SPIA - what am I missing

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Tim18
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SPIA - what am I missing

Post by Tim18 »

I have just seen reference to SPIA and have read a bit about it. The comments made in another topic talks about a 6% payout. On another site I read this:

As determined by the individual, the income guarantee can cover a specific period of time, or it can cover the person’s lifetime. In either case, the life insurer guarantees that all of the principle plus all of the interest it is projected to earn, will be paid out in equal periodic installments, typically monthly, until it is completely distributed.

Might a SPIA be used in lieu of stocks and bonds? When would one want to consider using a SPIA. Being able to count on 6% makes me think I am missing something? Perhaps allocate some amount to a SPIA and the balance in regular stock/bonds. Isn't that 6% number a secure percentage? Help me out. :?:
hicabob
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Re: SPIA - what am I missing

Post by hicabob »

That's a strange definition for an SPIA. Typically an SPIA pays out an equal amount every month until the annuitant is dead - COLA, Survivorship, guaranteed minimum payouts etc lower the amount of the monthly payment for a given investment.
dhodson
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Re: SPIA - what am I missing

Post by dhodson »

Tim18 wrote:I have just seen reference to SPIA and have read a bit about it. The comments made in another topic talks about a 6% payout. On another site I read this:

As determined by the individual, the income guarantee can cover a specific period of time, or it can cover the person’s lifetime. In either case, the life insurer guarantees that all of the principle plus all of the interest it is projected to earn, will be paid out in equal periodic installments, typically monthly, until it is completely distributed.

Might a SPIA be used in lieu of stocks and bonds? When would one want to consider using a SPIA. Being able to count on 6% makes me think I am missing something? Perhaps allocate some amount to a SPIA and the balance in regular stock/bonds. Isn't that 6% number a secure percentage? Help me out. :?:
The amount of payout isnt guaranteed at 6%. There are no guarantees of what the % will be if you are talking lifetime. They guarantee you a certain amount per month/year for the rest of your life in regards to a lifetime spia not including taxes. If you live a very long time then it will be a better deal. If you live a shorter life then it wont be a great deal. In general these companies are investing the money in their general accounts which are primarily bonds/treasuries. They have substantial costs including the actual insurance component and then the rest is passed through. Thus if they were some how giving you 6% then they would need to be able to guarantee themselves 8-9%. I dont believe anyone has a method today to do that. Also take a look at the guaranteed returns on their deferred fixed annuities (where they dont have to guarantee you income for life). You will notice those arent 6% either.
Khanmots
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Re: SPIA - what am I missing

Post by Khanmots »

Think of a SPIA is insurance not an investment. You're insuring against living too long.

Consider you and your buddy having $100k each. Assume you're both 70, in poor health, and are only expecting to make it to age 78 or so. :( Now, that $100k will last you until age 80, so you're ok if you live a little longer than expected... but what happens if one of you lives until they're 85?

Well, both of you are worried about this so you get together and make a pact. You'll combine your $100k to have $200k total. You'll both withdraw at the same rate and when one of you dies the other gets what's left. Now, if one of you dies at 75 and the other lives to 85 you're both fine.

But what if both of you beat the odds and live to 85? Well... how about you get some more buddies involved? The more of you there are the more likely it is that you all won't defy the odds... and here is where SPIA show up. They help you get hundreds of thousands of people to make this pact with.

Just like buying insurance on your house, you're not expecting a return from it. You're expecting to be able to not be put in the poorhouse if your house burns down. In this case the risk isn't fire, it's you living too long. A SPIA is insurance against this. If you *do* live "too long" then you get more than you paid in. If you don't you get less... with the extra you paid going to those who live longer.

Now it's a bit more complex than that as the provider takes a cut for managing all this, and they'll keep the funds invested in stocks/bonds not just sitting around as cash; but this is the basic idea.
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Re: SPIA - what am I missing

Post by Khanmots »

dhodson wrote:The amount of payout isnt guaranteed at 6%. There are no guarantees of what the % will be if you are talking lifetime. They guarantee you a certain amount per month/year for the rest of your life in regards to a lifetime spia not including taxes. If you live a very long time then it will be a better deal. If you live a shorter life then it wont be a great deal. In general these companies are investing the money in their general accounts which are primarily bonds/treasuries. They have substantial costs including the actual insurance component and then the rest is passed through. Thus if they were some how giving you 6% then they would need to be able to guarantee themselves 8-9%. I dont believe anyone has a method today to do that. Also take a look at the guaranteed returns on their deferred fixed annuities (where they dont have to guarantee you income for life). You will notice those arent 6% either.
Note they're talking about an average payout... including return of principle. This is not the same as a return on principle. (But some sellers of SPIAs sure like to make it sound similar so as to confuse people!)
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HomerJ
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Re: SPIA - what am I missing

Post by HomerJ »

Tim18 wrote:I have just seen reference to SPIA and have read a bit about it. The comments made in another topic talks about a 6% payout. On another site I read this:

As determined by the individual, the income guarantee can cover a specific period of time, or it can cover the person’s lifetime. In either case, the life insurer guarantees that all of the principle plus all of the interest it is projected to earn, will be paid out in equal periodic installments, typically monthly, until it is completely distributed.

Might a SPIA be used in lieu of stocks and bonds? When would one want to consider using a SPIA. Being able to count on 6% makes me think I am missing something? Perhaps allocate some amount to a SPIA and the balance in regular stock/bonds. Isn't that 6% number a secure percentage? Help me out. :?:
SPIA is fairly simple... You give an insurance company $100,000, they give you, say, $6000 a year for the rest of your life... That's where you see the 6% payout... Single-payment, immediate annuity. You pay them one large payment, they pay you annually starting immediately. But the $100,000 is gone. It's not your money anymore. They keep it even if you die 2 years later. Your $100,000 is not "growing" at 6%. It's gone...

And they aren't going to give that kind of money to you unless you're pretty old... At 70, you might get $6,000 a year, at 80, you might get $10,000 a year. At 50, you'll might only get $2,000.

It's all about mortality rates... See, if you die 2 years into a SPIA, you don't get any money back... So you may have given them $100,000 and only got paid $12,000. But if you live to be 105, you will get paid a lot. The insurance companies can use some of the money from the people who die early to pay the people who die late.

SPIA is the only good annuity. Very straightforward. Very easy. But it's probably not worth doing until you're in your late 60s or 70s.
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Tim18
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Re: SPIA - what am I missing

Post by Tim18 »

Thanks much. On track again.
Tim
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HomerJ
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Re: SPIA - what am I missing

Post by HomerJ »

I've been trying to talk my father-in-law (he's 81) to buy a SPIA...

We keep telling him to spend some of his money for fun stuff, and he says "But what if I live to be 100?"

So I'm trying to get him to throw his half his money into a couple of SPIAs. At his age, the payouts are very good (like $11,000 a year for $100,000 because they figure he's going to die in 5 years).

That way, his basic needs are totally covered (x2!), and he can feel free to spend some money on fun stuff, because he's guaranteed that money coming in.

But then he asks "But what if I die at 84?" And he can't stand the thought of giving away half his money

Heh.

I can't win for trying.

(It's also good dementia protection - My FIL is still pretty sharp, but say at 90 his mind starts to wander... He might give away or lose a huge chunk of his money... With a SPIA, the payments just keep coming in, so he can't bankrupt himself with bad decisions)
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Re: SPIA - what am I missing

Post by nisiprius »

Tim18 wrote:Might a SPIA be used in lieu of stocks and bonds?
Yes.
When would one want to consider using a SPIA?
When one does not want to leave an inheritance, and does want to use all of one's own money as "efficiently" as possible for ones' self. When the portfolio is borderline in terms of being able to sustain the desired amount of income.
Being able to count on 6% makes me think I am missing something?
What you might be missing is that the 6% is not an investment return. It is a combination of investment returns and your own premium being paid back to you. Also, you might be missing that the 6% is a level amount and does not increase with inflation. There are annuities whose payouts are indexed to the CPI, and you can get easily quotations on them if you have an account at Vanguard, and there are annuities whose payouts increase by a specific percentage every year (e.g. 3%). Since these annuities would be expected to pay out much more later, they pay out much less earlier.
Perhaps allocate some amount to a SPIA and the balance in regular stock/bonds?/quote]Many experts suggest this and this happens to be what I am doing myself.
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Quickfoot
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Re: SPIA - what am I missing

Post by Quickfoot »

You typically use a SPIA to provide for your base living expenses to insulate yourself from market movements. You can get one as early as 60, or as late as you want. SPIAs pay a higher amount than bonds and the payments last for your life, you can get a 20 year rider with essentially no decrease in payments which guarantees at least your principle will be paid back to either you or your heirs. They are a good choice because they enable a higher spend rate in the early years of retirement, protect you from market movements, and guarantee you wont run out of money. Most states guarantee the principle up to a certain amount (300K in Idaho). The guarantee is per company so you can have multiple SPIAs and be protected from loss of principle.

When we retire we'll likely use a SPIA for base living expenses and consider market returns gravy. We may purchase a SPIA as soon as 60 or may delay to 67, just depends on our situation and SPIA payout rates at the time. We will delay social security to 70 because it's basically an inflation adjusted annuity.
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archbish99
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Re: SPIA - what am I missing

Post by archbish99 »

In short, a SPIA is reverse life-insurance. Life insurance hedges the risk that you die before you (well, your dependents) can afford to do without your income, and it provides a lump-sum which you expect to cover their needs that you can no longer fulfill, in return for monthly/annual payments until then. A SPIA hedges the opposite risk -- that you don't die when you're out of money. It takes a lump-sum, and turns it into monthly/annual payments that are guaranteed for your life, however long or short that is.

Some people "win big" with life insurance, being diagnosed with terminal cancer two months after signing up. Others pay in for years, and don't die. Same happens with a SPIA, in reverse. And like life insurance, you can self-insure -- if you have sufficient assets to cover you no matter how long you live, there's not too much point.
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Tortoise Banker
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Re: SPIA - what am I missing

Post by Tortoise Banker »

" Since these annuities would be expected to pay out much more later, they pay out much less earlier.[quote]Perhaps allocate some amount to a SPIA and the balance in regular stock/bonds?/quote]Many experts suggest this and this happens to be what I am doing myself.

"When we retire we'll likely use a SPIA for base living expenses and consider market returns gravy. We may purchase a SPIA as soon as 60 or may delay to 67, just depends on our situation and SPIA payout rates at the time."

@[b]nisiprius and quickfoot [/b]If you don't mind me asking, will you be using COLA SPIAs or non-COLA SPIAs?

I've been debating which to use. Thanks!
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Munir
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Re: SPIA - what am I missing

Post by Munir »

HomerJ wrote:I've been trying to talk my father-in-law (he's 81) to buy a SPIA...

We keep telling him to spend some of his money for fun stuff, and he says "But what if I live to be 100?"

So I'm trying to get him to throw his half his money into a couple of SPIAs. At his age, the payouts are very good (like $11,000 a year for $100,000 because they figure he's going to die in 5 years).

That way, his basic needs are totally covered (x2!), and he can feel free to spend some money on fun stuff, because he's guaranteed that money coming in.

But then he asks "But what if I die at 84?" And he can't stand the thought of giving away half his money

Heh.

I can't win for trying.

(It's also good dementia protection - My FIL is still pretty sharp, but say at 90 his mind starts to wander... He might give away or lose a huge chunk of his money... With a SPIA, the payments just keep coming in, so he can't bankrupt himself with bad decisions)
If he uses the time-certain provision (say five or ten years), then he or his heirs will be paid for that period of time whether he is alive or dead. If the time-certain period is chosen carefully, he (or his heirs) will get back all the original premium paid. If he lives longer, he will contiue to receive payments as long as he is alive. Check out that option.
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Frugal Al
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Re: SPIA - what am I missing

Post by Frugal Al »

To expand a bit on what others above have said, payout and equivalent compounded rate of return should not be confused.
A recent non-indexed SPIA payout for a 65 year old male was listed at 7.05% (up from 6.45% just a few months ago).
On a $100k annuity, 7.05% payout = 587.50/month
If that person lives to the average age of 84, the compounded return equivalent = 3.23%
25% will live to age 90, and the compounded return equivalent = 5.05%
10% will live until past age 95, and the compounded return equivalent at 95 or past = 5.81% or better
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Rob5TCP
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Re: SPIA - what am I missing

Post by Rob5TCP »

Here is a good site for annuity estimates

http://www.immediateannuities.com/

I asked for rates at 50, 65 and 80 on 100,000 and here were the results (and the annual % return of your money)

$440 (5.28%) / $585 (7.02%) / $972 (11.66%)
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Frugal Al
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Re: SPIA - what am I missing

Post by Frugal Al »

Rob5TCP wrote: here were the results (and the annual % return of your money)
Yes, return of your money, not on your money.
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Re: SPIA - what am I missing

Post by Khanmots »

Tortoise Banker wrote:" Since these annuities would be expected to pay out much more later, they pay out much less earlier.
Perhaps allocate some amount to a SPIA and the balance in regular stock/bonds?/quote]Many experts suggest this and this happens to be what I am doing myself.

"When we retire we'll likely use a SPIA for base living expenses and consider market returns gravy. We may purchase a SPIA as soon as 60 or may delay to 67, just depends on our situation and SPIA payout rates at the time."

@nisiprius and quickfoot If you don't mind me asking, will you be using COLA SPIAs or non-COLA SPIAs?

I've been debating which to use. Thanks!
I'm a long ways from needing to make this decision myself... but my personal belief is that you're trying to hedge outliving your money. And given how inflation and time work... inflation is not an independent risk here.

I'd suggest that the decision on COLA or not should be based on how many years you're worried about the SPIA supporting in the worst reasonable case. i.e., if you're in your 60s and based on health and family history there's a reasonable probability that you could live 40 more years I'd think that COLA would be highly important. If you're 85 or 90 and are in failing health and have already lived longer than anyone in your families history, I'd suspect COLA isn't all that helpful. If you're in between these two extremes... well... maybe. :mrgreen:
ndchamp
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Re: SPIA - what am I missing

Post by ndchamp »

Frugal Al wrote:
Rob5TCP wrote: here were the results (and the annual % return of your money)
Yes, return of your money, not on your money.
True, but if you were to withdraw that 7% from your money annually, how long would it last?
A lifetime?
What are the odds? Transferring that risk to an insurance company is a strategy, not an investment.
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Re: SPIA - what am I missing

Post by hicabob »

Frugal Al wrote:To expand a bit on what others above have said, payout and equivalent compounded rate of return should not be confused.
A recent non-indexed SPIA payout for a 65 year old male was listed at 7.05% (up from 6.45% just a few months ago).
On a $100k annuity, 7.05% payout = 587.50/month
If that person lives to the average age of 84, the compounded return equivalent = 3.23%
25% will live to age 90, and the compounded return equivalent = 5.05%
10% will live until past age 95, and the compounded return equivalent at 95 or past = 5.81% or better

It's impressive that the rate has gone up .6% already. Back in the days of real interest rates (let's say 7% money market rates) (and before I has a clue what an SPIA was) what would an SPIA payout percentage for a 65 year old man have been?
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Frugal Al
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Re: SPIA - what am I missing

Post by Frugal Al »

hicabob wrote:It's impressive that the rate has gone up .6% already. Back in the days of real interest rates (let's say 7% money market rates) (and before I has a clue what an SPIA was) what would an SPIA payout percentage for a 65 year old man have been?
This is in our Wiki I believe and was originally posted by bluestar, as I recall. It's worth a repost. The original source might actually be Morningstar.

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jwa
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Re: SPIA - what am I missing

Post by jwa »

SPIA annuity payouts are based upon three components. Interest returns, return of principal and survivorship credits. The latter component is rarely thought about in threads on SPIA. This is one reason insurance carriers can pay out 6% when the wag in the other room says it can't be done because Dr Wade Pfau now tells me that even 4% isn't a SWR % at this time with market returns where they are.

The first component is easy enough to understand. The second point should be easy enough to understand. One reason to use after tax dollars on an annuity is that the return of principal part isn't income that is taxed. I've seen that in the early years of an annuity that only 60% of the payout is taxed which makes that 6% payout even more attractive. The final component of survivorship credits works like this. Using an earlier example of two people placing $100,000 with an insurance carrier. One dies two years in and only collects $12,000, what happens to the rest of the dough? It is used to help make the payouts to the survivor who lives to 105. Sort of a zero sum game if you will.

So if one considers all three components a 6% payout is not only plausible it can actually be done. I may be wrong and if I am someone feel free to correct me but this is how I understand it from what I've read. Of course when interest rates rise, which I am assuming will be the case someday, the 6% payout can and will be increased even higher.

When threads get started on SPIAs the one component I see missed regularly is survivorship credits are part of the payout.
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Re: SPIA - what am I missing

Post by dbr »

jwa wrote:SPIA annuity payouts are based upon three components. Interest returns, return of principal and survivorship credits. The latter component is rarely thought about in threads on SPIA. This is one reason insurance carriers can pay out 6% when the wag in the other room says it can't be done because Dr Wade Pfau now tells me that even 4% isn't a SWR % at this time with market returns where they are.

The first component is easy enough to understand. The second point should be easy enough to understand. One reason to use after tax dollars on an annuity is that the return of principal part isn't income that is taxed. I've seen that in the early years of an annuity that only 60% of the payout is taxed which makes that 6% payout even more attractive. The final component of survivorship credits works like this. Using an earlier example of two people placing $100,000 with an insurance carrier. One dies two years in and only collects $12,000, what happens to the rest of the dough? It is used to help make the payouts to the survivor who lives to 105. Sort of a zero sum game if you will.

So if one considers all three components a 6% payout is not only plausible it can actually be done. I may be wrong and if I am someone feel free to correct me but this is how I understand it from what I've read. Of course when interest rates rise, which I am assuming will be the case someday, the 6% payout can and will be increased even higher.

When threads get started on SPIAs the one component I see missed regularly is survivorship credits are part of the payout.
You are correct that the insurance component, pooled risk, survivorship, mortality credits or whatever one calls it is often misunderstood. I'm not sure those threads get very far without someone providing a reminder, however. In any case if one starts reading comments about the "return" obtainable in an SPIA there is probably a misunderstanding. It is also important to recognize the different flavors of risk and what can be done to ameliorate risk. This same concept applies to discussions of when to initiate Social Security.

This also goes back to the fact that the real point about SWR is that it is very difficult to match variable assets to stable income. It is not, however a foregone conclusion that no one can rationally retire on a portfolio alone. However, there is a popular concept these days, though probably going back to some old roots, of looking more closely at how to sensibly supply income streams.
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Frugal Al
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Re: SPIA - what am I missing

Post by Frugal Al »

jwa wrote:When threads get started on SPIAs the one component I see missed regularly is survivorship credits are part of the payout.
Of course the beauty of SPIAs is that no one necessarily cares how the sausage is made, just how much they get. And we don't always get all the sausage we should get--or all of the survivorship credit. In some countries I believe the credit is a real accounting function on some annuities, i.e., someone dies early and their share is literally split amongst the other survivors. I can't imagine trying to manage that.
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Re: SPIA - what am I missing

Post by RockyMountain »

Not only can the insurance company diversify risk away by pooling a bunch of customers, they also diversify by selling both SPIAs and life insurance.

Life Ins : Insurance company wins if you live longer
SPIA : Insurance company wins if you die sooner

By selling both, insurance companies are on both sides of the mortality table. If they sell an equal amount of SPIAs and Life Insurance contracts, then can simply collect a percentage off the top for guaranteed profit no matter when people die. This is similar the the casino setting sports betting lines. As long as the casino can set the line so that money is even on both sides of the bet, then they can count on a profit no matter the outcome.

This is a pretty cool deal and highlights the value that an insurance company is well positioned to provide. But what could be a great deal for consumers is soured by the greed of the insurance company. Simple SPIAs are the cheapest form of annuity primarily because they are commodity products and you can easily comparison shop. But salesmen like to throw all kinds of riders into the mix, things like guaranteed payout periods and tracking market returns with guaranteed limits on losses and gains. All these extras increase the "expense ratio" and make it harder for you to comparison shop with apples to apples. Because of the simplicity, transparency and competition, salesmen earn the smallest commission for selling simple SPIAs. Bad for salesman = good for you. But you better know this going in, because a salesman is going to sell you an SPIA only if you know already that is what you want.
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Re: SPIA - what am I missing

Post by Munir »

[quote="Khanmots][/quote]

I'm a long ways from needing to make this decision myself... but my personal belief is that you're trying to hedge outliving your money. And given how inflation and time work... inflation is not an independent risk here.

I'd suggest that the decision on COLA or not should be based on how many years you're worried about the SPIA supporting in the worst reasonable case. i.e., if you're in your 60s and based on health and family history there's a reasonable probability that you could live 40 more years I'd think that COLA would be highly important. If you're 85 or 90 and are in failing health and have already lived longer than anyone in your families history, I'd suspect COLA isn't all that helpful. If you're in between these two extremes... well... maybe. :mrgreen:[/quote]

The payout amount is significantly lower when you add an inflation rider. I had read in the past (do not have the reference) that it takes about 12-14 years for a payout with an inflation rider to reach the level of the plain payout without an inflation rider. Is this correct?
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BrandonBogle
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Re: SPIA - what am I missing

Post by BrandonBogle »

Munir,

While I do not have an answer to your question (haven't look), I will say that personally, I would convert SOME of my assets into a SPIA and leave the rest invested. To me, that would be my own "inflation" rider. But, just as with the SPIA decision itself, it's a question about whether it is more effective for you to "self-insure" versus buying the "insurance".
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Re: SPIA - what am I missing

Post by dbr »

Frugal Al wrote: In some countries I believe the credit is a real accounting function on some annuities, i.e., someone dies early and their share is literally split amongst the other survivors. I can't imagine trying to manage that.
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RockyMountain
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Re: SPIA - what am I missing

Post by RockyMountain »

BrandonBogle wrote:Munir,

While I do not have an answer to your question (haven't look), I will say that personally, I would convert SOME of my assets into a SPIA and leave the rest invested. To me, that would be my own "inflation" rider. But, just as with the SPIA decision itself, it's a question about whether it is more effective for you to "self-insure" versus buying the "insurance".
Agreed. I could see myself buying an SPIA to cover only my essential expenses. I would not buy the COLA rider. I would instead invest my remaining portfolio rather aggressively (the SPIA would be a large bond allocation) with an emphasis on inflation (stocks, real estate, commodities, energy). When my SPIA won't cover my essential expenses any more, I could harvest another piece of my portfolio and by another SPIA. Presumably my portfolio is keeping up with inflation. Buying another SPIA when I am older should result in higher payout rates. And if I die relatively young, I will still have something pass on to heirs.
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