SPIA or 3% Interest

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Lynxville
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SPIA or 3% Interest

Post by Lynxville » Sat Jan 18, 2014 7:12 am

I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?

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Re: SPIA or 3% Interest

Post by prudent » Sat Jan 18, 2014 7:18 am

Do you need more income?

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Re: SPIA or 3% Interest

Post by dickenjb » Sat Jan 18, 2014 7:28 am

Are you in excellent health?

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Taylor Larimore
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Re: SPIA or 3% Interest

Post by Taylor Larimore » Sat Jan 18, 2014 7:55 am

Lynxville:

How old are you?

Is leaving money to heirs important?

Best wishes.
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Re: SPIA or 3% Interest

Post by nisiprius » Sat Jan 18, 2014 8:29 am

There's no absolute. It's like asking which is better, a briefcase or a canvas tote bag. You could take papers to the office in a tote bag and you could take sand toys to the beach in an attache case. It's pretty hard to say which is the better deal. Prove to me that a canvas tote bag is overpriced and that an attache case is a better deal and I still wouldn't take sand toys to the beach in an attache case.

The easy statement is that an SPIA is not a good "deal." That is to say, even with the best will toward insurance companies, a) they have to make a buck, and b) the SPIA locks your money into very safe, conservative, low-earning investments that are probably too conservative and not what you would choose for yourself. As with all insurance, if you truly don't need it, then on the average, statistically, you are better off in dollars not to have it. As with all insurance, there is also a grey area where you might not need it, but a sane person might choose to take a slightly unfavorable proposition anyway for convenience or peace of mind. For example, we could "afford" to replace our car in a collision but we carry collision insurance anyway.

Very rough way to think about it. Since you do not know how long you will live, it is NOT possible to use every dollar you've saved for yourself and "have the check to the underwriter bounce." Assume that your average life expectancy at age 65 is 18 years, but that you could live very possibly live another 36 years. That is, you could live twice as long as your life expectancy. In order to provide for that, you need to regulate your spending to be much lower than needed for a known 18-year retirement, BUT since you probably won't live 36 years there probably will be money left at the end.

If you have kids you want to leave money to, you want there to be money left at the end.

You need to regulate your spending to be much lower than needed for a known 18-year retirement, but it's not half as much, it's better than that, because your money is earning a real return. But spending at an 18-year rate and living 36 years won't work. I can't think of a good numerical mental-arithmetic way to show this, but there certainly have been 18-year periods when the stock market would swell your portfolio so much faster than you spend it down that you'd luck out, but often you wouldn't.

If you have enough money and are willing to budget your living expenses so that you can support yourself on the actual income from your investments without spending your investments down at all--then it's not clear why you'd want an SPIA.

SPIAs are most relevant when you have "only just barely enough." When it looks as if you could hack it for an 18-year retirement, but not a 36-year retirement.

The big take-home for me from all of the "safe withdrawal rate" studies is that a prudent person will be careful about spending down "principal" (or "capital"). I don't think the "safe" withdrawal rates are safe enough, and the strongest evidence for this is the way they have continuously been revised downwards since they started doing them.

Another issue with spending down, is if you and your kids have a firm expectation that there will be money for them at the end, they may be happy to see you living a long life but in the back of their minds they are picturing their inheritance shrinking, shrinking, shrinking. It is very weird how soap-opera and Shakespearian situations do play a role in real life--I remember once realizing that there was a situation in the provisions of my parents' wills that meant that my brother and I would, in fact, each profit from each others' demise. We joked about it. I think we were joking.

I think there is "insurance versus investment" rivalry, with both sides putting some propaganda spin on it, but the bedrock reality of the situation is pretty clear: Longevity risk is real. You don't know how long you will live.

Given that, any individual investment plan that involves intentionally spending down a portfolio is tricky. An SPIA actually tackles longevity risk, by cross-subsidizing longer-lived participants from shorter-lived participants, an investment portfolio does not. For the same spending level, the SPIA will have less risk of depletion; for the same risk of depletion, the SPIA will give you more dollars per month to spend--and less dollars left at the end.

The argument in favor of using only individual investments is that by making use of risky investments--riskier than an insurance company uses--you can pile up an accumulation so much bigger that you do not need to deal with longevity risk.

Investment approach: you can grow the pile big enough to fund 36 years and if you only need 18 years, someone you choose gets to keep the extra. Great if you get the growth you planned on.

Insurance approach: you grow the pile big enough to fund 18 years. If you need 28 years, you make up the different from someone who only needed 8 years. If you only need 8 years, your amount left over goes to fund someone who needed 28--another policy holder, not a family or person you choose.
Last edited by nisiprius on Sat Jan 18, 2014 10:06 am, edited 3 times in total.
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Re: SPIA or 3% Interest

Post by livesoft » Sat Jan 18, 2014 8:34 am

I found Jim C. Otar's book "Unveiling the Retirement Myth" to have good chapters on whether and when to buy or ladder SPIAs.
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Re: SPIA or 3% Interest

Post by HomerJ » Sat Jan 18, 2014 3:45 pm

nisiprius wrote:I don't think the "safe" withdrawal rates are safe enough, and the strongest evidence for this is the way they have continuously been revised downwards since they started doing them.
I think that's just evidence that even economist PhDs are affected by recency basis.

Excellent post otherwise... Sorry to nitpick.

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Re: SPIA or 3% Interest

Post by MN Finance » Sat Jan 18, 2014 4:36 pm

I have a minivan, should I trade it in for a motorcycle? This is not a choice of one or the other because they have totally different utility values.

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Re: SPIA or 3% Interest

Post by Van » Sat Jan 18, 2014 4:41 pm

Lynxville wrote:I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?
Where are you getting 3%? I cannot seem to find a return that good in an investment with little or no risk to the principal.

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Re: SPIA or 3% Interest

Post by stan1 » Sat Jan 18, 2014 6:31 pm

Van wrote:
Lynxville wrote:I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?
Where are you getting 3%? I cannot seem to find a return that good in an investment with little or no risk to the principal.
That's an easy question: Pentagon Federal Credit Union 5 and 7 year CDs, at least until the end of the month.

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Re: SPIA or 3% Interest

Post by Kevin M » Sat Jan 18, 2014 7:03 pm

Did you see this recent thread: Bogleheads • View topic - Have you invested in an SPIA??

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Re: SPIA or 3% Interest

Post by Munir » Sat Jan 18, 2014 8:57 pm

In short, get an SPIA. Equities are fickle, bonds provide meager if any income, and CDs are a hassle.

The alleged shortcomings of SPIAs are addressed in many publications but I recommend the "Boglehead Investing In Retirement" (not sure of the exact wording of the title) for a thorough and concise evaluation. I am a retiree who has three SPIAs and am ready to purchase another one to add to my laddered joint survivor with 10 or 15 fixed period SPIAs purchased thru the Vanguard web site.

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Re: SPIA or 3% Interest

Post by Kevin M » Sat Jan 18, 2014 10:29 pm

For a countervailing view, read W. Bernstein's e-book, "The Ages of the Investor".

Already quoted in the thread I linked to above, but for those who didn't follow the link and read the thread:
W. Bernstein wrote:A TIPS ladder protects the retiree from a severe financial crisis in a way that commercial annuities cannot, and it comes fairly close to providing a lifetime income.
W. Bernstein wrote:While we may well avoid another crisis, particularly one that might devastate the insurance industry, I would not want to bet my retirement on it with either an immediate annuity or a deferred annuity.
W. Bernstein wrote:By age 70, the investor should have accumulated enough safe assets, including Treasury bills, notes and CDs, to fund at a bare minimum, 20 years of the cash-flow needs remaining after Social Security and pension payments. An LMP of 25 years of living expenses would be even better. Further, with today's historically low TIPS and annuity payouts, it might not be a bad idea to hold off purchasing TIPS for awhile.
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Re: SPIA or 3% Interest

Post by jimb_fromATL » Sat Jan 18, 2014 11:00 pm

Lynxville wrote:I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?
I think poster nisiprius summed up a lot of points very well. It can be good or bad depending on what you need -- and how well you understand it.

A SPIA is not an investment intended to gain in value. You could think of a SPIA as buying a life insurance policy that pays you a little bit of the payout every month as long as you live instead of waiting until you die to give a lump sum to your beneficiaries.

In the case of a life insurance policy, your heirs win if you die young. With an immediate annuity you win if you live longer than your normal life expectancy, but your heirs lose if you die young. So part of the decision may be how much you want to be worth to your heirs dead. :twisted:

To give you an example:

According to immediateannuities.com a couple both age 65 could buy a $100,000 lump sum joint annuity and receive a guaranteed $486 per month ($5832 per year) for life.

In an investment account the $100,000 earning a steady 3% and withdrawing $486 per month would be gone in about 289 months (24.1 years) -- at age 89. Too bad if you live longer.


jimb

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Re: SPIA or 3% Interest

Post by VictoriaF » Sat Jan 18, 2014 11:08 pm

jimb_fromATL wrote:
To give you an example:

According to immediateannuities.com a couple both age 65 could buy a $100,000 lump sum joint annuity and receive a guaranteed $486 per month ($5832 per year) for life.

In an investment account the $100,000 earning a steady 3% and withdrawing $486 per month would be gone in about 289 months (24.1 years) -- at age 89. Too bad if you live longer.


jimb
Assuming that the money comes from the taxable accounts, is there any difference in taxation? If you invest $100k, you pay taxes on the earnings (3% in your example). If you spend $100k on an annuity, is it taxed?

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Re: SPIA or 3% Interest

Post by jimb_fromATL » Sat Jan 18, 2014 11:14 pm

VictoriaF wrote:
Assuming that the money comes from the taxable accounts, is there any difference in taxation? If you invest $100k, you pay taxes on the earnings (3% in your example). If you spend $100k on an annuity, is it taxed?

Victoria
ARTICLE about taxation.

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Re: SPIA or 3% Interest

Post by VictoriaF » Sat Jan 18, 2014 11:28 pm

jimb_fromATL wrote:
VictoriaF wrote:
Assuming that the money comes from the taxable accounts, is there any difference in taxation? If you invest $100k, you pay taxes on the earnings (3% in your example). If you spend $100k on an annuity, is it taxed?

Victoria
ARTICLE about taxation.

jimb
Very interesting! Thanks,

Victoria
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Re: SPIA or 3% Interest

Post by Leeraar » Sun Jan 19, 2014 2:59 am

nisiprius makes some great points.

An SPIA provides a guaranteed income stream for as long as you live. If you need such an income stream, you should consider an SPIA. Go and read Zwecher, Otar, and Bernstein.

It mystifies me that some seem to have a deep set fundamental opposition to the idea of an SPIA. It is simply using a lump sum to buy a pension. As I said in another thread, it is not a bet involving you vs. the insurance company. It is pooling your longevity risk with a group of your peers. Check out Tontine at Wikipedia.

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

Well, some say, what if I die before my life expectancy? Well, everyone dies short of their life expectancy. Think about it.

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Re: SPIA or 3% Interest

Post by The Wizard » Sun Jan 19, 2014 4:48 am

Leeraar wrote:
...Well, some say, what if I die before my life expectancy? Well, everyone dies short of their life expectancy. Think about it.
They don't really.
Your life expectancy, for purposes of an annuity, is fixed as of the date you buy that annuity.
Your updated life expectancy five years down the road has no bearing on it...
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Re: SPIA or 3% Interest

Post by frugaltype » Sun Jan 19, 2014 5:23 am

Leeraar wrote: It mystifies me that some seem to have a deep set fundamental opposition to the idea of an SPIA.
I don't like handing over a sizable lump of money to an entity that may disappear.

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Re: SPIA or 3% Interest

Post by Carl53 » Sun Jan 19, 2014 7:28 am

VictoriaF wrote:
jimb_fromATL wrote:
VictoriaF wrote:
Assuming that the money comes from the taxable accounts, is there any difference in taxation? If you invest $100k, you pay taxes on the earnings (3% in your example). If you spend $100k on an annuity, is it taxed?

Victoria
ARTICLE about taxation.

jimb
Very interesting! Thanks,

Victoria
I have nothing to say on whether SPIAs might be appropriate for a particular situation but when you look at sites depicting financial or any other information, consider that there may be an agenda by those posting. Looking at the reference article on SPIAs, it touts that the free income, return of capital, is really worth a larger number, as if it would have been taxed at 25%. However, the detailed example they show at the bottom of the page for the same person mentioned above is nearly $10k in income below the top of the 15% bracket. I'm not saying that they intentionally were mentally setting you up to think yes I'll save 25% if I do this, but effectively they did, as it is most curious they did not come up with a scenario to present that supported that number. I'm not sure why, as I think one could have, but the income level would have been substantially higher and perhaps they want to target lower income individuals for the product.

Disclaimer, I have no financial interests in the sales of any financial products, nor do I currently have any SPIAs, but might consider them.

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Re: SPIA or 3% Interest

Post by Frugal Al » Sun Jan 19, 2014 7:41 am

Leeraar wrote:It mystifies me that some seem to have a deep set fundamental opposition to the idea of an SPIA.
What a coincidence, it mystifies me that some don't have a "deep set fundamental opposition to the idea of an SPIA." That doesn't mean that they aren't appropriate in some (many?) circumstances, especially for those in their mid 70s and anticipate beyond average longevity, but they're not the panacea some would like us to think they are. What mystifies me most are those that will consider purchasing an annuity at today's relatively poor payout rates, and at the same time choose to forgo delayed SS.

Carl, I share your observation with the annuity taxation article, it does seem a bit biased, or overenthusiastic about the obvious. Wow, who'd have thought we aren't taxed on our own after tax money. While I think they are probably trying to point out how to calculate the cash flow, the real takeaway is that much of the money they distribute back to the annuitant is just their own money...duh.
Last edited by Frugal Al on Sun Jan 19, 2014 8:00 am, edited 1 time in total.

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Re: SPIA or 3% Interest

Post by VictoriaF » Sun Jan 19, 2014 7:58 am

Frugal Al wrote:
Leeraar wrote:It mystifies me that some seem to have a deep set fundamental opposition to the idea of an SPIA.
What a coincidence, it mystifies me that some don't have a "deep set fundamental opposition to the idea of an SPIA." That doesn't mean that they aren't appropriate in some (many?) circumstances, especially for those in their mid 70s and anticipate beyond average longevity, but they're not the panacea some would like us to think they are. What mystifies me most are those that will consider purchasing an annuity at today's relatively poor payout rates, and at the same time choose to forgo delayed SS.
I agree that delaying Social Security until the age of 70 is a far better decision than buying an SPIA. You are also right that the 70s are a good time to consider an SPIA. But the current poor payout rates are a two-edge sword. Hypothetically, if/when the rates rise significantly, people will move money from equities to fixed income and stock prices will drop. At that time, SPIAs would be paying more, but the funds for buying them would be smaller.

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Re: SPIA or 3% Interest

Post by Levett » Sun Jan 19, 2014 8:11 am

It both amuses and occasionally mystifies me that "pension," both as word and a possession that's widely embraced, has been so thoroughly dissociated from "annuity." The confusion doesn't suggest the highest level of financial acumen. Pensions=good. Annuities (e.g., SPIA)=bad.

"Defined benefit plans distribute their benefits through life annuities. In a life annuity, employees receive equal periodic benefit payments (monthly, quarterly, etc.) for the rest of their lives. A defined benefit pension plan allows joint distributions so a surviving spouse can still receive 50 percent of your payment.[7]

In the United States, 88 percent of public employees are covered by a defined benefit pension plan."


The confusion is partly do to the expansion of 401K la la land, which incorporates the old ad tag line: "Mother, I'll do it myself! ;-)

I believe even Mr. Bogle has recently argued that 401K plans need to offer a decumulation option of SPIAs. He said something like this in his little volume, Enough.

Lev

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Re: SPIA or 3% Interest

Post by Lynxville » Sun Jan 19, 2014 8:26 am

prudent wrote:Do you need more income?
No I don't but sure would spend it. I just thought Spia might make me more diversified. I am also laddered at Penfed and thought another 3% cd isn't needed. Not concerned about leaving money to kids, there doing better than I did. But they will inherit some nice realestate. I am 65 and in good health.

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Re: SPIA or 3% Interest

Post by Frugal Al » Sun Jan 19, 2014 8:31 am

Victoria, I understand your point, but we can have higher rates and a significantly valued stock market at the same time. On the other hand, for those that would be in dire straights due to a poor sequence of returns, I can understand buying now.

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Re: SPIA or 3% Interest

Post by Frugal Al » Sun Jan 19, 2014 8:45 am

Levett wrote:It both amuses and occasionally mystifies me that "pension," both as word and a possession that's widely embraced, has been so thoroughly dissociated from "annuity." The confusion doesn't suggest the highest level of financial acumen. Pensions=good. Annuities (e.g., SPIA)=bad.
There was a big difference between my pension, as with most DB pensions, and an SPIA: my pension didn't cost me anything. And, by the way, I took it as a lump sum because I didn't like the relative payout rate and the fact that it wasn't inflation indexed.

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Re: SPIA or 3% Interest

Post by ndchamp » Sun Jan 19, 2014 8:55 am

Levett wrote: I believe even Mr. Bogle has recently argued that 401K plans need to offer a decumulation option of SPIAs. He said something like this in his little volume, Enough.

Lev
In his book "The Clash of the Cultures; Investments vs Speculation", he also advocated for Annuities to protect against longevity risk.

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Re: SPIA or 3% Interest

Post by obgyn65 » Sun Jan 19, 2014 10:38 am

Have you thought about the possibility of putting half the money in laddered SPIAs and the other half in laddered CDs?
Lynxville wrote:I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?
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Re: SPIA or 3% Interest

Post by Levett » Sun Jan 19, 2014 11:06 am

Al,

Have you met an insurance agent who makes his/her money as a career salesperson of SPIAs? To put it succinctly: that's not where the commissions are.

Re Mr. Bogle, this is what he wrote in Enough (p. 151):

"401(k) investors are notorious for performance chasing....Traditionally, the most popular funds in our retirement funds have been those with extraordinary past performance....We also offer too many choices, sowing confusion among participants....And we are only now developing annuity-linked programs that allow our clients a seamless move from their years of accumulating assets to their years when they begin to draw those assets down, secure from the risk of exhausting them.' (boldface added)

Mr. Bogle's emphasis on "annuity-linked [decumulation] programs" strikes me as perfectly consistent with his emphasis on indexing: that emphasis is informed by the general view that investors, on the whole (including Bogleheads), are not above average.

Lev

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Re: SPIA or 3% Interest

Post by jimb_fromATL » Sun Jan 19, 2014 11:26 am

Lynxville wrote:
prudent wrote:Do you need more income?
No I don't but sure would spend it. I just thought Spia might make me more diversified. I am also laddered at Penfed and thought another 3% cd isn't needed. Not concerned about leaving money to kids, there doing better than I did. But they will inherit some nice realestate. I am 65 and in good health.
Since the main reason to buy a SPIA is to have a guaranteed monthly income while you're alive, but you don't need the income, I'd guess that you don't really need the annuity.

From what you've said, it sounds like CDs or any other stable value funds will be just fine. Plus you can put your hands on the lump sum if you ever do need it. (It's gone if you buy the annuity.)

Maybe even consider a balanced fund with a little more risk. The more I look, the more I keep comng back to Wellington (VWELX) -- especially considering its quick recovery from the 2nd worst crash in history in 2008/9, and that your age and health suggest that you'll have plenty of time for it to recover next time the market crashes.

jimb

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Re: SPIA or 3% Interest

Post by jimb_fromATL » Sun Jan 19, 2014 11:34 am

ndchamp wrote:
Levett wrote: I believe even Mr. Bogle has recently argued that 401K plans need to offer a decumulation option of SPIAs. He said something like this in his little volume, Enough.

Lev
In his book "The Clash of the Cultures; Investments vs Speculation", he also advocated for Annuities to protect against longevity risk.
Ironically, some folks in congress have mentioned that it might be nice to have a government-insured annuity plan made available as another option in retirement plans, which has been met by outcries in the fear-mongering media that it's part of the government's nefarious plan to seize all the 401(k)s.

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Re: SPIA or 3% Interest

Post by tibbitts » Sun Jan 19, 2014 11:49 am

HomerJ wrote:
nisiprius wrote:I don't think the "safe" withdrawal rates are safe enough, and the strongest evidence for this is the way they have continuously been revised downwards since they started doing them.
I think that's just evidence that even economist PhDs are affected by recency basis.

Excellent post otherwise... Sorry to nitpick.
I don't think the 4% or 3% rates have been accepted all that universally accepted. The studies are all based on a tiny slice of history that may be completely irrelevant going forward.

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Re: SPIA or 3% Interest

Post by MN Finance » Sun Jan 19, 2014 3:30 pm

Lynxville wrote:
prudent wrote:Do you need more income?
No I don't but sure would spend it. I just thought Spia might make me more diversified. I am also laddered at Penfed and thought another 3% cd isn't needed. Not concerned about leaving money to kids, there doing better than I did. But they will inherit some nice realestate. I am 65 and in good health.
Then the question has been answered. A SPIA does not increase investment diversification. It's for an entirely different purpose.

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Re: SPIA or 3% Interest

Post by Frugal Al » Mon Jan 20, 2014 9:36 am

Levett wrote:Al,
Have you met an insurance agent who makes his/her money as a career salesperson of SPIAs? To put it succinctly: that's not where the commissions are.
Lev, you're missing my point. It has absolutely nothing to do with salesperson commissions. It has to do the the execution of the product. You're trying to equate a DB pension with an SPIA, and the fact that everyone loves the idea of a DB pension, but perhaps not so much the SPIA. The DB pension often doesn't cost the beneficiary anything, and there's generally a small window of time when the beneficiary must decide how to receive their benefit. The SPIA "investment" on the other hand is discretionary, both in the amount invested and when. Let's use that discretion and not get blinded by seemingly generous payout rates (of our own money), a false sense of beyond average longevity, and a false sense of zero risk. We should be leery of long time horizons combined with non inflation indexed annuities--the still relatively low payout rates just exacerbate the problem. I think we need to be careful anytime we claim something is categorically good or bad. It's all in the proper usage of the tool.

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Investment or Insurance?

Post by Taylor Larimore » Mon Jan 20, 2014 4:25 pm

Lynxville wrote:I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?
Lynxville:

You have received many very good replies. It might help with your decision by asking yourself this question:

Are you worried about running out of money before running out of life? If so, a SPIA may be the answer.

Think of it as insurance to protect you from running out of money.

Best wishes.
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Munir
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Re: Investment or Insurance?

Post by Munir » Mon Jan 20, 2014 7:26 pm

Taylor Larimore wrote:
Lynxville wrote:I have a good chunk of money at 3% interest, I am well diversified in my investments, and retired. Just wondering if putting this money in a SPIA would be better than just leaving it there for the interest money?
Lynxville:

You have received many very good replies. It might help with your decision by asking yourself this question:

Are you worried about running out of money before running out of life? If so, a SPIA may be the answer.

Think of it as insurance to protect you from running out of money.

Best wishes.
Taylor
+1. Words of wisdom.

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