Why is this SPIA a bad idea?

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Wricha
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Re: The SPIA Guarantee

Post by Wricha »

Gill wrote: Mon Jul 27, 2020 2:02 pm
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.
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Alex GR
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Re: Why is this SPIA a bad idea?

Post by Alex GR »

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.
Thanks for this very informative reply.
I read somewhere that as long as the amount is below $250k it doesn't matter, because it's covered by State Guaranty, so I didn't take that into consideration.
The amount would probably be 170-200k or so (for a monthly payment of $800-1000), just to cover the gap between SS and living expenses.
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vineviz
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Re: Why is this SPIA a bad idea?

Post by vineviz »

Alex GR wrote: Mon Jul 27, 2020 2:47 pm I read somewhere that as long as the amount is below $250k it doesn't matter, because it's covered by State Guaranty, so I didn't take that into consideration.
That’s MOSTLY true.

The exact protections vary by state, and for a very plain SPIA with no riders (eg. COLA, guaranteed refunds, etc) a bankruptcy probably isn’t going make much difference (except for the hassle and delays).
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Alex GR
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Re: Why is this SPIA a bad idea?

Post by Alex GR »

Ben Mathew wrote: Sun Jul 26, 2020 4:19 pm
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.
Ben,
But TIPS produce a return of what, 1%? I am willing to make an argument that if someone does not have any heirs (no children, wife, or living parents), does not wish to leave money to charity, and generally does not care what happens after death, SPIA beats TIPS hands down because it pays 5-6% a year (as far as that person is concerned) vs. 1% in other guaranteed investments.
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vineviz
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Re: Why is this SPIA a bad idea?

Post by vineviz »

Alex GR wrote: Mon Jul 27, 2020 3:42 pm
But TIPS produce a return of what, 1%? I am willing to make an argument that if someone does not have any heirs (no children, wife, or living parents), does not wish to leave money to charity, and generally does not care what happens after death, SPIA beats TIPS hands down because it pays 5-6% a year (as far as that person is concerned) vs. 1% in other guaranteed investments.
I'd go further and say that income annuities probably beat TIPS in most cases where the investor DOES have heirs or otherwise wants to maximize the value of their estate. Locking in the desired lifetime income by using an annuity allows the investor to take more risk (and get the commensurate higher expected return) with the rest of the portfolio.

The one big retirement risk that income annuities don't address as well as TIPS do is inflation risk.

For that I reason, I suspect that most investors would be best off to build a TIPS ladder (in the way that Ben suggested) approximately large enough to cover the portion of their basic (non-discretionary) living expenses that Social Security won't cover, purchase immediate and/or deferred annuities to cover the rest of their expected expenses (i.e. the discretionary portion), and invest whatever wealth they have left over in manner consistent with their bequest motives (e.g 100/0 or 90/10) to maximize capital growth.

This way basic living expenses are guaranteed to be covered for life with inflation protection. Desired-but-optional living expenses are covered by the income annuities. And the reserve wealth is growing to cover emergencies, heirs, and/or charitable giving.
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CWRadio
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Re: Why is this SPIA a bad idea?

Post by CWRadio »

Can a Boglehead please point me in the right direction on how to build a step by step TIPS ladder as described in the above message.
Thanks Paul
beanie
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Re: Why is this SPIA a bad idea?

Post by beanie »

vineviz wrote: Mon Jul 27, 2020 4:00 pm
Alex GR wrote: Mon Jul 27, 2020 3:42 pm
But TIPS produce a return of what, 1%? I am willing to make an argument that if someone does not have any heirs (no children, wife, or living parents), does not wish to leave money to charity, and generally does not care what happens after death, SPIA beats TIPS hands down because it pays 5-6% a year (as far as that person is concerned) vs. 1% in other guaranteed investments.
... I suspect that most investors would be best off to build a TIPS ladder (in the way that Ben suggested) approximately large enough to cover the portion of their basic (non-discretionary) living expenses that Social Security won't cover, purchase immediate and/or deferred annuities to cover the rest of their expected expenses (i.e. the discretionary portion), and invest whatever wealth they have left over in manner consistent with their bequest motives (e.g 100/0 or 90/10) to maximize capital growth.

This way basic living expenses are guaranteed to be covered for life with inflation protection. Desired-but-optional living expenses are covered by the income annuities. And the reserve wealth is growing to cover emergencies, heirs, and/or charitable giving.
Sure, you get inflation protected with a TIPs ladder covering basic expenses, but you expose yourself to longevity risk. If I live longer than expected, I personally would rather cover my basic expenses with a SPIA, knowing that there is at least a floor of payments that last for life. Otherwise you have to set up a ladder that exceeds your life expectancy.
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vineviz
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Re: Why is this SPIA a bad idea?

Post by vineviz »

beanie wrote: Mon Jul 27, 2020 5:03 pm Sure, you get inflation protected with a TIPs ladder covering basic expenses, but you expose yourself to longevity risk. If I live longer than expected, I personally would rather cover my basic expenses with a SPIA, knowing that there is at least a floor of payments that last for life. Otherwise you have to set up a ladder that exceeds your life expectancy.
You should solve for the risks YOU face, of course, and not blindly follow anyone else’s plan.

That said, I think the approach I laid out could - with whatever tweaks you want to apply - successfully balance both longevity risk and inflation risk.

For instance, let’s say the TIPS ladder provides a floor of inflation income up to age 85. Layer on a SPIA starting at age 70 with a 1% fixed COLA.

Add in a deferred annuity that starts paying at age 85 with a fixed 4% COLA. Or buy, at age 70, a 30-year TIPS sufficient to buy a second SPIA at age 82. Or whatever. Invest the rest of your wealth in 100% VTWAX.

Rearrange the pieces so that you’re keeping whatever balance of interest rate risk, inflation risk, longevity risk, and equity risk you think suits your needs.

For retirees whose Social Security covers all their basic living expenses, maybe the TIPS ladder is completely unneeded. An investor with a 2% withdrawal rate might not benefit much from the annuities. Etc
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hudson
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Re: Why is this SPIA a bad idea?

Post by hudson »

vineviz wrote: Mon Jul 27, 2020 5:17 pm
You should solve for the risks YOU face, of course, and not blindly follow anyone else’s plan.

Rearrange the pieces so that you’re keeping whatever balance of interest rate risk, inflation risk, longevity risk, and equity risk you think suits your needs.

For retirees whose Social Security covers all their basic living expenses, maybe the TIPS ladder is completely unneeded. An investor with a 2% withdrawal rate might not benefit much from the annuities. Etc
Useful info...Thanks!
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Taylor Larimore
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SPIA's can be a good idea if you have heirs

Post by Taylor Larimore »

[Alex GR wrote: I am willing to make an argument that if someone does not have any heirs (no children, wife, or living parents), does not wish to leave money to charity, and generally does not care what happens after death, SPIA beats TIPS hands down because it pays 5-6% a year (as far as that person is concerned) vs. 1% in other guaranteed investments.
AlexGR:

I have heirs and also wish to leave money to charity. My annuities provide a guaranteed lifetime income which allows me to give my money to heirs and to charity now while I am still alive.

The guaranteed income from my Single Premium Immediate Annuities (SPIAs) is the reason I am able to donate my book royalties to The John C. Bogle Center for Financial Literacy now. My remaining portfolio is small--but I don't care.

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 return."
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international001
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Re: Why is this SPIA a bad idea?

Post by international001 »

vineviz wrote: Mon Jul 27, 2020 10:06 am

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).
Sure, there is always a chance that market goes down more than in the past. If you consider SPIAs 100% safe, then go with SPIAs all the way for those rare events.

I'm simplifying and assuming the worst case scenario of the past. This is what SWR (30 years or perpetual portfolio) I'm considering

vineviz wrote: Mon Jul 27, 2020 10:06 am 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.
My point is that if you assume a permanent portfolio you can trust on, you are right. For argument sake, I consider the 3% CPI adjustment as reasonable.
But it really doesn't maximize 'lifetime income', but 'minimum lifetime income'
If that's your goal (you need that minimum income and cannot go lower, you don't want go go higher, and you don't want to leave anything to heirs), then SPIA work.
I'd question this is the case for many people here.
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Re: Why is this SPIA a bad idea?

Post by international001 »

Alex GR wrote: Mon Jul 27, 2020 2:47 pm
Thanks for this very informative reply.
I read somewhere that as long as the amount is below $250k it doesn't matter, because it's covered by State Guaranty, so I didn't take that into consideration.
The amount would probably be 170-200k or so (for a monthly payment of $800-1000), just to cover the gap between SS and living expenses.
Which state? What if you move around?
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Re: Why is this SPIA a bad idea?

Post by White Coat Investor »

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?
Why do you think it is a bad idea other than your youth and the difficulty in finding a SPIA with a COLA these days (and the fact that 2% doesn't go very far if inflation hits 10%)?
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rgs92
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Re: Why is this SPIA a bad idea?

Post by rgs92 »

Can't you roughly mimic an inflation-adjusted annuity by setting aside a part of each monthly payment from a simple fixed SPIA and investing it into a 3-fund-portfolio?
Of course, this would take some discipline, so it's easier said than done, but that's a behavior-related issue.

By the way, Fidelity offers SPIAs that incorporate a small fixed increase each year, like 2%. So these exist. It is genuine CPI-linked ones that have gone away (or are very rare at least [I heard Principal has them, but for some reason they aren't very good]).
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ResearchMed
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Re: Why is this SPIA a bad idea?

Post by ResearchMed »

rgs92 wrote: Tue Jul 28, 2020 5:29 pm Can't you roughly mimic an inflation-adjusted annuity by setting aside a part of each monthly payment from a simple fixed SPIA and investing it into a 3-fund-portfolio?
Of course, this would take some discipline, so it's easier said than done, but that's a behavior-related issue.
That is one way to try to mimic IN PART a COLA'd SPIA if one has a level SPIA, with emphasis on "try" and "IN PART".

However, you still wouldn't be able to capture the "best use/availsbility of the money as long as you live" aspect of an SPIA, and that aspect is quite important to most who get life annuities.

RM
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Re: Why is this SPIA a bad idea?

Post by rgs92 »

Thanks R.Med. True that the 3-funder is not a true substitute for an inflation-tracking lump of money, but since it's invested over time, there is a good chance it would be close (well, after a little leap of faith). And at other points, I suppose you could buy some TIPSs with it, or a TIPS fund.

The idea is that there would be some source of extra funds for when inflation kicked in and your expenses went up. You would need to estimate how much you could take from this extra nest-egg lump. I don't see it as exactly formulaic.

Probably for many people, this same approach would be more commonly used with a non-inflation-adjusted pension, which seems to be the most universal kind these days.

So I think it is worth studying this kind of strategy for fixed income streams. I don't see it discussed much. It's nice that FIRECALC can simulate this situation; you can easily incorporate a fixed income stream into your financial profile and see what happens in the results.

In fact, now that I think about it, a good answer to the OP's original question would be to just use FIRECALC with the SPIA stream tossed in to see how it helps with the success rate.
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Re: Why is this SPIA a bad idea?

Post by Ben Mathew »

Alex GR wrote: Mon Jul 27, 2020 3:42 pm
Ben Mathew wrote: Sun Jul 26, 2020 4:19 pm
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.
Ben,
But TIPS produce a return of what, 1%? I am willing to make an argument that if someone does not have any heirs (no children, wife, or living parents), does not wish to leave money to charity, and generally does not care what happens after death, SPIA beats TIPS hands down because it pays 5-6% a year (as far as that person is concerned) vs. 1% in other guaranteed investments.
The 1% vs 5-6% is not a fair comparison. But it's true that annuities will generally provide a higher income than a TIPS ladder reaching into a high enough age like age 100. From immediateannuities.com, I get that a 60 year old man in WA state can purchase a monthly income for life of $2,186 or $26,232 per year for $500,000. The value of this payout will decline over time due to inflation. Since we don't know the rate of inflation, we don't know exactly what it will pay out. But if it is 1.5%, it will dwindle to $14,461 per year by age 100.

If we try to replicate this with a TIPS ladder yielding say -.60%, I get that it will cost $905,641. So, a lot more expensive than the SPIA. But, it has the advantage of inflation protection which the SPIA does not have.

If inflation adjusted SPIAs had been available, there would be no problem--we could just buy those. But given that we don't have inflation adjusted SPIAs, the strategy I outlined tries to balance the inflation protection provided by TIPS and social security, and the longevity insurance provided by SPIAs and social security. If you calculate the true cost of this strategy, I doubt it will be excessively high compared to buying a SPIA, which would entail taking on a lot of inflation risk. TIPS are not any more expensive than treasuries, so you won't lose much by funding the early years with TIPS instead of SPIAs. Longevity risk becomes more important in the later years and you would be funding those years with deferred Social Security and a SPIA, not TIPS.
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Re: Why is this SPIA a bad idea?

Post by hudson »

CWRadio wrote: Mon Jul 27, 2020 4:47 pm Can a Boglehead please point me in the right direction on how to build a step by step TIPS ladder as described in the above message.
Thanks Paul
Paul,
I am looking at doing a TIPS ladder in a few years. This discussion which you are probably already looking at may be a good start:

viewtopic.php?f=10&t=320347

This book: https://thefinancebuff.com/explore-tips

another recent discussion: viewtopic.php?f=10&t=320295&hilit=ladder

You may want to start a discussion on building a TIPS Ladder?

EDIT: I found one more link that might help: viewtopic.php?p=5394448#p5394448
international001
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Re: Why is this SPIA a bad idea?

Post by international001 »

ResearchMed wrote: Tue Jul 28, 2020 5:35 pm
rgs92 wrote: Tue Jul 28, 2020 5:29 pm Can't you roughly mimic an inflation-adjusted annuity by setting aside a part of each monthly payment from a simple fixed SPIA and investing it into a 3-fund-portfolio?
Of course, this would take some discipline, so it's easier said than done, but that's a behavior-related issue.
That is one way to try to mimic IN PART a COLA'd SPIA if one has a level SPIA, with emphasis on "try" and "IN PART".

However, you still wouldn't be able to capture the "best use/availsbility of the money as long as you live" aspect of an SPIA, and that aspect is quite important to most who get life annuities.

RM
Or use any fund for that:

https://www.portfoliovisualizer.com/bac ... ion1_1=100
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