A self constructed annuity

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Hexdump
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A self constructed annuity

Post by Hexdump »

I had originally intended to buy one from Vanguard using $300,000.00 from my T-IRA which is 100% invested in
VWIAX, Wellesley Admiral.

I delayed the purchase since I wanted to wait until the year end capital gains are paid.
Well, as if often my wont, I have started trying other ideas, one of which would be to put the $300,000.00 into something that I could sell each month and give me the same payment as the original annuity.

Original annuity = a monthly payment of $1,420.61 which they say is a yield of 5.68%.

If I simply left the $$$ in Wellesley and sold enough each month for $1,420.61, andl if Wellesley continued to perform as in the past, that should suffice.
Since inception it is 7.14%

And I know all about past performance, etc., but what else do we have to go on ?

So, if you were to build your own annuity what would it look like ?
For other reasons, I want to keep it simple. 1 fund is best, 3 is max.

Thanks
Professor Emeritus
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Re: A self constructed annuity

Post by Professor Emeritus »

You are not describing an annuity. It is simply an investment subject to market risks. I have lots of money in VWIAX. It's a fine investment and I will take some of that money out to allow me to defer Social Security, thus "buying" a very cheap inflation protected annuity.

What you have to go on is what the market is offering for the next 25 years.
No question if you have a guaranteed 7% return for the rest of your life TAKE IT. I would.
But no one seems to be offering 7% guaranteed over the next 25 years.
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nisiprius
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Re: A self constructed annuity

Post by nisiprius »

I just wish people wouldn't use the word "annuity" for this. An insurance company life annuity works by pooling the lives of many annuitants, subsidizing the extended payments to the longer-lived ones from the unused principal left by the shorter-lived ones. You can't "self construct" an annuity like this.

There are two basic approaches to getting lifetime income from an investment portfolio. One might be called a "perpetuity" because the idea is that it can keep making the payout forever, therefore it can keep making the payout to you for however long you live, with the portfolio being left to your heirs. You could do this, for example, by investing in the Wellesley Income Fund and never selling any fund shares, spending only the dividends distributed from that fund, adjusting to variations.

The other approach which I guess is what you are thinking about, is discussed in this forum under the rubric of "safe withdrawal rate," in which you spend more, allow spending to draw down the portfolio at times, and accept the possibility that the "terminal value" of your portfolio may be small, just as long as it never hits zero.

Your reasoning is dangerously like that commonly used in the 1990s, when people based projections merely on average past returns and concluded that you could have a safe withdrawal rate of 7%. It turns out that is dangerously wrong, because it doesn't take into account "sequence of returns" risk. If you have the bad luck of having a bear market arrive early in retirement, your portfolio shrinks--either because withdrawals exceed return, or because the stock market is declining so fast that the portfolio would shrink even without withdrawals. So the same amount of money that was 7% of portfolio, as the portfolio shrinks, becomes 8% and 9%, and 10% and the shrinkage accelerates. The result is that even if a bull market arrives, one that is big enough to restore the average performance for someone who is buying and holding, it doesn't restore your portfolio because it is growing something that has already shrunk.

It was discovered in the late 1990s that if you want a good chance to have your portfolio survive thirty years, and if you want your spending to increase with inflation, you cannot spend 7% or anything close to it. The safe withdrawal rate is much lower than the average long-term return of the portfolio.

The rule of thumb is 4% (of the initial portfolio). That is, if you start with $1,000,000 you can withdraw $40,000 the first year and increase it for inflation each year thereafter.

Vanguard has a sort of calculator for this here: Retirement Nest Egg Calculator. You can't actually plug in Wellington or Wellesley but you can plug in the same stock/bond allocation.

The past/future problem is always there, but BASED ON THE PAST the safe withdrawal rate is in the ballpark of 4% and oddly enough experts have done nothing but reduce it as time goes on. Many are saying now that 4% may be too much.

Vanguard has been compelled to reduce the payout on their Managed Payout Growth & Distribution Fund, an aggressively-managed portfolio with a heavy stock allocation, from 5% to 4%.
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.
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Re: A self constructed annuity

Post by Professor Emeritus »

nisiprius wrote:I just wish people wouldn't use the word "annuity" for this. An insurance company life annuity works by pooling the lives of many annuitants, subsidizing the extended payments to the longer-lived ones from the unused principal left by the shorter-lived ones. You can't "self construct" an annuity like this.
.

I share your frustration and agree with the rest of the post but there are technically quite a number of types of annuities

an·nu·i·ty
əˈn(y)o͞oitē/
noun
noun: annuity; plural noun: annuities

1.
a fixed sum of money paid to someone each year, typically for the rest of their life.
"he left her an annuity of $1,000 in his will"

such annuities payable from property were a common feature of 17th to 19th century wills. they were similar to a possessory life estate. Often the eldest son got possession but had to pay an annuity to the the others from the estate.
They were a burden on the sale of property so it became possible to substitute an insurance or bank annuity for the one backed by the property.
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nisiprius
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Re: A self constructed annuity

Post by nisiprius »

Professor Emeritus wrote:
nisiprius wrote:I just wish people wouldn't use the word "annuity" for this. An insurance company life annuity ...
there are technically quite a number of types of annuities...
Which is why I used the phrase "insurance company life annuity." Literally the word annuity by itself just means any series of periodic payments.

The tables that used to be in the math table handbooks--back in the days when you needed books of tables--had things like "Table of Present Value of an Annuity," which meant payments for a fixed number of years... not forever, not for a lifetime. In that sense, a mortgage or car loan is an annuity--from the point of view of the bank.
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.
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Re: A self constructed annuity

Post by hoppy08520 »

There have been threads about creating a quasi-"annuity" through an I Bond or EE Bond ladder:
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Taylor Larimore
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Re: A self constructed annuity

Post by Taylor Larimore »

Hexdump:

A single premium lifetime annuity (SPIA) provides the highest guaranteed lifetime income of any investment. You cannot match it.

Best wishes.
Taylor
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whomever
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Re: A self constructed annuity

Post by whomever »

You don't mention your age/life expectancy, which matters when asking these questions.

FWIW, I went to firecalc.com and plugged in a 300K balance, 36% stocks (approx what Wellesley is), $17040 annual spending, and a 40 year period, to make it sort-of-annuity-like. The most pessimistic case went to a zero balance in 15 years or so; many cases went to zero in less than 25 years. You might want to go there and plug in some numbers.

What firecalc and similar tools do is take your numbers and then use actual historical returns; if you had retired in 1950 and gotten the subsequent N years of market performance and inflation, then if you had retired in 1951, .... This comes up with numbers that are more pessimistic than assuming a straight X% return each year because in some years you have a bad run right after you retire; if you retire today intending to withdraw $17K from $300K and the market drops 50%, you're taking $17K from $150K. It doesn't take very much of that early on to really torpedo things.

On the flip side, with an annuity you want to think about what effect inflation will have over time; even 2% inflation over 20 years makes a big difference (assuming a non-indexed annuity).
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Re: A self constructed annuity

Post by umfundi »

If you want to understand the basic idea of an immediate annuity (which is an insurance contract, not an investment), check out what a "tontine" is:

http://en.wikipedia.org/wiki/Tontine

If you buy a Single Premium Immediate Annuity you will get a return (not a "yield") which is part investment return, part return of capital, and part "mortality credit" which is the money not paid to those who have died before you.

The mortality credit increases the payment beyond any other guaranteed contract you can purchase, as Taylor has pointed out.

An annuity is insurance against longevity risk, against ever running out of money or income. Sure, you might die early, but you might also live to be 100.

If you want to build your own guaranteed income stream, you can do it. I recommend "Asset Dedication" by Huxley and Burns.

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Re: A self constructed annuity

Post by Professor Emeritus »

nisiprius wrote:
Professor Emeritus wrote:
nisiprius wrote:I just wish people wouldn't use the word "annuity" for this. An insurance company life annuity ...
there are technically quite a number of types of annuities...
Which is why I used the phrase "insurance company life annuity." Literally the word annuity by itself just means any series of periodic payments.

The tables that used to be in the math table handbooks--back in the days when you needed books of tables--had things like "Table of Present Value of an Annuity," which meant payments for a fixed number of years... not forever, not for a lifetime. In that sense, a mortgage or car loan is an annuity--from the point of view of the bank.
My minor and thoroughly pedantic issue is that even an "An insurance company life annuity" does not have to involve pooling at all. Such annuities often involved collateral guarantees based on actuarial analysis.

Edmond Halley, (yes that Halley) was instrumental in the development of the mathematical basis for annuities
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Hexdump
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Re: A self constructed annuity

Post by Hexdump »

Professor Emeritus wrote:
nisiprius wrote:I just wish people wouldn't use the word "annuity" for this. An insurance company life annuity works by pooling the lives of many annuitants, subsidizing the extended payments to the longer-lived ones from the unused principal left by the shorter-lived ones. You can't "self construct" an annuity like this.

The other approach which I guess is what you are thinking about, is discussed in this forum under the rubric of "safe withdrawal rate," in which you spend more, allow spending to draw down the portfolio at times, and accept the possibility that the "terminal value" of your portfolio may be small, just as long as it never hits zero.

.

I share your frustration and agree with the rest of the post but there are technically quite a number of types of annuities

an·nu·i·ty
əˈn(y)o͞oitē/
noun
noun: annuity; plural noun: annuities

1.
a fixed sum of money paid to someone each year, typically for the rest of their life.
"he left her an annuity of $1,000 in his will"

such annuities payable from property were a common feature of 17th to 19th century wills. they were similar to a possessory life estate. Often the eldest son got possession but had to pay an annuity to the the others from the estate.
They were a burden on the sale of property so it became possible to substitute an insurance or bank annuity for the one backed by the property.
Sigh. Well, not to increase your levels of frustration but let me get this "exactly" right, if that is even possible.
And no, I am not confusing this with a SWR.
I was thinking along the lines of the discussions on "self insurance" so I guess that "self annuitize" would also bring down the wrath.
==========================
Hoppy08520, thank you for your comments they are helpful. I had searched here but I had the wrong search phrase.
There have been threads about creating a quasi-"annuity" through an I Bond or EE Bond ladder:

Build Your Own Annuity (great thread started by Mel Lindauer)
Yet another I-Bond Thread: Ladders
===============================
Whomever, thank you. I mistakenly left out the bit about ages,and I will give firecalc a try.
====================
unfundi, thank you for the reference. It sounds like a worthwhile read and I had never heard of a tontine.
===================
Taylor, thank you for reminding me of the guaranty. I tend to forget it when I look at the dismal rates.
============================

So let me rephrase it so I don't offend anyone.
I want to put $300,000.00 somewhere so that it pays me back $1,420.61 per month for 35 years. I don't care that part of the payback is partly principle.
Perhaps impossible but Wellesley seems close, no guaranty though.
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Re: A self constructed annuity

Post by momar »

You are going to have to actually explain how you are not confusing this with a SWR.
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Re: A self constructed annuity

Post by ncole1 »

Is the 5.68% annuity adjusted for inflation?

If not, it would likely be a mistake since you will lose purchasing power over time.

If so, go for it, as it is higher than the 4% "safe withdrawal rate" rule, unless you want to leave more to your heirs or have not yet purchased long term care coverage.
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Re: A self constructed annuity

Post by Hexdump »

ncole1 wrote:Is the 5.68% annuity adjusted for inflation?

If not, it would likely be a mistake since you will lose purchasing power over time.

If so, go for it, as it is higher than the 4% "safe withdrawal rate" rule, unless you want to leave more to your heirs or have not yet purchased long term care coverage.
It is not adjusted and we, the wife and I have had discussions about it before we saw the numbers.
Only one company offered a COLA policy and the numbers looked like this.
No COLA = $1,406.89
COLA (CPI-U) = $931.15
3% = $938, $966, $995, $1,025, $1,055

We looked at the COLA vs No COLA numbers and said no.
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Re: A self constructed annuity

Post by The Wizard »

ncole1 wrote:Is the 5.68% annuity adjusted for inflation?

If not, it would likely be a mistake since you will lose purchasing power over time.

If so, go for it, as it is higher than the 4% "safe withdrawal rate" rule, unless you want to leave more to your heirs or have not yet purchased long term care coverage.
Although one cannot construct a self-annuity for reasons mentioned earlier, one CAN easily deal with inflation by using multiple annuities as needed over time.
$300K now, another $100K in 6-7 years, etc...
Attempted new signature...
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Re: A self constructed annuity

Post by Ron »

The Wizard wrote:Although one cannot construct a self-annuity for reasons mentioned earlier, one CAN easily deal with inflation by using multiple annuities as needed over time.
$300K now, another $100K in 6-7 years, etc...
I agree (as a holder of a joint life SPIA)...
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Re: A self constructed annuity

Post by Hexdump »

Ron wrote:
The Wizard wrote:Although one cannot construct a self-annuity for reasons mentioned earlier, one CAN easily deal with inflation by using multiple annuities as needed over time.
$300K now, another $100K in 6-7 years, etc...
I agree (as a holder of a joint life SPIA)...
Did y'all do a ladder of SPIAs /

Hmmm, I wonder how a ladder of term SPIAs would look or does it even make sense ? Just thinking out loud here.
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Re: A self constructed annuity

Post by umfundi »

Hexdump wrote:Hmmm, I wonder how a ladder of term SPIAs would look or does it even make sense ? Just thinking out loud here.
Hexdump,

Here is my own *opinion*.

Stay away from all varieties of annuities except Single Premium Immediate Lifetime Annuities. You are much better off to delay SS before you buy an annuity.

While you can buy an annuity that is indexed for inflation, they seem expensive to me. My plan is to purchase an annuity that is not indexed for inflation. Then when its value gets eroded, purchase another.

There is no point to purchasing a "ladder" of annuities. Just buy them as you need them. There is something called a deferred (rather than immediate) annuity, where you buy it now and payments start later. Seems odd to me.

If you are worried about not getting your money's worth from an annuity, buy a separate term life insurance policy.

Keith
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Re: A self constructed annuity

Post by Dandy »

The risk of the annuity is that the insurance company would default and any rescue would not cover your scheduled payments. Absent that you get payments for life

A mutual fund no matter how good past performance has been is very different. You have market, interest rate, portfolio management risks and no lifetime guarantee. This is significantly riskier if the intent is to provide income for life -- possibly a long life.

Don't buy an annuity until you need it - every year you wait is likely to increase your monthly payments due to mortality credits - that might be affected by changes in interest rates.
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