the smallest number of years his money must last and the largest number of years his money must last gets larger. And the payout as a percentage of premium increases. For all these reasons, SPIAs become more attractive with age.

But let's look at the tradeoffs near the young end of the spectrum, because that's where the controversy is.

First, the "cost" of the lock-in depends on what else the annuitant would have done with the money. The opportunity cost depends on the opportunity. But if the annuity is being purchased for the purposes of covering known and essential expenses, then a prudent (or risk-averse) individual might well have felt obliged to put it into something like a bond ladder anyway.

The opportunity cost of locking in a chunk one's asset allocation into something resembling Treasury bonds is not that high if they would have been in Treasury bonds anyway.

(Yes, one can concoct scenarios... the kidnapper wants a million in small bills, and darn it all, you had a million in small bills just the other day! If only you hadn't bought that SPIA with $200,000 of them yesterday! Or, the only doctor in the world who can save your life charges a lot of money and doesn't participate in your PPO plan....)

Second, the annuity locks in the premium, but the premium also locks in the annuity. If you buy an annuity at age 65 instead of 75, you forgo the possibility of doing anything else with the premium, but there is a return: you receive the benefit of knowing at age 65 what the terms of the annuity will be at age 75. You can't back out of the deal; the insurance company can't back out of the deal.

(An interesting special case concerns CPI-adjusted annuities. The longest TIPS available now are only for twenty years. So a CPI-adjusted annuity provides a hopefully-longer-term inflation-indexed promise than the Treasury does).

In the case of a CPI-adjusted annuity, the annuitant (i.e. me) might say: Interest rates might rise or fall in the future, inflation might increase or decrease in the future, and longevity might increase or decrease in the future. Five, ten, fifteen years from now, the deals available for annuities might be better or worse than the deals available now. But annuities are bought for the purpose of reducing risk, not for the purpose of earning a reward. If an annuity is "good enough" now, it could be rational to buy it now. In the context of reducing risk, it would be worse to wait, and find out later that a "good enough" annuity is no longer available, then to buy now and find out later that one could have gotten a better one.
_________________
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

[bob90245]

[alvinsch]

Does anyone disagree with the following supposition? Most people (but not all), considering an annuity for "longevity insurance" should first delay receiving SS benefits as a more economical first step because annuities have a build in profit margin (gotta pay those insurance agents pushing them), so one should expect to receive less on average. However, whether one delays SS or not, they should be statistically equal (same probability expectation)?

Although, because of the complex SS rules with regard to spouses, I would assume there would be many cases where an annuity might be better than delaying SS. Anyone have examples?

Thanks
- Al

[Ariel]

[mephistophles]

I associate with a lot of CLU's as that was my business. Not one of them owns an IIA nor plans to buy one for their own personal use. All of these people are licensed to sell this product and have the added benefit of getting a commission on the sale to themselves. Many are in their 60's 70's.

In the last few years I have asked many of these people why they think this way. The universal answer is almost always that they do not think it is worth it to tie up their money, irrevocably, with an insurance company and deny their heirs the proceeds at death. Most believe that they can do better with this money and produce a higher yield for themselves by investing in a diversified portfolio of equities, bonds/C.D.s and cash. A few have commercial real estate investments which ties up some of their money.

Not that CLU's are a different class of investors but they are licensed for, trained in and do sell annuities. For the most part they sell deferred annuities and not IIA's.

Regards,
meph

[bobcat2]

Hi Ariel,
That's really good news for 65 year old males. Why wouldn't nearly any guy who is 65 years old and in reasonably good health and retired consider one of these. What alternative investment would give him such a high return and low risk. For that matter why wouldn't guys slightly younger consider this unless the return falls off very sharply by age.

Bob K
_________________
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it.

[sscritic]

[mephistophles]

Good point sscritic (what does that mean) I think that CLU's in retirement would have a net worth higher than the average but few would be considered rich. I would guess an average worth of about two million which really is not a whole lot of money today if you use 4% as a safe withdrawal rate. If my assumption is correct CLU's would be candidates for IIA's.

Another interesting point is my observation that career insurance folks, in general, would seem to be more conservative in their risk profiles than the average Diehard. I guess we may just be a stingy lot and do not want to turn our retirement assets over to the insurance companies we served for all those decades

Regards,

ole meph

[bob90245]

I confess not to be up on all the acronyms related to annuities. I know that SPIA is used to refer to Fixed Immediate Annuities. And IVA is used to refer to Immediate Variable Annuities.

However, I have never run across "IIA" before. What are these?

[mephistophles]

IIA means Immediate Income Annuity, same as SPIA, which is Single Premium Income Annuity. Usually used to distinguish from Deferred Annuity or DA. Annuities can also be fixed as in FA or variable as in VA. And just to confuse the issue you have Equity Indexed Annuities as in EIA's

ole meph

[mephistophles]

SPIA is Single Premium Immediate Annuity.

[nisiprius]

[nisiprius]

[bob u.]

Nisiprius--

You might enjoy the following piece on "money's worth" with respect to SPIAs. http://knowledge.wharton.upenn....icleid=308 You can download the pdf.

Bob U.

[bobcat2]

Nisiprius wrote:

[nisiprius]

[frank_davis]

bob90245:

Using your return sequences, here is the return on one dollar after the following number of years. Scroll down to see the table. For some reason my HTML table tags caused a gap that I cannot get rid of.

Year	-7,-7,7,7,7...	6,6,6...	0,6,12,0,6,12...	12,6,0,12,6,0...
1	0.93	1.06	1.00	1.12
10	1.49	1.79	1.67	1.87
20	2.92	3.21	2.97	3.32
30	5.75	5.74	5.56	5.56
40	11.31	10.29	9.31	10.42
50	22.25	18.42	16.51	18.49

Notice that at only at 30 years are the returns comparable.
I do not know what you are trying to show when you are comparing returns that differ by so much? Of course if you withdraw from the -7,-7,7,7,7... sequence early, you will deplete faster as it has a lower return until 30 years out. But then it overtakes the other sequences after that. This has nothing to do whether you should annuitize or not, it represents the growth of different return sequences.

Frank.

[Ariel]

[ndchamp]

Thanks to nisiprius for his insights on Immediate Annuities.
Much food for thought in his postings, and a great starting point for researching retirement income options.

Nelson

[bobcat2]

Two points
1) If they are going to support the same standard of living in retirement, either the annuitant saves some of the annuity income or the non-annuitant withdraws at a higher than 4% rate. Otherwise the comparison is apples to oranges. The aged non-annuitant left more to heirs because his standard of living in retirement was lower. Yes, but the annuitant can also lower her standard of living and save part of the annual annuity income and leave more for heirs.

2) The 6.4% rate is for age 65. If annuitization starts at age 65 and continues through age 80, one would expect the overall annuitization rate of return to be higher than 6.4%, not lower.

Bob K
_________________
A new scientific truth does not triumph by convincing its opponents and making them see the light, but rather because its opponents die and a new generation grows up that is familiar with it.

[Rick Ferri]

[SoonerSunDevil]

Nisiprius,

I want to let you know that your posts on this thread are some of the best that I have ever read on the topic of annuities, specifically SPIAs. Your posts easily articulate a somewhat complex investment, and your clarity and knowledge rivals that of any other poster.

I hope you continue to post.

John

[bnwest]

The irrevocability part is easy: an annuity isn't just illiquid, it's irrevocable. The money is gone. Four years later, you decide to gamble your whole net worth to start your own business? you can mortage or sell your house, but you can't get the principal out of the annuity.

There are companies that will buy revenue streams.

Brian

[AlanK]

I'm not sure when -- probably years ago -- a conversation took place on the difficulty potential consumers would have in determining the yield from an annuity they were considering buying. In today's discussion, the yield seems easy to find. You take the amount you are putting into an annuity along with the monthly payment. Divide one by the other and you have the yield.

Is it really this straight-forward? Am I confusing this topic's use of "yield" with something else that is related to annuities? I know many comment that the interest rate paid at the time of buying an annuity is important. Am I confusing "interest rate" with "yield?"

[nisiprius]

[bob90245]

[Raybo]

I have a question about annuities.

By the time I get to 65 (another 10 years), I will likely only have IRA money left. If I want to annuitize then I will have to take money out of my IRA to do so. This will make the transaction much more costly.

While I realize it makes no sense to buy a variable annuity inside an IRA, does it make any sense when distributing assets and buying an immediate annuity?

Is it even possible to buy an immediate annuity inside an IRA?

Thanks,

Ray
_________________
Click www below to visit my Bike Touring Archive at biketouringtips.com.

[Barry Barnitz]

[bob u.]

Speaking of heirs and bequests, it seems the bequest motive is not quite as powerful as one might believe from some commentary that resists the idea of SPIAs on the grounds that SPIAs eliminate "bequests." Have a look. http://www.newsday.com/busines....4894.story

If someone has a link to the Jagadeesh Gokhale/Laurence Kotlikoff Federal Reserve Bank of Cleveland paper identifying a "declining bequest ethic," I'd sure like to see it.

If our kids are a reasonable example (ages early 30s - 40) they kinda like "living bequests," so to say--like having been put through college debt free, like receiving help with first home, like gifts of travel and leisure, and such. We're of the view that not only is it better to give than to receive, but it's still better to give while you're alive and get the living benefit of delight at both ends.

If I read Bob K correctly, he's quite right that a generous payout from an SPIA (as well as an IVA) also enables gifting in the here and now. I can testify to this. Of course, some payouts just ain't what they used to be, but this could change.

Bottom line (for me at least): there are nuances to the use of immediate annuities (fixed/variable) and those nuances seriously undercut a narrowly circumscribed idea of what constitutes a "bequest." Cheers. Bob U.

[frank_davis]

Your analysis is based on a 4% withdrawal rate.

[Barry Barnitz]

I am not sure if this is the paper referenced in the article, since it dates from the year 2000:

The Baby Boomers’ Mega-Inheritance —Myth or Reality? by Jagadeesh Gokhale and Laurence J. Kotlikoff

[Greenberry]

[dbr]

I'm trying to think what can be added to Al and Greenberry:

SS is a COLA adjusted (or is it wage adjusted?) 50% joint and survivor annuity pending the complications aluded to regarding spousal benefit. Anyway comparison to commercial annuity returns should keep this in mind and run the numbers for a person looking at age 62 to start.

SS is taxed at a varying rate depending on other income and may become more taxed in future. An annuity is taxed in proportion to qualified vs. after tax funding. Tax rates for ordinary income are also subject to "Congress Risk." Result = "it depends"

SS may have "Congress Risk" but for those already qualified today this seems minor, relatively speaking. Annuties have agency risk (right term?) but is this overblown?

These seem like small points compared to the no-brainer value of postponing SS to buy longevity insurance. I see this as especially helpful in the case of a person with a non-COLA pension and SS contributing about equally as postponing SS is a weapon against inflation risk.

[mephistophles]

My brokerage house, which represents many companies gets a gross commission payout from the insurance company of 4% of the investment amount. 3% goes to the agent and 1% goes to the brokerage house. I would imagine that these numbers would apply to other brokerage houses and insurance companies whether they market through agents or direct.

There are a number of carrier with Best ratings of A++ including Sun Life. Many other companies carry A+ ratings such as Genworth. Right now, American National with an A+ rating is very competitive.

The profit to the insurance company comes out of the 96% of the premium they get to keep. I do not know what their average profit margin is for SPIA's. I do know that they are a profitable item for the Insurance Company as they actively promote the product to their brokers and agents.

These annuities are profitable for agents/brokers/financial advisors who sell them as they are generally a big ticket item. If I sell one for $100,000 I make $3,000 commission for recommending and selling this product to a client. The paperwork is just a few simple forms as their is no underwriting. The commission comes through fast and quick in most cases. Compared to sales of other products, annuities are the easiest and perhaps most profitable time wise. By the way, in all cases where I have sold IIA's I always disclose my commission up front, even though I am not required to. I do no fee work and I do not take a percentage of income to manage portfolio's.

I would recommend that anyone buying one of these products ask the seller exactly how they are paid if they recommend and sell you an annuity themselves, through a company they have a financial interest in or through any partnering arrangement where commission dollars flow back to the seller. If you are also paying management fees of any kind I would recommend looking at all compensation paid to the agent/planner so that you get a good idea of the total sales load you are paying.

Regards,
ole meph

[nisiprius]

[nisiprius]

[mephistophles]

Very good posts.

Long ago we were trained to think of life insurance as insurance against dying to soon and annuities as insurance against living too long.

Most CLU's I know have Long Term Care Insurance. I never inquired as to amount.

Regarding annuitization, the subject sometimes comes up in discussion groups or at meetings and sometimes in personal conversations. I get the sense that CLU's do not plan to annuitize at any point down the road but this is subjective. Nor have I ever discussed running the numbers on IIA vs other vehicles except in a very, very general way. Believe it or not, CLU's crunch numbers mainly for clients and not for themselves. Most of us have defined benefit pension plans in addition to our Social Security. Since both of these are paid as annuities maybe we feel that is enough money tied up that way. Most of us also have 401k's/thrift plans and we generally plan to make withdrawals from them, as needed, in the latter stages of our retirement.

I think that, perhaps intuitively, CLU's just have a general sense that SPIA's are probably more profitable to the company than the individual. We know that when someone talks of their monthlyor annual payouts as yield that they do not understand that they are receiving part principle and part interest and what they are getting from the company is just a guarantee that the income stream won't run out. Also, most CLU's continue to carry permanent life insurance into retirement and plan to die with it. We do this, not because we need it but because we want it to leave our heirs better off than we were at their ages and to leave money to institutions and other good causes.

Hope that helps clarify.

Regards,

ole meph

[bob u.]

Barry--

Thanks! That's the one--October, 2000. Bob U.