Why do people buy annuities?

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Claudia Whitten
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Why do people buy annuities?

Post by Claudia Whitten »

I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
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Re: Why do people buy annuities?

Post by dbr »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
The quip is that people don't buy annuities; they are sold annuities. This means that predatory salesmen convince people against their interest that they should buy the annuity. SPIAs and MYGAs are probably exceptions to this and there could be a small number of cases where someone in particular could conceivably take advantage of certain annuities, perhaps a variable annuity invested at low costs.
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Re: Why do people buy annuities?

Post by retired@50 »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
There are two annuities that are generally accepted as "good" annuities, and dozens of others that aren't.

Multi-Year Guaranteed Annuity (MYGA) has a mega thread by Stinky (the resident expert) here: viewtopic.php?t=334589 These are often used as a substitute for a bond fund.

Single Premium Immediate Annuities are also "good" in the sense that you're making a one-time payment (say in your 70s) for a paycheck for the rest of your life. These are often described as longevity insurance, i.e. so you can't outlive your money.
See link: https://www.bogleheads.org/wiki/Immediate_fixed_annuity

As for the "why" part, I suspect some people are just risk averse enough to not want to deal with the ups and downs of the stock and bond markets.

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Johm221122
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Re: Why do people buy annuities?

Post by Johm221122 »

There are many types of annuities

MYGA's are basically like a CD. They can provide a little more return but are a little more difficult to buy and sell. They also have a little more risk because they are not FDIC insured

Single Premium immediate annuities (SPIA) are like a pension. You hand over a lump sum and the insurance company gives you a check for life. The longer you live the better they are. You do have to plan for inflation with SPIA's because inflation can be a problem long term just like a pension that doesn't adjust for inflation.

The kind of annuity that your referring to is different and usually sold to someone and not bought. I can't explain these or why people use them.
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Re: Why do people buy annuities?

Post by sschullo »

I own an annuity, the Tradition Annuity with TIAA, currently paying 5.25%, which I had from my former employer. It is only available if TIAA is part of your 401k, 403b, or 457b plan with an employer. It's perfect for my fixed account allocation. I also have principle protection, free to move at any time without surrender fees, and no hideous M&E fees. There is a fee to the TPA of $50 per year.
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Re: Why do people buy annuities?

Post by Kagord »

You can get a free steak dinner out of it and you'll make nominal currency units whether the market goes up or down.
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Re: Why do people buy annuities?

Post by Valuethinker »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
The "10% return" is:
- confusing return of capital with investment income (deliberately), when an annuity pays out both OR
- only a forecast, based on an outright lie (cloaking a forecast as a promise) - the fine print will note market fluctuations & performance may vary

The core annuity product, the Single Premium Income Annuity (SPIA) is one of the oldest financial products out there. And for good reasons. (there's a wiki here, somewhere)

It provides longevity insurance. You cannot outlive your savings. It is the only way that you can provide longevity insurance.** What you have in effect is a Defined Benefit pension scheme - and this was the standard for American employees in the middle 20th Century up until the last 30 years or so. Now basically almost only for public servants. Throw in a survivor benefit, and you have not only protected yourself, you have protected your spouse -- that's an incredible benefit.

It's a competitive market. So pricing is keen-- insurers don't make a lot of money on these. Actuarial assumptions that are used are regulated. So Insurance companies try to sell you other products - with "annuity" in the name, but they are not SPIAs. They are almost always very bad value for investors: opaque to higher fees and risks being run.

All the research suggests that people with a steady income in retirement are happier than people with a large lump sum. It's a huge puzzle in financial economics why annuities are not more widely used. With explanations from Behavioural Finance as to why not.

What are the risks of an SPIA:

1. the insurance company goes broke. States have insurance schemes, which the insurers cannot mention in their promotional literature. Nisiprius here has done a tremendous amount of research on these and written about it here, if you use the search function on the relevant posts.

Suffice it to say, the bottom line is that the schemes do protect investors against loss of insurer. Up to the State Guarantee limits. However for large annuitants, as for example the customers of Executive Life in California, that went broke on junk bond investments, they can suffer significant uninsured losses.

If there was a serial and catastrophic failure of insurers - AIG in 2008 for example, had it not been bailed out - it's likely the guarantee schemes would be overwhelmed. So you have to hope then for a Federal government bailout. And that State Regulators have been sufficiently tough and avoided regulatory capture on the way (regulators becoming "owned" by the industry).

Unfortunately due to the long term nature of the product, a good credit rating now for an insurer is no protection against changes. AIG was at least A rated, if not AA.

2. inflation. The US market does not, currently, offer inflation-linked annuities. Inflation is the big risk to retirees in the long run. For this reason, here we usually advise Social Security recipients to delay as long as possible. SS Is inflation-indexed, and is "actuarially fair" ie the Present Value, given average life expectancy, is the same whatever year you first take benefits. So by delaying, you increase your inflation protection in the long run, which is what matters. The devil is in the detail (I am not US-based) when we come to spousal taking of SS etc.

Note escalating annuities (eg +3% pa) are actually worse, in that you get more of the money later, so you are *more* exposed to unexpected inflation.

Generally people don't like tying up their capital. As long as their mental cognition holds, most Bogleheads can probably be trusted to manage a lump sum of capital through their retirement. Often, however, their spouses may not be au fait with finance & investing.

The best approach, one followed by Taylor Larrimore, the now 100-year old eminence grise of this Board, is probably to "phase" annuities -- don't buy them all at once at x age. The "mortality credit" -- the amount you get for repayment of capital due to diminished life expectancy as you age - increases as you get older and in a non-linear fashion (ie it increases as an upward curve).

Note that if you have diminished life expectancy due to health or other issues this is very much to your favour in buying annuites, a "rated" policy. Annuitants, as a group, live longer than the population as a whole, a form of "adverse selection" against annuity buyers.

** there is now a thing called a "longevity swap" that pension funds use to rid themselves of risks of pensioners living too long. But that's only available in the wholesale market to DB pension funds.

In the UK, Church of England (ie Anglican/ Episcopal) men & women of the cloth (clergy) have the longest life expectancy of any occupational group. It is causing great stress for their pension scheme.

ENDING RANT

When people talk about "the 4% rule". They are really talking about annuities. Except they think they can take their portfolio, take 4% off each year, growing with inflation, and live on that.

There is no such rule. Even the originators of the original study noted that the low failure rates for that strategy depended upon a particularly favourable time for returns of both bonds and equities. It's just not a number you can rely upon for the next 30-35 years, say. And barring another Covid type thing, the sort of person who posts here, if aged 60 or 65, does have to think about living to at least 95 (and if they have a female spouse, almost certainly for her).

A SPIA does provide that certainty, as long as the insurer does not go broke. But you still have the risk of unexpected inflation. So it's not a total solution to the problem.
Last edited by Valuethinker on Mon Apr 01, 2024 10:18 am, edited 1 time in total.
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Re: Why do people buy annuities?

Post by Sandtrap »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
The "guaranteed for life" monthly payment of an annuity continues and ensures the same psychological and lifestyle comfort zone, and sense of financial reliability and security, that an institutional paycheck has provided over a lifetime prior.

Regardless of "boglehead" perspectives and spreadsheet logics, this "need" to "feel safe and secure" within a well known life paradigm, emotionally and mentally, prioritizes nearly everything in life for most "non bogleheads".

"The need to feel safe and unthreatened and secure" is a base core need that is innate".

And, all the thinking and talking and reading and discussing and convincing and "Spock like" logic, is not going to change someone's perspective and what drives them in life in this way.

to op: your answer has nothing to do with numbers. And, perhaps the majority of "non bogleheads" are incapable and unwilling to look at or hear numbers.

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Re: Why do people buy annuities?

Post by bsteiner »

People buy the good kind (where you give the insurance company a large check and they give you, or you and your significant other, a small check each month for life) to protect against living too long and running out of money, and to avoid having to live meagerly for fear of living too long and running out of money. If you take the annuity from an employer plan, you may get a better price than if you bought one individually, especially for women since ERISA plans use unisex pricing.

People buy the other kinds to pay high expenses (though a couple of them have relatively modest expenses), to convert dividends and capital gains to ordinary income, and to give up the basis step-up at death. If you buy it in an IRA you pay the expenses but don't get the income tax results.

But occasionally someone in a high bracket uses one with modest expenses for tax-inefficient assets such as high yield debt or some hedge funds. If they can hold it for a very long time, the deferral may outweigh the expenses.
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Re: Why do people buy annuities?

Post by KlangFool »

OP,

Almost everyone has a Cost of Living Adjusted (COLA) based annuities, it is called social security. And, usually, if someone delayed withdrawing their social security at 62 years old, they get 8% per year increase in their benefits. And, if someone's retirement expense is mostly covered by the social security, they do not need additional annuities. But, the problem with the above advice is that no one will make money out of you by giving above advice.

So, the very first question that you need to ask is how much of the retirement expense is covered by social security and pension? And, the person can buy more social security benefits by delaying their withdrawal from social security.

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Post by bertilak »

"Why do people buy annuities?" For the guaranteed income.

I wouldn't buy an annuity from someone who talked about it in terms of potential return. A 'pure" annuity is a contract with a contracted payout. It is a guarantee, not a projection nor a prediction.

I am retired and my pension is an annuity -- not like an annuity but an actual annuity. The company I retired from bought for me. I also bought a smaller annuity on my own to "top up" my income to better match expenses, current and and projected. If my projections turn out to be too low, I can buy another.
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Re: Why do people buy annuities?

Post by abc132 »

An annuity can help maximize your spend rate if leaving a big inheritance is not a priority. This works better as you get into your 70's because of the longevity payoff from the increasing number of annuitants who die early.
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Re: Why do people buy annuities?

Post by ruralavalon »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
"a 10 percent per year return" is too good to be true, so it's not true, it's a lie if promised. If a projection it's very unrealistic.

Your friend might consider a simple, inexpensive Single Premium Immediate Annuity (SPIA) if she is retired or ready to retire soon, or a deferred income annuity (DIA) if not ready to retire soon. For rates see: immediateannuities.com. Those types of annuities can provide a guaranteed income stream for a lifetime, no investment in the stock market required.

As for other types of annuities, people don't "buy" them, they are "sold" by insurance salesmen and are almost never a good idea.
Last edited by ruralavalon on Mon Apr 01, 2024 10:44 am, edited 2 times in total.
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Re: Why do people buy annuities?

Post by SmileyFace »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am She's ... deathly afraid of stock market volatility.
I think this is answering your own question.
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Re: Why do people buy annuities?

Post by Stinky »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
You’ve gotten some excellent comments above, especially from retired@50 and valuethinker. So I won’t go into “repeat” mode on what they said.

As to the 10% per year that your friend may be “promised” -

There are no annuities that pay that kind of rate over a period of years. Zero. Zip. Nada.

Either your friend didn’t catch all of the nuances of the annuity sales pitch, or the advisor is lying. (Or maybe both. :twisted: ) But 10% per year guaranteed return is not even remotely within the bounds of reason.

It’s most likely that your friend is being pitched an indexed annuity, which will pay a fat commission (maybe 6-8%) to the salesman and will provide inferior value to your friend. If you want to go into a deep dive on that particular product, please post the product name and issuing company, plus any more details you have.

As to why Bogleheads might consider an annuity -

There are two types of annuities that many Bogleheads find attractive. I happen to own both -

—- Multi year guaranteed annuities (MYGAs), sometimes called “CD annuities”, which provide a fixed and guaranteed rate of interest for a fixed time.

—- Single premium immediate annuities (SPIAs), which can provide periodic payments for the rest of your lifetime.

Both of these are relatively simple, low commission, high consumer value products.

Post back if you want to take a deeper dive on anything I’ve said.
Last edited by Stinky on Mon Apr 01, 2024 10:55 am, edited 1 time in total.
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Topic Author
Claudia Whitten
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Re: Why do people buy annuities?

Post by Claudia Whitten »

And then a related question is how do insurance companies make money on annuities?
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Re: Why do people buy annuities?

Post by Stinky »

Claudia Whitten wrote: Mon Apr 01, 2024 10:52 am And then a related question is how do insurance companies make money on annuities?
For both MYGAs and SPIAs, they invest their assets to earn more than they pay out to policyholders. Kind of like banks do.

And for SPIAs, they use their knowledge of mortality patterns to predict how many policyholders will die at what age, and then set their product prices to earn money on mortality.
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Claudia Whitten
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Re: Why do people buy annuities?

Post by Claudia Whitten »

Stinky wrote: Mon Apr 01, 2024 10:55 am
Claudia Whitten wrote: Mon Apr 01, 2024 10:52 am And then a related question is how do insurance companies make money on annuities?
For both MYGAs and SPIAs, they invest their assets to earn more than they pay out to policyholders. Kind of like banks do.
Right. So the salesperson made my friend think that the folks at the insurance company had some magic sauce or sophisticated investing knowledge that allowed them to make the kinds of returns necessary to offer the attractive payouts. My BS sensor went off quickly.

So what are these insurance companies investing in that no one else in the world seems privy to?
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Re: Why do people buy annuities?

Post by Elysium »

Claudia Whitten wrote: Mon Apr 01, 2024 10:52 am And then a related question is how do insurance companies make money on annuities?
Same way they make money on any insurance premium you pay. They pay less than expected, because the insured incident did not happen and they did not pay you more than they expected. In the case of annuity, instead of living longer you die before expected age and they get to keep the premium. On average they know most people will buy annuity at an earlier age than they should and then end up not collecting enough.
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Re: Why do people buy annuities?

Post by Stinky »

Claudia Whitten wrote: Mon Apr 01, 2024 10:57 am
Stinky wrote: Mon Apr 01, 2024 10:55 am
Claudia Whitten wrote: Mon Apr 01, 2024 10:52 am And then a related question is how do insurance companies make money on annuities?
For both MYGAs and SPIAs, they invest their assets to earn more than they pay out to policyholders. Kind of like banks do.
Right. So the salesperson made my friend think that the folks at the insurance company had some magic sauce or sophisticated investing knowledge that allowed them to make the kinds of returns necessary to offer the attractive payouts. My BS sensor went off quickly.

So what are these insurance companies investing in that no one else in the world seems privy to?
Beyond regular old Treasuries and corporate bonds, insurers can invest in much larger sizes, and in asset classes which may be illiquid for a period of time. Assets like private placements, commercial mortgages, a smattering of less than investment grade bonds, etc.

Insurers have a well-honed sense of the future cash flows from their book of business, so they can trade some temporary illiquidity for higher yields.

And they can invest at much larger scale than mere mortals like you and me.

But they don’t invest at a high enough rate to pay 10% per year to policyholders. :twisted:
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Claudia Whitten
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Re: Why do people buy annuities?

Post by Claudia Whitten »

This doesn't pass the common sense test to me on so many levels. If annuities are such a great deal and insurance companies can do it better than we can, why isn't everyone buying an annuity? Why don't corporations, endowments, and indeed governments run to insurance companies, saying, "here take my money, your returns are so great."

I don't know. They sound like a "just say no" situation to me.
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Re: Why do people buy annuities?

Post by Johm221122 »

Claudia Whitten wrote: Mon Apr 01, 2024 11:10 am This doesn't pass the common sense test to me on so many levels. If annuities are such a great deal and insurance companies can do it better than we can, why isn't everyone buying an annuity? Why don't corporations, endowments, and indeed governments run to insurance companies, saying, "here take my money, your returns are so great."

I don't know. They sound like a "just say no" situation to me.
Which annuity are you referring too?

The one pitched to your friend, I agree

MYGA'S and SPIA's, depending on goals and situation they can be great tools for your retirement plan
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Re: Why do people buy annuities?

Post by rich126 »

It is just sad that people are so naive and financially illiterate to believe what people tell them. And even sadder that companies do this and apparently are allowed to avoid providing true details in an easier to read format for the buyer.

SPIAs/Immediate annuities people buy for a guaranteed amount of money per year, unfortunately inflation will eat away and what seemed like a good amount won't be 15-25 years down the road.

I was going to say this isn't any different than people who ignore doctor's advice and will instead take supplements or do other questionable things but in this case these products are often sold by financial people and people assume they know what they are talking about and have their best interests in mind but instead they are just sales people looking to make commissions.
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Claudia Whitten
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Re: Why do people buy annuities?

Post by Claudia Whitten »

Valuethinker wrote: Mon Apr 01, 2024 10:13 am 2. inflation. The US market does not, currently, offer inflation-linked annuities. Inflation is the big risk to retirees in the long run.
Correct me if I'm wrong, but my sense is that people tend to forget about the effect of inflation when purchasing an annuity. Inflation can really make an initially-high-looking payout seem pretty pathetic over time, especially if inflation runs higher than the long-term historical average (3.267 percent).

https://www.usinflationcalculator.com/i ... ion-rates/
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Re: Why do people buy annuities?

Post by Oicuryy »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am The company is promising her a 10 percent per year return.
No it isn't.

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Re: Why do people buy annuities?

Post by Johm221122 »

Claudia Whitten wrote: Mon Apr 01, 2024 11:25 am
Valuethinker wrote: Mon Apr 01, 2024 10:13 am 2. inflation. The US market does not, currently, offer inflation-linked annuities. Inflation is the big risk to retirees in the long run.
Correct me if I'm wrong, but my sense is that people tend to forget about the effect of inflation when purchasing an annuity. Inflation can really make an initially-high-looking payout seem pretty pathetic over time, especially if inflation runs higher than the long-term historical average (3.267 percent).

https://www.usinflationcalculator.com/i ... ion-rates/
Yes it's one downside among many for SPIA'S

But it's often recommended you take the rest of your portfolio and invest aggressively.

You may want to actually look at a calculator for a SPIA, especially for people 70+

Then inflation doesn't change the fact that if you buy a MYGA over a CD you will probably get more return. Of course people shouldn't invest in CDs or MYGA'S for long term goals in general
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Re: Why do people buy annuities?

Post by WillRetire »

Claudia Whitten wrote: Mon Apr 01, 2024 11:25 am
Valuethinker wrote: Mon Apr 01, 2024 10:13 am 2. inflation. The US market does not, currently, offer inflation-linked annuities. Inflation is the big risk to retirees in the long run.
Correct me if I'm wrong, but my sense is that people tend to forget about the effect of inflation when purchasing an annuity. Inflation can really make an initially-high-looking payout seem pretty pathetic over time, especially if inflation runs higher than the long-term historical average (3.267 percent).

https://www.usinflationcalculator.com/i ... ion-rates/
Hopefully they understand that when purchasing an SPIA-type product. Best to purchase when older vs. younger. Bogleheads seem to like SPIAs at 80.

SPIAs provide a pension of sort. If you are a federal retiree with a federal pension (IIRC you are), you probably needn't concern yourself with an SPIA unless your pension is very low.

Inflation is misunderstood and difficult to predict. Food inflation impacts young growing families more than the elderly. If you buy an SPIA at age 80, you don't need to worry too much about inflation. If you buy an SPIA at age 50 and live to age 95, an SPIA will lose a lot of its value.
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Re: Why do people buy annuities?

Post by cshell2 »

I'm only 55 now, but do plan on buying an SPIA with a COL adjustment around age 65 or 70 with a small portion of my retirement savings (maybe 20%). My social security check won't be enough to cover but a very bare bones existence and I will have no other guaranteed income. The annuity would go a long ways for the "peace of mind" factor for me...especially since I like to be invested pretty aggressively.
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Re: Why do people buy annuities?

Post by WillRetire »

cshell2 wrote: Mon Apr 01, 2024 11:40 am I'm only 55 now, but do plan on buying an SPIA with a COL adjustment around age 65 or 70 with a small portion of my retirement savings (maybe 20%). My social security check won't be enough to cover but a very bare bones existence and I will have no other guaranteed income. The annuity would go a long ways for the "peace of mind" factor for me...especially since I like to be invested pretty aggressively.
+1
snic
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Re: Why do people buy annuities?

Post by snic »

This discussion makes me wonder why no insurance company has come up with a "social security SPIA". That is, you hand over $X, and the insurance company agrees to make monthly payouts with cost-of-living adjustments according to exactly the same formula that the social security administration uses, for the rest of your life. That way, you could, say, double your social security income.

The usefulness of such a scheme is that it reduces both longevity risk and inflation risk. The only annuity that currently does both is social security. The value to the customer is that if you know what your minimum expenses are, and they're greater than your SS check, then you can make up that deficit by paying $X now and then never have to worry about being able to afford your minimally acceptable lifestyle.

If wise Bogleheads are able to deal with inflation risk by investing in TIPS and bonds, why not insurance companies?
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Re: Why do people buy annuities?

Post by Johm221122 »

snic wrote: Mon Apr 01, 2024 11:43 am This discussion makes me wonder why no insurance company has come up with a "social security SPIA". That is, you hand over $X, and the insurance company agrees to make monthly payouts with cost-of-living adjustments according to exactly the same formula that the social security administration uses, for the rest of your life. That way, you could, say, double your social security income.

The usefulness of such a scheme is that it reduces both longevity risk and inflation risk. The only annuity that currently does both is social security. The value to the customer is that if you know what your minimum expenses are, and they're greater than your SS check, then you can make up that deficit by paying $X now and then never have to worry about being able to afford your minimally acceptable lifestyle.

If wise Bogleheads are able to deal with inflation risk by investing in TIPS and bonds, why not insurance companies?
The part about inflation adjustments on an annuity comes up often here and if I remember the past posts about this it was because of lack of demand. Annuities without inflation adjustments pay more initially
snic
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Re: Why do people buy annuities?

Post by snic »

Johm221122 wrote: Mon Apr 01, 2024 11:47 am
snic wrote: Mon Apr 01, 2024 11:43 am This discussion makes me wonder why no insurance company has come up with a "social security SPIA". That is, you hand over $X, and the insurance company agrees to make monthly payouts with cost-of-living adjustments according to exactly the same formula that the social security administration uses, for the rest of your life. That way, you could, say, double your social security income.

The usefulness of such a scheme is that it reduces both longevity risk and inflation risk. The only annuity that currently does both is social security. The value to the customer is that if you know what your minimum expenses are, and they're greater than your SS check, then you can make up that deficit by paying $X now and then never have to worry about being able to afford your minimally acceptable lifestyle.

If wise Bogleheads are able to deal with inflation risk by investing in TIPS and bonds, why not insurance companies?
The part about inflation adjustments on an annuity comes up often here and if I remember the past posts about this it was because of lack of demand. Annuities without inflation adjustments pay more initially
But none of them actually have inflation adjustments. They have a fixed % increase per year that mimics inflation adjustment, but isn't because inflation could be much higher or lower.

You are right, of course, that the initial payout would be lower than an annuity without such an adjustment. What I'm wondering is whether marketing it as "just like social security" would convince people who expect to live a long time to take the initial hit.
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Re: Why do people buy annuities?

Post by Stinky »

Claudia Whitten wrote: Mon Apr 01, 2024 11:10 am If annuities are such a great deal and insurance companies can do it better than we can, why isn't everyone buying an annuity? Why don't corporations, endowments, and indeed governments run to insurance companies, saying, "here take my money, your returns are so great."
Insurance companies can invest at greater scale, and can take more liquidity and credit risk, than individuals can.

Large foundations can invest like insurance companies. And so can state government pension plans. Plus they can invest in equities, which life insurance companies don’t use to back their liabilities.

But insurance companies don’t pass on all their returns to policyholders. Foundations and state pension plans are better off doing their investing on their own than using insurance companies as a middleman.
Claudia Whitten wrote: Mon Apr 01, 2024 11:10 am
I don't know. They sound like a "just say no" situation to me.
It’s perfectly fine for you to just say no to annuities.

But they are a good fit for certain people in certain situations.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
Johm221122
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Re: Why do people buy annuities?

Post by Johm221122 »

snic wrote: Mon Apr 01, 2024 11:53 am
Johm221122 wrote: Mon Apr 01, 2024 11:47 am
snic wrote: Mon Apr 01, 2024 11:43 am This discussion makes me wonder why no insurance company has come up with a "social security SPIA". That is, you hand over $X, and the insurance company agrees to make monthly payouts with cost-of-living adjustments according to exactly the same formula that the social security administration uses, for the rest of your life. That way, you could, say, double your social security income.

The usefulness of such a scheme is that it reduces both longevity risk and inflation risk. The only annuity that currently does both is social security. The value to the customer is that if you know what your minimum expenses are, and they're greater than your SS check, then you can make up that deficit by paying $X now and then never have to worry about being able to afford your minimally acceptable lifestyle.

If wise Bogleheads are able to deal with inflation risk by investing in TIPS and bonds, why not insurance companies?
The part about inflation adjustments on an annuity comes up often here and if I remember the past posts about this it was because of lack of demand. Annuities without inflation adjustments pay more initially
But none of them actually have inflation adjustments. They have a fixed % increase per year that mimics inflation adjustment, but isn't because inflation could be much higher or lower.

You are right, of course, that the initial payout would be lower than an annuity without such an adjustment. What I'm wondering is whether marketing it as "just like social security" would convince people who expect to live a long time to take the initial hit.
They did in the past
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funxional
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Re: Why do people buy annuities?

Post by funxional »

Valuethinker wrote: Mon Apr 01, 2024 10:13 am Note that if you have diminished life expectancy due to health or other issues this is very much to your favour in buying annuites, a "rated" policy. Annuitants, as a group, live longer than the population as a whole, a form of "adverse selection" against annuity buyers.
I don't follow you here. Annuities are priced based on customers living longer than average. If you die sooner how is that to your advantage? Is that based on return of principle after death? I am only nominally (no pun intended) familiar with annuities.

Edit: you would have to worry less about inflation but that doesn't seem like a benefit of the annuity per se
Last edited by funxional on Mon Apr 01, 2024 12:06 pm, edited 1 time in total.
bikechuck
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Re: Why do people buy annuities?

Post by bikechuck »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
Recently at the age of 70.5 I decided to annuitize approximately 8% of my portfolio that I had invested in TIAA Traditional. I had been taking interest only payments from this investment since I retired at the age of 64 and was planning to continue doing so throughout my retirement years.

When I checked into it I realized that if I annuitized this money my monthly payout (partially a return on investment but partially a return of my own money) would be approximately double the amount of my interest only payments. I chose a joint annuity with a 20 year period certain meaning that the payments will continue for as long as either my wife or I live and for twenty years payable to our daughters should we both die during the twenty year period.

I feel good about my decision because I am drawing less from the remainder of my portfolio and I can invest that money more aggressively. I was not "sold" this annuity ... I decided to purchase it on my own because I thought it was a sensible decision.
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Re: Why do people buy annuities?

Post by simplesimon »

Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
In the case of SPIA, to transfer market risk from the individual to the insurer and potentially benefit from mortality credits if the buyer lives longer than expected.

Your friend's reasoning of investing to get "better returns than the market" doesn't apply and does sound fishy. There's no free lunch.
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Re: Why do people buy annuities?

Post by cshell2 »

cshell2 wrote: Mon Apr 01, 2024 11:40 am I'm only 55 now, but do plan on buying an SPIA with a COL adjustment around age 65 or 70 with a small portion of my retirement savings (maybe 20%). My social security check won't be enough to cover but a very bare bones existence and I will have no other guaranteed income. The annuity would go a long ways for the "peace of mind" factor for me...especially since I like to be invested pretty aggressively.
Another reason I have for considering an annuity, is I have a very hard time spending savings. I am high risk to die with a pile of money (which I realize a lot of Boglehead's might not consider a bad thing) but it's a little depressing to me to think I sacrificed my whole life just for numbers in an account when I check out. I do not have nearly the emotional hang up with spending income however, so this guarantees I maximize my use of at least some of my savings no matter what the market is doing.
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Re: Why do people buy annuities?

Post by gougou »

So she put in $1M she can draw $100K/yr for life? That sounds like a reasonable deal if she can live a long life. It’s also more tax-efficient than bond.

If you put $1M in 3-funds you can’t guarantee $100K/yr for life. If market stays flat for 10 years you are out.
The sillier the market’s behavior, the greater the opportunity for the business like investor.
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Re: Why do people buy annuities?

Post by Taylor Larimore »

Claudia:
My wife and I bought an immediate annuity (SPIA) in our late 70s. The purchase went so well we bought another a year later.

I am now 100 years old and my two payments come in each month like clockwork. They are the best worry-free investments we ever made.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "I probably prefer an immediate annuity which starts paying you right away."
"Simplicity is the master key to financial success." -- Jack Bogle
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Re: Why do people buy annuities?

Post by Dottie57 »

Claudia Whitten wrote: Mon Apr 01, 2024 11:10 am This doesn't pass the common sense test to me on so many levels. If annuities are such a great deal and insurance companies can do it better than we can, why isn't everyone buying an annuity? Why don't corporations, endowments, and indeed governments run to insurance companies, saying, "here take my money, your returns are so great."

I don't know. They sound like a "just say no" situation to me.
Annuities don’t (in general) have inflation protection.

Annuities are expensive.
The insurance company has great statistics on when people die.
Most of annuities should be bought as longevity insurance - worry about living longer than your money.
Annuities are not investments becaise of high fees.
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Re: Why do people buy annuities?

Post by Dottie57 »

Taylor Larimore wrote: Mon Apr 01, 2024 12:31 pm Claudia:
My wife and I bought an immediate annuity (SPIA) in our late 70s. The purchase went so well we bought another a year later.

I am now 100 years old and my two payments come in each month like clockwork. They are the best worry-free investments we ever made.

Best wishes.
Taylor
Jack Bogle's Words of Wisdom: "I probably prefer an immediate annuity which starts paying you right away."
I only have one quibble with your statement. I think your SPIAs are the best INSURANCE purchase you made.
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Re: Why do people buy annuities?

Post by bonesly »

Claudia Whitten wrote: Mon Apr 01, 2024 11:10 am This doesn't pass the common sense test to me on so many levels. If annuities are such a great deal and insurance companies can do it better than we can, why isn't everyone buying an annuity? Why don't corporations, endowments, and indeed governments run to insurance companies, saying, "here take my money, your returns are so great."

I don't know. They sound like a "just say no" situation to me.
Everyone would certainly be buying an annuity if they offered a guaranteed 10% return on investment. Maybe not so much if that 10% is a 4% return on investment and 6% return of your original principal.
Valuethinker wrote: Mon Apr 01, 2024 10:13 am The "10% return" is:
- confusing return of capital with investment income (deliberately), when an annuity pays out both OR
- only a forecast, based on an outright lie (cloaking a forecast as a promise) - the fine print will note market fluctuations & performance may vary
It sure seems like your friend is not buying a product, but rather a product is being sold to her by a deceptive salesman that stands to make a big commission. Your friend should be very wary. Your "too good to be true" BS sensor is spot-on. Have her read the fine print before buying. Get the specifics of the policy and post them here for feedback to relay to your friend.
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Re: Why do people buy annuities?

Post by GaryA505 »

rich126 wrote: Mon Apr 01, 2024 11:24 am It is just sad that people are so naive and financially illiterate to believe what people tell them. And even sadder that companies do this and apparently are allowed to avoid providing true details in an easier to read format for the buyer.

SPIAs/Immediate annuities people buy for a guaranteed amount of money per year, unfortunately inflation will eat away and what seemed like a good amount won't be 15-25 years down the road.

I was going to say this isn't any different than people who ignore doctor's advice and will instead take supplements or do other questionable things but in this case these products are often sold by financial people and people assume they know what they are talking about and have their best interests in mind but instead they are just sales people looking to make commissions.
It is also sad that people are so naive and financially illiterate that they think all types of annuities are the same.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: Why do people buy annuities?

Post by Box of Rain »

My spouse will get a state pension, it will pay to the end of both of our lives. There is no cost of living adjustment at all. In the beginning of our retirement at ages 60 and 62 it will pay about 34% of our annual mandatory expenses and 27% will come from our savings and investments. By the time my spouse is 85, the pension will be covering only 15% of our inflation-adjusted expenses, and we will need the savings and investments to cover 53%. By the time one or both of us is in the mid-90's, pension will only be paying 10% of our annual expenses. That is not good math! Even at mild, average annual inflation rate (low 3% range) the price level doubles in low 20+ years. Can not imagine buying a SPIA at any point in my retirement. I am half way through DK's "Can I Retire Yet?" book, and he talks about how he plans to buy an annuity in his 60's for part of his income needs. Does mention inflation issues, but then moves right along to say he is going to be buying one. That book is really good (the intention to buy a SPIA notwithstanding) and I know it is from about 2016, so maybe he has changed his mind since then? Can't understand the annuity buying. Looking at my cost and income projections as I get ready for retirement, the impact of even low inflation rates is really dramatic.
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Re: Why do people buy annuities?

Post by GaryA505 »

bikechuck wrote: Mon Apr 01, 2024 12:06 pm
Claudia Whitten wrote: Mon Apr 01, 2024 9:53 am I'm trying to understand this. Why do people buy annuities? A friend is planning to buy one. The company is promising her a 10 percent per year return. She's retirement age and deathly afraid of stock market volatility.

My default reaction to annuities has always been "no." I'm not saying they're scams, necessarily, but they always make me think of the saying "if it sounds too good to be true, it is." I also don't like the idea of giving my money to an insurance company.

Please help me understand (a) why people buy annuities and (b) why or when they might be a good idea.
Recently at the age of 70.5 I decided to annuitize approximately 8% of my portfolio that I had invested in TIAA Traditional. I had been taking interest only payments from this investment since I retired at the age of 64 and was planning to continue doing so throughout my retirement years.

When I checked into it I realized that if I annuitized this money my monthly payout (partially a return on investment but partially a return of my own money) would be approximately double the amount of my interest only payments. I chose a joint annuity with a 20 year period certain meaning that the payments will continue for as long as either my wife or I live and for twenty years payable to our daughters should we both die during the twenty year period.

I feel good about my decision because I am drawing less from the remainder of my portfolio and I can invest that money more aggressively. I was not "sold" this annuity ... I decided to purchase it on my own because I thought it was a sensible decision.
This is a smart usage of a SPIA, with a decision based on numbers rather than emotion. Using a SPIA to compliment other sources if fixed income to produce a base income floor, then investing the remainder of assets more aggressively is a solid strategy. I plan to annuitize (SPIA) about 10% of our assets to do this when I'm about 75 years old.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
James.534
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Re: Why do people buy annuities?

Post by James.534 »

My wife and I bought an immediate annuity (SPIA) in our late 70s. The purchase went so well we bought another a year later.

I am now 100 years old and my two payments come in each month like clockwork. They are the best worry-free investments we ever made.
This is due to good fortune, good health and longevity.

And for the poor soul, who bought the same annuity at 70 and died at 71 , it was the worst investment they ever made. And for them it probably doesnt matter , but it may matter to the surviving spouse depending upon the contract
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Re: Why do people buy annuities?

Post by GaryA505 »

Box of Rain wrote: Mon Apr 01, 2024 12:57 pm My spouse will get a state pension, it will pay to the end of both of our lives. There is no cost of living adjustment at all. In the beginning of our retirement at ages 60 and 62 it will pay about 34% of our annual mandatory expenses and 27% will come from our savings and investments. By the time my spouse is 85, the pension will be covering only 15% of our inflation-adjusted expenses, and we will need the savings and investments to cover 53%. By the time one or both of us is in the mid-90's, pension will only be paying 10% of our annual expenses. That is not good math! Even at mild, average annual inflation rate (low 3% range) the price level doubles in low 20+ years. Can not imagine buying a SPIA at any point in my retirement. I am half way through DK's "Can I Retire Yet?" book, and he talks about how he plans to buy an annuity in his 60's for part of his income needs. Does mention inflation issues, but then moves right along to say he is going to be buying one. That book is really good (the intention to buy a SPIA notwithstanding) and I know it is from about 2016, so maybe he has changed his mind since then? Can't understand the annuity buying. Looking at my cost and income projections as I get ready for retirement, the impact of even low inflation rates is really dramatic.
You hit on an important point. IMO a SPIA should only be used to add to other, inflation-adjusted sources of fixed income to provide an income floor. And, the SPIA should only be used if those other, inflation-adjusted sources of income provide a large percentage (let's say 75%) of the income floor.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Claudia Whitten
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Re: Why do people buy annuities?

Post by Claudia Whitten »

cshell2 wrote: Mon Apr 01, 2024 12:14 pm
cshell2 wrote: Mon Apr 01, 2024 11:40 am I'm only 55 now, but do plan on buying an SPIA with a COL adjustment around age 65 or 70 with a small portion of my retirement savings (maybe 20%). My social security check won't be enough to cover but a very bare bones existence and I will have no other guaranteed income. The annuity would go a long ways for the "peace of mind" factor for me...especially since I like to be invested pretty aggressively.
Another reason I have for considering an annuity, is I have a very hard time spending savings. I am high risk to die with a pile of money (which I realize a lot of Boglehead's might not consider a bad thing) but it's a little depressing to me to think I sacrificed my whole life just for numbers in an account when I check out. I do not have nearly the emotional hang up with spending income however, so this guarantees I maximize my use of at least some of my savings no matter what the market is doing.
Spending savings...Doesn't having more disposable income lose its luster after a while, though? I mean, later in life, what do you really need that (more) money can buy? Often money just buys stuff that you have to maintain and that adds complexity to your life--not something I want later in life. Unless I'm living on the edge and need more money for food, experiences, or other things of obvious value, then what's the point of more?

Seems to me a lot of these financial products or "opportunities" are offered to people on the assumption that they want more, more, more. The older I get, the more I personally want less, less, less.
GaryA505
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Re: Why do people buy annuities?

Post by GaryA505 »

James.534 wrote: Mon Apr 01, 2024 1:03 pm
My wife and I bought an immediate annuity (SPIA) in our late 70s. The purchase went so well we bought another a year later.

I am now 100 years old and my two payments come in each month like clockwork. They are the best worry-free investments we ever made.
This is due to good fortune, good health and longevity.

And for the poor soul, who bought the same annuity at 70 and died at 71 , it was the worst investment they ever made. And for them it probably doesnt matter , but it may matter to the surviving spouse depending upon the contract
1. A SPIA doesn't have to be life-only. It can be bought with a period certain.
2. A SPIA can be bought joint life, in which case the payment continues (at a percentage you select) to the surviving spouse.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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