Whether to annuitize (or not) an IRA

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echidna
Posts: 45
Joined: Thu Jan 18, 2018 7:01 pm

Whether to annuitize (or not) an IRA

Post by echidna » Thu Jan 18, 2018 7:59 pm

Hi,

I'm a new member here in what seems like a great resource, and looking to educate myself on managing my retirement portfolio. My question (I'm sure I'll ask a lot more!) is about using annuities in a specific situation.

I've done a fair bit of reading on the forum in the annuity threads (frankly, there is way too much there to read it all in detail), so apologize if I may have missed something.

What I was looking for, but did not find was some quantitative analysis of annuities vs. regular market investments.

This is going to be a bit verbose, so I will post in several segments, to make it easier to read and reply to. Please bear with me while I do this.


I have about $400k in a traditional IRA, and will be age 70 early this year (2018), so RMD's must begin.

Because my health and genetics are good (both my parents had long lives - my father lived to 99), I'm concerned about longevity risk (hopefully, a high-class problem!). To this end, I want the income stream from the IRA to last at least 30 years until age 100.

I'm also concerned about the effects of inflation over this long time, so would prefer an income stream that is indexed for inflation.


Assumed conditions:

Money in a traditional IRA, all contributions pre-tax.
Single male, age 70 in early 2018
RMD's must begin in 2018.
Want an inflation-adjusted income stream thru at least age 100.
No death benefit or access to principal desired.
IRA to be considered in isolation from any other income/investments.

The aim is to maximize the income stream from the IRA consistent with a low probability of failing to sustain that stream thru age 100.


I've been looking at two scenarios:

(1) Keeping the IRA as is, optimizing the investment portfolio, and withdrawing at least the RMD each year;

(2) Annuitizing the entire balance up front.

For the latter, I'm looking at two options:

(a) a SPIA with no COLA or CPI inflation adjustment; and

(b) a SPIA with inflation adjustment.


The question I asked myself is, how easy is it to at least match the annuity income streams with periodic withdrawals from a well-managed portfolio inside the IRA?
Last edited by echidna on Thu Jan 18, 2018 8:50 pm, edited 3 times in total.

echidna
Posts: 45
Joined: Thu Jan 18, 2018 7:01 pm

Re: Whether to annuitize (or not) an IRA

Post by echidna » Thu Jan 18, 2018 8:14 pm

Taking case (a) above first, from immedannuities.com, I got a quote of about $29.0k income per year (7.26%) from a $400k SPIA contract for life.

For the managed IRA, with annual withdrawals of this amount, I calculate that for a portfolio of 50/50 bonds and stocks, with a constant annual return of 4.0% on the bonds and 9.4% on the stocks (6.7% overall), the portfolio is exhausted just after the age 100 payment.

You could maybe improve this result with a larger allocation to stocks, but at higher risk. For example, adding in some sequencing risk (simulating a significant bear market* in stocks in the next few years, but with the same total return over 30 years), I find that the portfolio collapses quite early (at age 91) even with a 50/50 allocation and a constant return of 4.0% from bonds. This seems to be largely a result of the high initial withdrawal rate (7.3%).


Looking at case (b), I had difficulty finding data for CPI-adjusted SPIA's, so I took the example of a SPIA with 3% COLA, for which I determined an initial income rate of 5.26% ($21.0k) per year**, increasing to $51.0k per year by age 100.

In this case it required a marginally greater 9.5% return on stocks and 4.0% on bonds (50/50 split, 6.8% return overall) to just make the age 100 payment.

Adding the same level of "sequencing risk" as before again caused an early collapse (at age 95), but not as bad as for the constant, initially larger withdrawals.

Putting this another way, the 5.3% initial withdrawal rate is less than for case (a) but still higher than what is generally considered safe (4-4.5%) for generating reliable, long-term, inflation-adjusted income from an investment portfolio. Note that the inflation rate I assumed above (a constant 3%) is probably lower than the average assumed in portfolio studies.

Dropping the initial withdrawal to around 4.8% with my "bear market" case allowed the portfolio to survive to age 100.


* My artificial bear market assumed annual stock returns (beginning with the first year) of -30%, -30%, 20% and continuing at 20% (or rather less for the final year) until recovered to par with the constant return case. It's intended as a crude approximation to the 2000 and 2008 crashes.

** Based on older data found at spiaquote.com for age 67; adjusted approximately by me to age 70 and current rates from immediateannuities.com.

echidna
Posts: 45
Joined: Thu Jan 18, 2018 7:01 pm

Re: Whether to annuitize (or not) an IRA

Post by echidna » Thu Jan 18, 2018 8:23 pm

Assuming my calculations above are correct, what I take away from this is that the SPIA annuities beat the managed portfolio at achieving my goals, unless relatively high and consistent rates of return are assumed for the latter.

I would be interested in members opinions on how likely it is that long-term total return rates of

4.0% for bonds
9.5% for stocks
(or an overall rate of 6.8%)

will be achievable over the next 10-30 years.

My own reading suggests these numbers are optimistic.

For reference, I took a look at a Bogleheads 3-fund portfolio of VTSMX, VGTSX, VBMFX (48%, 12%, 40%) and estimate a total return of around 5.9% for the ten years thru 12-31-17.


Also, remember that the aim here is to match the annuities in a worst-case (say 10-20% percentile) market scenario, not merely a likely market scenario, thus providing a reasonable guarantee that the managed portfolio income stream will last as expected.

Finally, in my rather crude attempt at analysis, when inflation was included, it was at a constant 3% rate. Historically, there have been periods that would create far more challenging combinations of inflation and market returns than I have assumed.

Gill
Posts: 4302
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: Whether to annuitize (or not) an IRA

Post by Gill » Thu Jan 18, 2018 8:48 pm

You’re about at the right age to consider a QLAC with a portion of your IRA. That would give you a nice bump in your guaranteed income 15 years out, in effect offering some inflation protection.
Gill

rgs92
Posts: 1888
Joined: Mon Mar 02, 2009 8:00 pm

Re: Whether to annuitize (or not) an IRA

Post by rgs92 » Thu Jan 18, 2018 8:49 pm

COLA-adjusted immediate annuities have become rare and dear (meaning extremely expensive). They used to be quite common 15-20 years ago when I was looking, but no more. They are basically prohibitively expensive and not worth it in my opinion.

The next best thing is one that adjusts upward by, say, 2% a year (Fidelity has these, or at least did a year or 2 ago).

But I feel the best is an SPIA with a simple fixed amount for life and use a separate lump sum in a regular stock index fund for the growth component.

[ I do remember around 2000, many companies like Vanguard and T Rowe Price and TIAA/CREF had inflation adjusted annuities (SPIAs) at reasonable prices, like 20% over a fixed one I recall, but those days are gone it seems. ]

Gill
Posts: 4302
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: Whether to annuitize (or not) an IRA

Post by Gill » Thu Jan 18, 2018 8:56 pm

rgs92 wrote:
Thu Jan 18, 2018 8:49 pm
But I feel the best is an SPIA with a simple fixed amount for life and use a separate lump sum in a regular stock index fund for the growth component.
Completely agree and my retirement is partially structured in this manner.
Gill

echidna
Posts: 45
Joined: Thu Jan 18, 2018 7:01 pm

Re: Whether to annuitize (or not) an IRA

Post by echidna » Thu Jan 18, 2018 9:10 pm

rgs92 wrote:
Thu Jan 18, 2018 8:49 pm
COLA-adjusted immediate annuities have become rare and dear (meaning extremely expensive). They used to be quite common 15-20 years ago when I was looking, but no more. They are basically prohibitively expensive and not worth it in my opinion.

The next best thing is one that adjusts upward by, say, 2% a year (Fidelity has these, or at least did a year or 2 ago).
I have certainly had a hard time finding information on US inflation-adjusted SPIA's online. I'm currently overseas, so will look further for quotes (including with Fidelity) when I return.


Meantime, I'm now in Australia (where I originally come from), visiting family. Curiously, there seems to be no problem finding quotes for inflation-adjusted annuities here.

From https://www.challenger.com.au/products/rates.asp, for my parameters (age 70, male), I find initial income rates of:

SPIA with no inflation protection: 8.26%
SPIA with "full" (Australian-CPI-based) inflation protection: 6.63%

The income rate for the fixed income SPIA is quite a bit higher than I'm seeing in the US, and the inflation-adjusted rate is also better than anything I can come up with in US data.

In fact, the rates look so attractive that I'm tempted to investigate further, despite tax and exchange-rate complications. The fact that I have something of a presence in Australia, and may in my retirement spend much more time here works somewhat in my favor.

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