Why is this SPIA a bad idea?

Have a question about your personal investments? No matter how simple or complex, you can ask it here.
Topic Author
mapleleaf
Posts: 7
Joined: Fri Feb 13, 2015 11:59 am

Why is this SPIA a bad idea?

Post by mapleleaf »

We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?
User avatar
sergeant
Posts: 1612
Joined: Tue Dec 04, 2007 11:13 pm
Location: The Golden State

Re: Why is this SPIA a bad idea?

Post by sergeant »

It might be a great idea but there isn't enough provided information to give an answer.
AA- 20+ Years of Expenses Fixed Income/The remainder in Equities.
User avatar
happysteward
Posts: 208
Joined: Tue Jun 16, 2015 11:42 am

Re: Why is this SPIA a bad idea?

Post by happysteward »

I did a SPIA for my dad to close the gap between his income (SS and small pension) and his expenses. Even told him how long he had to live to make the SPIA a good move financially, he’s almost there :-)
"How much money is enough?", John Rockefeller responded, "...just a little bit more."
User avatar
nisiprius
Advisory Board
Posts: 42005
Joined: Thu Jul 26, 2007 9:33 am
Location: The terrestrial, globular, planetary hunk of matter, flattened at the poles, is my abode.--O. Henry

Re: Why is this SPIA a bad idea?

Post by nisiprius »

I generally think SPIAs are good ideas, but would like to know more details. SPIAs are easy to understand, you can tell what you are getting, you can compare them with others from other insurers, it's mostly a question of whether they do something that you want and need done. I think you really need a COLA. When I bought the one I own, it was possible to get an actual CPI-linked SPIA and I still think that's the best choice if any still exist. Otherwise you need to guess the number... historically over long periods of time it's been more like 3% than 2%...
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.
SimplicityNow
Posts: 526
Joined: Fri Aug 05, 2016 10:31 am

Re: Why is this SPIA a bad idea?

Post by SimplicityNow »

Some types of annuities can be bad but SPIAs are usually recognized as a good choice depending on your circumstances.

Of course the younger you are when you annuitize a potion of your retirement savings, the smaller the payment amounts will be.

In some cases it makes sense to delay an SPIA until you are older and use other income streams first.

And of course if you get one that is inflation adjusted the initial payment will be lower still.

Here is a link to Mike Pipe's Oblivious Investor website where he describe them pretty well

https://obliviousinvestor.com/single-pr ... e-annuity/

Here is additional information from our Bogleheads website

https://www.bogleheads.org/wiki/Immediate_fixed_annuity
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: Why is this SPIA a bad idea?

Post by hudson »

mapleleaf,
I think SPIAs can be a good idea if they fit your situation.
A SPIA buyer needs to fully understand their state's guarantee program. States set up the guarantee program, but the insurance companies pool together for the guarantee.
Maybe look at W. Bernstein's Ages of the Investor, Book 1
User avatar
Taylor Larimore
Advisory Board
Posts: 29970
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

SPIAs Can Be A Good Idea

Post by Taylor Larimore »

mapleleaf wrote: Sat Jul 25, 2020 11:29 am We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?
mapleleaf:

We purchased two SPIA annuities (the only good kind) in our early eighties and I am VERY happy with them (I'm 96). However, I think it is probably a mistake to purchase a SPIA in the "late 50's". Here's why I think it us usually best to wait until around age 80 before purchasing a Single Premium Immediate Annuity (SPIA) for these reasons:

* You might need the cash for an emergency.
* If your health deteriorates an annuity is usually a bad choice.
* Life income is larger or premium less if you wait.
* Inflation is less of a factor which allows an expensive "inflation rider" to be avoided.
* Current low interest rates may become higher which will make payments higher.
* If you wait, your portfolio should become larger and you might not want or need an annuity.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high returns."
"Simplicity is the master key to financial success." -- Jack Bogle
Topic Author
mapleleaf
Posts: 7
Joined: Fri Feb 13, 2015 11:59 am

Re: Why is this SPIA a bad idea?

Post by mapleleaf »

thank you all so much!
tj
Posts: 3388
Joined: Thu Dec 24, 2009 12:10 am

Re: Why is this SPIA a bad idea?

Post by tj »

mapleleaf wrote: Sat Jul 25, 2020 11:29 am We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?


It sounds like you are considering a single premium deferred annuity rather than an spia. Will the payments not start until social security starts? Please explain further. It may or may not be a good idea.
grok87
Posts: 9153
Joined: Tue Feb 27, 2007 9:00 pm

Re: Why is this SPIA a bad idea?

Post by grok87 »

mapleleaf wrote: Sat Jul 25, 2020 11:29 am We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?
do you have a pension? and any flexibility as to when to take it? when were you planning on taking social security?
RIP Mr. Bogle.
dbr
Posts: 33842
Joined: Sun Mar 04, 2007 9:50 am

Re: Why is this SPIA a bad idea?

Post by dbr »

As a point of information SPIA payouts are less when interest rates are low. Also an SPIA might be more astute at an older age. But I have no special recommendation one way or the other right now.

Some other considerations include:

1. If a person already has a lot of annuitized income, or will in the future, such as Social Security, more annuitization may not be that important.

2. A person should not give up the majority of their assets to an annuity leaving no reserve for contingencies that need more money than a monthly income. That might be especially true for someone who has many years to go.

3. I am not sure how annuitizing assets affects eligibility for public assistance in old age. I have had the experience of people not qualifying for certain types of aid due to too much (but hardly enough) pension income, for example. The alternative is that one spends down assets and then is qualified for assistance. I don't know if this is of any relevance at all.
Wrench
Posts: 134
Joined: Sun Apr 28, 2019 10:21 am

Re: Why is this SPIA a bad idea?

Post by Wrench »

I view an annuity as much as an insurance product as an investment. If you want to insure that you have a certain income for as long as you live (and optionally as long as your spouse lives), annuities are great. You are buying longevity insurance so you won't outlive your money. Most BHs seem to suggest that it is better to wait until you are in your 70s or 80s to buy an SPIA, but I bought a deferred income annuity (DIA) last year at age 65 (I assume that is what you are considering since you don't need income immediately?). It pays out a CPI-U adjusted ~5.2% on premium beginning when I am 70. I'm glad I bought last year because now it seems the CPI-U adjusted annuity is no longer available from any company (last year there was only one that offered it - The Principal). Plus, rates are much lower now. Who knows where they will be when I am 70? So, my advice, shop around and if you find a DIA now that will meet your financial goals when you retire, go for it especially if it is only a relatively small fraction of your portfolio, and it helps you sleep better at night.
User avatar
Nate79
Posts: 6438
Joined: Thu Aug 11, 2016 6:24 pm
Location: Delaware

Re: Why is this SPIA a bad idea?

Post by Nate79 »

Sounds like you are buying this product at way too young of an age.
DesertGator
Posts: 64
Joined: Thu Jun 21, 2018 11:12 pm

Re: SPIAs Can Be A Good Idea

Post by DesertGator »

Jack Bogle's Words of Wisdom: "Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high returns."
[/quote]

Does such an animal exist? And if so, from a reputable, reasonably "safe" provider?
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: SPIAs Can Be A Good Idea

Post by hudson »

DesertGator wrote: Sun Jul 26, 2020 12:01 pm
Jack Bogle's Words of Wisdom: "Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high returns."
Does such an animal exist? And if so, from a reputable, reasonably "safe" provider?
[/quote]

I just checked immediateannuities.com

An 80 year old can invest $300K and get $1730 per month. That's a yearly 6.92% of $300K.
I know there's a lot that I'm not saying.
If at age 80, I was in a cash crunch, I would take a look.
khart23
Posts: 57
Joined: Thu Jun 18, 2020 7:21 am

Re: Why is this SPIA a bad idea?

Post by khart23 »

SPIAs can be great when 1) used correctly & 2) properly set up

You need to dig a little deeper into if the leftover principle to your heirs is important (that’s a cash refund rider you can add), what investments you have on the side that could fight the inflation in lieu of the COLA rider, etc? Planning with those details and than seeing them modeled out (more than just quote a vs quote b) will typically make things very clear on what option best suits you.
User avatar
ResearchMed
Posts: 10697
Joined: Fri Dec 26, 2008 11:25 pm

Re: SPIAs Can Be A Good Idea

Post by ResearchMed »

hudson wrote: Sun Jul 26, 2020 12:09 pm
DesertGator wrote: Sun Jul 26, 2020 12:01 pm
Jack Bogle's Words of Wisdom: "Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high returns."
Does such an animal exist? And if so, from a reputable, reasonably "safe" provider?
I just checked immediateannuities.com

An 80 year old can invest $300K and get $1730 per month. That's a yearly 6.92% of $300K.
I know there's a lot that I'm not saying.
If at age 80, I was in a cash crunch, I would take a look.
[/quote]

--------


That "6.92%" is the PAYOUT rate, and NOT an "interest rate".
The principal is being paid out as well, and when the annuitant passes, there is nothing left (for a simple SPIA).
That's quite different than if someone had $300k, received some monthly/annual percentage, and then still had the $300k some years later.

RM
This signature is a placebo. You are in the control group.
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: Why is this SPIA a bad idea?

Post by hudson »

RM,
Thanks! I agree. There's still a lot more to learn before buying a SPIA.
User avatar
vineviz
Posts: 7845
Joined: Tue May 15, 2018 1:55 pm

Re: SPIAs Can Be A Good Idea

Post by vineviz »

ResearchMed wrote: Sun Jul 26, 2020 12:25 pm That "6.92%" is the PAYOUT rate, and NOT an "interest rate".
Sure, but that observation doesn’t invalidate the notion that the SPIA in question might offer “very low cost and commensurately high returns."

Insurance products don’t have “interest rates” that we can directly compare to a savings account or the yield on a bond. Their nature is different: comparing an income stream to a marketable asset is always difficult because they expose investors to different risks.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
petulant
Posts: 1901
Joined: Thu Sep 22, 2016 1:09 pm

Re: Why is this SPIA a bad idea?

Post by petulant »

It's a fine product if it fits your circumstances well. It's not clear whether you're buying inside or outside an IRA and how it impacts your ability to engage in good tax strategies. Annuities bought outside an IRA (nonqualified IRAs) are taxed as a partial return of basis and a gain, which is calculated at the time you start taking payments through an "exclusion ratio." That level of taxation lasts until your life expectancy at the time you started taking payments, at which point it all becomes taxable income. Committing yourself to this taxable income for the rest of your life may impact some tax strategies like Roth conversions or avoiding SS taxability. Do think about it from that perspective.
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: SPIAs Can Be A Good Idea

Post by hudson »

ResearchMed wrote: Sun Jul 26, 2020 12:25 pm
hudson wrote: Sun Jul 26, 2020 12:09 pm
DesertGator wrote: Sun Jul 26, 2020 12:01 pm
Jack Bogle's Words of Wisdom: "Depending on the particular circumstances, annuities are a good idea, but only annuities available at very low cost and commensurately high returns."
Does such an animal exist? And if so, from a reputable, reasonably "safe" provider?
I just checked immediateannuities.com

An 80 year old can invest $300K and get $1730 per month. That's a yearly 6.92% of $300K.
I know there's a lot that I'm not saying.
If at age 80, I was in a cash crunch, I would take a look.
--------


That "6.92%" is the PAYOUT rate, and NOT an "interest rate".
The principal is being paid out as well, and when the annuitant passes, there is nothing left (for a simple SPIA).
That's quite different than if someone had $300k, received some monthly/annual percentage, and then still had the $300k some years later.

RM
[/quote]

For the example above, the 80 year old could just keep the $300K and pay himself $1730 per month for 173.4 months or 14.45 years.
I know that I haven't included interest. He would run out at age 94.45 years.
User avatar
Taylor Larimore
Advisory Board
Posts: 29970
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

The SPIA Guarantee

Post by Taylor Larimore »

Bogleheads:

Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Variable annuities (not SPIAs) are very dangerous because they can't always deliver what they promise."
"Simplicity is the master key to financial success." -- Jack Bogle
User avatar
vineviz
Posts: 7845
Joined: Tue May 15, 2018 1:55 pm

Re: SPIAs Can Be A Good Idea

Post by vineviz »

hudson wrote: Sun Jul 26, 2020 12:45 pm For the example above, the 80 year old could just keep the $300K and pay himself $1730 per month for 173.4 months or 14.45 years.
I know that I haven't included interest. He would run out at age 94.45 years.
And a 80-year old woman has a 30% probability of living past age 95.

So we have a SPIA that pays the same monthly income as cash BUT also reduces the risk of running out of income from 30% to 0%. What’s the value of that lifetime guarantee? More than $0, surely.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Elysium
Posts: 3223
Joined: Mon Apr 02, 2007 6:22 pm

Re: Why is this SPIA a bad idea?

Post by Elysium »

mapleleaf wrote: Sat Jul 25, 2020 11:29 am We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?
mapleleaf, you asked why is this a bad idea, because of your age it is. It would make sense for someone over 80, but in late 50's you have better investment options without losing control of your capital.
bikechuck
Posts: 817
Joined: Sun Aug 16, 2015 9:22 pm

Re: Why is this SPIA a bad idea?

Post by bikechuck »

mapleleaf wrote: Sat Jul 25, 2020 11:29 am We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?
I will consider something like this in my mid to late 70s. However if you do move forward be aware that insurance companies can fail and you can mitigate this risk by purchasing two $200K SPIAs from two different highly rated companies.
000
Posts: 2842
Joined: Thu Jul 23, 2020 12:04 am

Re: The SPIA Guarantee

Post by 000 »

Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
petulant
Posts: 1901
Joined: Thu Sep 22, 2016 1:09 pm

Re: The SPIA Guarantee

Post by petulant »

000 wrote: Sun Jul 26, 2020 4:03 pm
Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
In the securities arena, "guarantee" is a technical term that means a contractual obligation exists to provide a specific outcome. SPIAs provide a guarantee for a certain amount of income for life--his claim should be understood to mean that it is the most generous guarantee you can get with an investment, not that it is the high income for life. None of the items you mentioned have a guarantee to provide anything; for example, the stock market may perform better, but it is not guaranteed.
000
Posts: 2842
Joined: Thu Jul 23, 2020 12:04 am

Re: The SPIA Guarantee

Post by 000 »

petulant wrote: Sun Jul 26, 2020 4:08 pm
000 wrote: Sun Jul 26, 2020 4:03 pm
Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
In the securities arena, "guarantee" is a technical term that means a contractual obligation exists to provide a specific outcome. SPIAs provide a guarantee for a certain amount of income for life--his claim should be understood to mean that it is the most generous guarantee you can get with an investment, not that it is the high income for life. None of the items you mentioned have a guarantee to provide anything; for example, the stock market may perform better, but it is not guaranteed.
My understanding of Taylor's post was that SPIA income was guaranteed to beat the income from any investment, which is not true. I acknowledge Taylor's phrasing is open to interpretation. Moreover, even the SPIA is not 100% guaranteed: it can lose value in real terms or the insurer can go bankrupt. I thought it was worthwhile to point these things out.
User avatar
Ben Mathew
Posts: 1234
Joined: Tue Mar 13, 2018 11:41 am
Location: Seattle
Contact:

Re: Why is this SPIA a bad idea?

Post by Ben Mathew »

mapleleaf wrote: Sat Jul 25, 2020 11:29 am We have around $400k that we would like to buy a lump sum SPIA with or without COLA 2%. ( we have other savings)
We would like to use that to supplement our Social Security. We are in our late 50's . Why is this a bad idea?
SPIAs tend to make more sense only after you have picked the lower hanging fruit, which is

(1) Purchase a low-cost inflation-adjusted annuity from the US federal government by deferring SS.
(2) Fill the gap years between retirement and the delayed SS with a TIPS ladder

If, after that, you still need more stable income in retirement, then do this:

(3) Create a TIPS ladder out to age 80.
(4) Buy an extra TIPS whose proceeds you will use to purchase a SPIA at age 80. The duration of the TIPS should match the duration of the SPIA you will be buying at age 80.
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

$300K SPIA or just draw down?

Post by hudson »

vineviz wrote: Sun Jul 26, 2020 12:59 pm
hudson wrote: Sun Jul 26, 2020 12:45 pm For the example above, the 80 year old could just keep the $300K and pay himself $1730 per month for 173.4 months or 14.45 years.
I know that I haven't included interest. He would run out at age 94.45 years.
And a 80-year old woman has a 30% probability of living past age 95.

So we have a SPIA that pays the same monthly income as cash BUT also reduces the risk of running out of income from 30% to 0%. What’s the value of that lifetime guarantee? More than $0, surely.
Good point!
The 80 year old needs to read this discussion!
Now, if she had another $300K to back that up....
petulant
Posts: 1901
Joined: Thu Sep 22, 2016 1:09 pm

Re: The SPIA Guarantee

Post by petulant »

000 wrote: Sun Jul 26, 2020 4:13 pm
petulant wrote: Sun Jul 26, 2020 4:08 pm
000 wrote: Sun Jul 26, 2020 4:03 pm
Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
In the securities arena, "guarantee" is a technical term that means a contractual obligation exists to provide a specific outcome. SPIAs provide a guarantee for a certain amount of income for life--his claim should be understood to mean that it is the most generous guarantee you can get with an investment, not that it is the high income for life. None of the items you mentioned have a guarantee to provide anything; for example, the stock market may perform better, but it is not guaranteed.
My understanding of Taylor's post was that SPIA income was guaranteed to beat the income from any investment, which is not true. I acknowledge Taylor's phrasing is open to interpretation. Moreover, even the SPIA is not 100% guaranteed: it can lose value in real terms or the insurer can go bankrupt. I thought it was worthwhile to point these things out.
I don't think it's reasonable to interpret the post that way since, in context, he and any informed reader would know that of course a risky investment with no guarantee has the possibility of out-performing an annuity. You're right that the guarantee is only the contractual guarantee of the insurance company, and since the insurance company isn't God, both inflation, bankruptcy, and any other type of mishap can happen.
DesertGator
Posts: 64
Joined: Thu Jun 21, 2018 11:12 pm

Re: The SPIA Guarantee

Post by DesertGator »

Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Bogleheads:

Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "Variable annuities (not SPIAs) are very dangerous because they can't always deliver what they promise."
- The insurance company needs to make some profit
- The insurance company must invest somewhat conservatively, not speculatively to avoid large losses of principal

Where is the free lunch that allows less than max risk exposure, additional fees, and still guarantee the largest life income of any investment?

It seems to me this is clearly the best type of investment, to be found within the worst category of investments.
Wrench
Posts: 134
Joined: Sun Apr 28, 2019 10:21 am

Re: Why is this SPIA a bad idea?

Post by Wrench »

DesertGator: The answer to your question about how annuities can pay more than bonds is mortality credits. See
https://www.kitces.com/blog/understandi ... nt-income/
for details. Annuities are an insurance product, just like life insurance or auto insurance or home insurance. They insure against longevity risk, i.e., you live a lot longer than you planned. Like any insurance, you probably will "lose" your bet in that what you are insuring against won't happen. In that case, the insurance company "wins" and makes money. (And that's OK because if they lose by you living a long, long time, they will still be around to pay you!). But, that does not prevent one from buying the product, be it auto, home, life insurance or an annuity. The key for any product and insurance (annuities) are no different, is to shop around to get the best product that meets your needs at the best possible price. I am thrilled to have my inflation adjusted SPIA that pays out ~5.2% on premium, but that might be a terrible product for you or someone else. SPIAs are not for everyone just like life insurance is not for everyone. But for those who want a guaranteed income regardless of how long they live, they are a fine product. The answer to OP question should not be "don't buy annuities, they suck", but rather "these are things to look for, pitfalls to avoid, good (or bad) times or ages to buy, etc". As a BH I try to keep an open mind about ALL financial instruments to understand when/why they might work for me.
international001
Posts: 1606
Joined: Thu Feb 15, 2018 7:31 pm

Re: Why is this SPIA a bad idea?

Post by international001 »

Ok.. So per my calculations, let's look if the return is reasonable for a 65 year old SPIA. Assume no CPI SPIA (just nominal)

A 65 years old has an average age expectancy of 20 more years.
If he the SPIA invests in cash, he can get a 5% payout (i.e. 5k/12 a month if he payout at front 100k). This is is because the insurance part (some people die before, some people day after 20 years)

If it's invested and you get a 2% nominal return, then you can get a payout of 6%. You can verify this on a spreadsheet, making sure the remaining balance after 20 years is 0, assuming the return is constant
3% return, gives you a 6.5% payout
4% return, gives you a 7% payout
..
8% return, gives you a 9.5% payout

I'm assuming reasonable return is 8% (nominal. 6% real + 2% inflation) if it's invested all on a 100% stocks. Since an insurance company can overlap many generations to compensate those periods of losses with those periods of excess.

So anything under a 9.5% payout can be considered as inefficiencies and fees?
User avatar
grabiner
Advisory Board
Posts: 27964
Joined: Tue Feb 20, 2007 11:58 pm
Location: Columbia, MD

Re: Why is this SPIA a bad idea?

Post by grabiner »

international001 wrote: Sun Jul 26, 2020 6:29 pm Ok.. So per my calculations, let's look if the return is reasonable for a 65 year old SPIA. Assume no CPI SPIA (just nominal)

A 65 years old has an average age expectancy of 20 more years.
If he the SPIA invests in cash, he can get a 5% payout (i.e. 5k/12 a month if he payout at front 100k). This is is because the insurance part (some people die before, some people day after 20 years)

If it's invested and you get a 2% nominal return, then you can get a payout of 6%. You can verify this on a spreadsheet, making sure the remaining balance after 20 years is 0, assuming the return is constant
3% return, gives you a 6.5% payout
4% return, gives you a 7% payout
..
8% return, gives you a 9.5% payout

I'm assuming reasonable return is 8% (nominal. 6% real + 2% inflation) if it's invested all on a 100% stocks. Since an insurance company can overlap many generations to compensate those periods of losses with those periods of excess.

So anything under a 9.5% payout can be considered as inefficiencies and fees?
There are two other factors which reduce payouts. People who buy annuities tend to have above-average life expectancy. Also, insurance companies do not invest in 100% stocks, because of the risks involved; a market crash could easily take a stock-heavy portfolio from overfunded to underfunded.

The best annuity around avoids the adverse selection issue. Delaying Social Security gives a return based on close to an actuarial life expectancy (and actually too short for most ages).
Wiki David Grabiner
User avatar
vineviz
Posts: 7845
Joined: Tue May 15, 2018 1:55 pm

Re: Why is this SPIA a bad idea?

Post by vineviz »

grabiner wrote: Sun Jul 26, 2020 6:42 pm
international001 wrote: Sun Jul 26, 2020 6:29 pm
I'm assuming reasonable return is 8% (nominal. 6% real + 2% inflation) if it's invested all on a 100% stocks. Since an insurance company can overlap many generations to compensate those periods of losses with those periods of excess.

So anything under a 9.5% payout can be considered as inefficiencies and fees?
There are two other factors which reduce payouts. People who buy annuities tend to have above-average life expectancy. Also, insurance companies do not invest in 100% stocks, because of the risks involved; a market crash could easily take a stock-heavy portfolio from overfunded to underfunded.
Yep.

The actuarial life tables put the life expectancy of a 65-year old man in excellent health at 23 years, which is 15% longer than the calculation above.

And according to the NAIC, only 0.9% of the average life insurance company portfolio is invested in common stocks. Over 80% is in bonds, split roughly 2:1:1 between corporate bonds, structured notes (e.g. agency notes, MBS), and government bonds. The SEC yield on Vanguard Long-Term Bond Index Fund (VBLLX) is 2.24%, so I'd be shocked if most insurance companies were earning much more than that on 80% of their assets.

Given the payout on a SPIA for 65-year old man, the insurance company would need to earn slightly over 3% to break even.

Put another way, the investor would need to find a risk-free asset that returned 3% or better to come out ahead on average relative to the SPIA. And if the investor lived 24 years or more, they'd be broke before they died if they tried to DIY.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Wrench
Posts: 134
Joined: Sun Apr 28, 2019 10:21 am

Re: Why is this SPIA a bad idea?

Post by Wrench »

You miss the point. You don't buy annuities (or any insurance) for the AVERAGE case. You buy it for the tail risk. When I (or more likely, my wife) become the oldest person ever at age 135, my annuity will still be paying me every month. :happy No other product out there can GUARANTEE that. (I know the come-back: how do I know the insurance company will still be around when I am 135? I don't, but I minimize that risk by (1) buying only from a top rated company that has been around for 100 years or more, AND (2) only buying from any one company up to the limit of my state guarantor agency backing ($250K in my state), which will cover the loss if the company goes belly up).

The other thing that a lot of annuity nay-sayers miss is that for most SPIA purchasers, an SPIA is only one piece of their overall portfolio. In fact, when I purchased, the company would not sell me the product if if was too large a fraction of my net worth. My SPIA is only ~10% of my net worth. Aside from what I view as the benefits I describe above, it also provides a form of diversification to my portfolio. The payout is completely uncorrelated to stock, bonds, gold, real estate or any other asset class. That adds some "sleep well at night" value to me.
User avatar
Taylor Larimore
Advisory Board
Posts: 29970
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

History & the benefit of SPIA annuities

Post by Taylor Larimore »

Bogleheads:

Many years ago I had a license to sell annuities. The general idea intrigued me:

1. A group of people (annuities began in the Roman Empire) get together and pool their savings for future income.

2. The group agree that the money in the pool that is saved by no longer paying those who die early (and no longer need it) will be paid to provide extra money for those who live longer (and will need it).

My wife and I bought two Life Income Annuities (SPIA's) when we approached age 80. Pat died in 2013 but our two annuities continue to provide me with a comfortable income free from worry about running out of money. :happy

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "The stock market casino has become a giant—and costly—distraction to the serious business of investing."
"Simplicity is the master key to financial success." -- Jack Bogle
international001
Posts: 1606
Joined: Thu Feb 15, 2018 7:31 pm

Re: Why is this SPIA a bad idea?

Post by international001 »

vineviz wrote: Sun Jul 26, 2020 7:04 pm
grabiner wrote: Sun Jul 26, 2020 6:42 pm
international001 wrote: Sun Jul 26, 2020 6:29 pm
I'm assuming reasonable return is 8% (nominal. 6% real + 2% inflation) if it's invested all on a 100% stocks. Since an insurance company can overlap many generations to compensate those periods of losses with those periods of excess.

So anything under a 9.5% payout can be considered as inefficiencies and fees?
There are two other factors which reduce payouts. People who buy annuities tend to have above-average life expectancy. Also, insurance companies do not invest in 100% stocks, because of the risks involved; a market crash could easily take a stock-heavy portfolio from overfunded to underfunded.
Yep.

The actuarial life tables put the life expectancy of a 65-year old man in excellent health at 23 years, which is 15% longer than the calculation above.

And according to the NAIC, only 0.9% of the average life insurance company portfolio is invested in common stocks. Over 80% is in bonds, split roughly 2:1:1 between corporate bonds, structured notes (e.g. agency notes, MBS), and government bonds. The SEC yield on Vanguard Long-Term Bond Index Fund (VBLLX) is 2.24%, so I'd be shocked if most insurance companies were earning much more than that on 80% of their assets.

Given the payout on a SPIA for 65-year old man, the insurance company would need to earn slightly over 3% to break even.

Put another way, the investor would need to find a risk-free asset that returned 3% or better to come out ahead on average relative to the SPIA. And if the investor lived 24 years or more, they'd be broke before they died if they tried to DIY.
Thanks, so all of that are the inefficiencies of the SPIAs. If they were completely efficient they would invest 100% stocks and they would be able to average it out over a 200 year period

So more or less, 4% is the CPI adjusted SWR for 30 years, and 4% is more or less the CPI adjusted annuity payout.
For a permanent portfolio, SWR is perhaps 3%.

So the real benefit of a SPIA is marginal (between that 3% and that 4%). Plus you miss on the likely extra returns. So if you don't want to leave money to your heirs or do not have the taste for extra spending, I guess it's fine
petulant
Posts: 1901
Joined: Thu Sep 22, 2016 1:09 pm

Re: Why is this SPIA a bad idea?

Post by petulant »

international001 wrote: Mon Jul 27, 2020 9:36 am
vineviz wrote: Sun Jul 26, 2020 7:04 pm
grabiner wrote: Sun Jul 26, 2020 6:42 pm
international001 wrote: Sun Jul 26, 2020 6:29 pm
I'm assuming reasonable return is 8% (nominal. 6% real + 2% inflation) if it's invested all on a 100% stocks. Since an insurance company can overlap many generations to compensate those periods of losses with those periods of excess.

So anything under a 9.5% payout can be considered as inefficiencies and fees?
There are two other factors which reduce payouts. People who buy annuities tend to have above-average life expectancy. Also, insurance companies do not invest in 100% stocks, because of the risks involved; a market crash could easily take a stock-heavy portfolio from overfunded to underfunded.
Yep.

The actuarial life tables put the life expectancy of a 65-year old man in excellent health at 23 years, which is 15% longer than the calculation above.

And according to the NAIC, only 0.9% of the average life insurance company portfolio is invested in common stocks. Over 80% is in bonds, split roughly 2:1:1 between corporate bonds, structured notes (e.g. agency notes, MBS), and government bonds. The SEC yield on Vanguard Long-Term Bond Index Fund (VBLLX) is 2.24%, so I'd be shocked if most insurance companies were earning much more than that on 80% of their assets.

Given the payout on a SPIA for 65-year old man, the insurance company would need to earn slightly over 3% to break even.

Put another way, the investor would need to find a risk-free asset that returned 3% or better to come out ahead on average relative to the SPIA. And if the investor lived 24 years or more, they'd be broke before they died if they tried to DIY.
Thanks, so all of that are the inefficiencies of the SPIAs. If they were completely efficient they would invest 100% stocks and they would be able to average it out over a 200 year period

So more or less, 4% is the CPI adjusted SWR for 30 years, and 4% is more or less the CPI adjusted annuity payout.
For a permanent portfolio, SWR is perhaps 3%.

So the real benefit of a SPIA is marginal (between that 3% and that 4%). Plus you miss on the likely extra returns. So if you don't want to leave money to your heirs or do not have the taste for extra spending, I guess it's fine
You're comparing a traditional portfolio to the SPIA. That's not the only comparison to make. You should also compare the SPIA to bonds within the portfolio, both as a direct substitute or as a strategy to reduce withdrawal needs and thus reconsider the initial asset allocation. SPIAs can function effectively in this manner since they are often driven by internal rates of return similar to bond funds while allowing higher early withdrawal rates since they insure against longevity.
User avatar
vineviz
Posts: 7845
Joined: Tue May 15, 2018 1:55 pm

Re: Why is this SPIA a bad idea?

Post by vineviz »

international001 wrote: Mon Jul 27, 2020 9:36 am Thanks, so all of that are the inefficiencies of the SPIAs. If they were completely efficient they would invest 100% stocks and they would be able to average it out over a 200 year period
No, not at all. The return profile for stocks is a HORRIBLE match for the liability profile of insurance companies. Insurance is a highly competitive industry: there are no "inefficiencies" anywhere near the order of magnitude you're suggesting.
international001 wrote: Mon Jul 27, 2020 9:36 amSo more or less, 4% is the CPI adjusted SWR for 30 years, and 4% is more or less the CPI adjusted annuity payout.
For a permanent portfolio, SWR is perhaps 3%.
Two things:

First, no. The expected SWR for 30 years is not 4% today. It's probably closer to 3% for a typical stock/bond portfolio.

Second, the SWR of a market portfolio is not directly comparable to the payout of an income annuity. They have very different risk profiles (the SWR has a non-zero chance of creating an income shortfall, whereas the annuity does not).
international001 wrote: Mon Jul 27, 2020 9:36 am So the real benefit of a SPIA is marginal (between that 3% and that 4%). Plus you miss on the likely extra returns. So if you don't want to leave money to your heirs or do not have the taste for extra spending, I guess it's fine
Except for highly risk-tolerant investors with very low withdrawal rates, converting some portion of wealth to an income annuity is generally optimal in the sense that it maximizes the ratio of lifetime income to terminal wealth.

If your initial withdrawal rate is less than, say, 2.5% AND you're comfortable maintaining a 100% equity portfolio for the rest of your life then an annuity probably offers no advantages for you. My guess is that most people don't fall into this category.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
Alex GR
Posts: 161
Joined: Mon Jul 31, 2017 9:17 am

Re: Why is this SPIA a bad idea?

Post by Alex GR »

May I ask a question on this topic?
If I don't have any heirs and I know I will not have any heirs at death, and I don't want to leave money to any charities, what specific SPIA can I go with to maximize the payout?
Which product/insurance company? Any catches/pitfalls to consider?
I really like the idea of SPIA for the gap between SS and living expenses.
User avatar
vineviz
Posts: 7845
Joined: Tue May 15, 2018 1:55 pm

Re: Why is this SPIA a bad idea?

Post by vineviz »

Alex GR wrote: Mon Jul 27, 2020 10:33 am May I ask a question on this topic?
If I don't have any heirs and I know I will not have any heirs at death, and I don't want to leave money to any charities, what specific SPIA can I go with to maximize the payout?
Which product/insurance company? Any catches/pitfalls to consider?
I really like the idea of SPIA for the gap between SS and living expenses.
Maximizing the payout is a dubious goal, since the insurance companies that offer the highest payouts are the ones most likely to go bankrupt. :(

There are two excellent websites I'm familiar with that aggregate quotes from various insurance companies, so I'd check them out.

https://www.immediateannuities.com

https://www.blueprintincome.com

I tend to find that the insurance companies rated either A+ or A++ have payouts that are very comparable to each other most of the time. Personally, I'd stick with companies rated either A+ or A++ but within that group I wouldn't have a concern with choosing the highest payout. The companies try to balance the risks of their different lines of insurance, so sometimes a company will be able to offer a slightly better payout for a particular combination of age, COLA, etc. Finding similar rated companies with payout that is +/- 10% of other companies isn't uncommon.
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: Why is this SPIA a bad idea?

Post by hudson »

Alex GR wrote: Mon Jul 27, 2020 10:33 am Any catches/pitfalls to consider?
I really like the idea of SPIA for the gap between SS and living expenses.
I am for SPIAs if they fit.
I would make sure that I understood how the state guarantee programs work. They are programs set up by the states, but funded by insurance companies.
sycamore
Posts: 1226
Joined: Tue May 08, 2018 12:06 pm

Re: Why is this SPIA a bad idea?

Post by sycamore »

Alex GR wrote: Mon Jul 27, 2020 10:33 am May I ask a question on this topic?
If I don't have any heirs and I know I will not have any heirs at death, and I don't want to leave money to any charities, what specific SPIA can I go with to maximize the payout?
Which product/insurance company? Any catches/pitfalls to consider?
I really like the idea of SPIA for the gap between SS and living expenses.
In addition to vineviz's reply, read the Bogleheads Wiki article on annuities, especially annuitization options.
Gill
Posts: 6709
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: The SPIA Guarantee

Post by Gill »

000 wrote: Sun Jul 26, 2020 4:03 pm
Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
Did you read what Taylor said? He emphasized "Guarantee". The examples you cite have no guarantees.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal
hudson
Posts: 3269
Joined: Fri Apr 06, 2007 9:15 am

Re: The SPIA Guarantee

Post by hudson »

Gill wrote: Mon Jul 27, 2020 11:39 am
000 wrote: Sun Jul 26, 2020 4:03 pm
Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
Did you read what Taylor said? He emphasized "Guarantee". The examples you cite have no guarantees.
Gill
More about the state guarantee associations: https://www.immediateannuities.com/stat ... ociations/
User avatar
Stinky
Posts: 5584
Joined: Mon Jun 12, 2017 11:38 am
Location: Sweet Home Alabama

Re: Why is this SPIA a bad idea?

Post by Stinky »

vineviz wrote: Mon Jul 27, 2020 10:43 am
Alex GR wrote: Mon Jul 27, 2020 10:33 am May I ask a question on this topic?
If I don't have any heirs and I know I will not have any heirs at death, and I don't want to leave money to any charities, what specific SPIA can I go with to maximize the payout?
Which product/insurance company? Any catches/pitfalls to consider?
I really like the idea of SPIA for the gap between SS and living expenses.
Maximizing the payout is a dubious goal, since the insurance companies that offer the highest payouts are the ones most likely to go bankrupt. :(

There are two excellent websites I'm familiar with that aggregate quotes from various insurance companies, so I'd check them out.

https://www.immediateannuities.com

https://www.blueprintincome.com

I tend to find that the insurance companies rated either A+ or A++ have payouts that are very comparable to each other most of the time. Personally, I'd stick with companies rated either A+ or A++ but within that group I wouldn't have a concern with choosing the highest payout. The companies try to balance the risks of their different lines of insurance, so sometimes a company will be able to offer a slightly better payout for a particular combination of age, COLA, etc. Finding similar rated companies with payout that is +/- 10% of other companies isn't uncommon.
This is great advice. Spot on point.
It's a GREAT day to be alive - Travis Tritt
000
Posts: 2842
Joined: Thu Jul 23, 2020 12:04 am

Re: The SPIA Guarantee

Post by 000 »

Gill wrote: Mon Jul 27, 2020 11:39 am
000 wrote: Sun Jul 26, 2020 4:03 pm
Taylor Larimore wrote: Sun Jul 26, 2020 12:53 pm Single Premium Immediate Annuities (SPIA's) guarantee the largest life income of any investment.
No, they do not. There are many investments that will provide a greater life income than a SPIA, like starting a successful business, picking the next Apple Inc, et cetera.

Of course even if we limit the investment selection to broadly diversified index funds, there is no guarantee the SPIA will beat the stock market and the income generated by an investment therein. Moreover, inflation may reduce the real income provided by the SPIA.
Did you read what Taylor said? He emphasized "Guarantee". The examples you cite have no guarantees.
Gill
I do not want to derail this thread with a discussion on semantics so this will be my last post on this subject.

"guarantee the largest life income of any investment" is NOT the same as "offer the largest guaranteed life income of any investment"

More importantly, even the weaker (second) form of this statement is not true in my opinion for reasons I stated upthread. Mostly due to concerns about inflation and the fact that no insurance company or reinsurance pool or government backstop is 100% guaranteed.
Gill
Posts: 6709
Joined: Sun Mar 04, 2007 8:38 pm
Location: Florida

Re: The SPIA Guarantee

Post by Gill »

000 wrote: Mon Jul 27, 2020 12:23 pm I do not want to derail this thread with a discussion on semantics so this will be my last post on this subject.

"guarantee the largest life income of any investment" is NOT the same as "offer the largest guaranteed life income of any investment"

More importantly, even the weaker (second) form of this statement is not true in my opinion for reasons I stated upthread. Mostly due to concerns about inflation and the fact that no insurance company or reinsurance pool or government backstop is 100% guaranteed.
Thanks for limiting your response. Guarantee with respect to an SPIA is used in its simplest contractual sense, i.e., there is an obligor (the insurance carrier) and an obligee (the annuitant) and the obligor is making the guarantee to the obligee. I continue to agree with Taylor.
Gill
Cost basis is redundant. One has a basis in an investment | One advises and gives advice | One should follow the principle of investing one's principal
Post Reply