Deferred Immediate Annuities

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umfundi
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Deferred Immediate Annuities

Post by umfundi » Tue Sep 24, 2013 1:27 pm

Wade Pfau recommends DIAs over SPIAs:

http://advisorperspectives.com/newslett ... _SPIAs.php

More food for thought.

Keith
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Levett
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Re: Deferred Immediate Annuities

Post by Levett » Tue Sep 24, 2013 2:01 pm

Yes. It came into my email and I was led to ask myself the proverbial question: Is a bird in the hand (an SPIA) worth two in the bush (a DIA)?

Time will tell! ;-)

Lev

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coachz
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Re: Deferred Immediate Annuities

Post by coachz » Tue Sep 24, 2013 2:02 pm

Will live long enough for the bush ?

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Re: Deferred Immediate Annuities

Post by technovelist » Tue Sep 24, 2013 2:03 pm

"Deferred Immediate"? Is that like "jumbo shrimp"? :oops:
In theory, theory and practice are identical. In practice, they often differ.

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Re: Deferred Immediate Annuities

Post by IlikeJackB » Tue Sep 24, 2013 2:09 pm

Wade calls 'em deferred-income annuities. :wink: Thanks for the link, Keith!
"Do what you will, the capital is at hazard." Justice Samuel Putnam, Harvard College vs Amory, 1830. The "Prudent Man Rule."

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Re: Deferred Immediate Annuities

Post by DickBenson » Tue Sep 24, 2013 2:39 pm

For both DIAs and SPIAs, a lump-sum premium is paid today in return for a guaranteed income for life. The difference is that for the DIA, the guaranteed income does not begin until a later date.
In a TIAA Traditional account one "buys" the guaranteed income for life with periodic payments rather than with a "lump sum", and one also can determine when the guaranteed income should begin. Why would this not be a better procedure than DIA?

Dick

umfundi
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Re: Deferred Immediate Annuities

Post by umfundi » Tue Sep 24, 2013 3:02 pm

DickBenson wrote:
For both DIAs and SPIAs, a lump-sum premium is paid today in return for a guaranteed income for life. The difference is that for the DIA, the guaranteed income does not begin until a later date.
In a TIAA Traditional account one "buys" the guaranteed income for life with periodic payments rather than with a "lump sum", and one also can determine when the guaranteed income should begin. Why would this not be a better procedure than DIA?

Dick
Sounds to me like a traditional DB (Defined Benefit) pension ... ?

Keith
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umfundi
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Re: Deferred Immediate Annuities

Post by umfundi » Tue Sep 24, 2013 3:08 pm

I believe there is something worth thinking about here.

Annuities (or DB pensions) are just about the only way you can buy mortality credits, aka longevity insurance.

I am 63. My life expectancy is age 83. If I live only to 83, I will be fine. (Well, fine financially. At age 83 under this scenario I will clearly not be fine :shock: )

If I live beyond age 83 (say, another 15 years) there's a real issue. Should I buy SPIAs as I need them (my current plan) or should I buy a DIA now, deferred for 20 years, and plan to use my remaining funds by age 83?

In other words, should I buy a DIA that indeed is insurance only if I live longer than my life expectancy?

Interesting.

Keith
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Frugal Al
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Re: Deferred Immediate Annuities

Post by Frugal Al » Tue Sep 24, 2013 3:14 pm

Interesting theory. Of course the elephant in the room is INFLATION, resulting in the same concerns we have with SPIAs when taken at a relatively young age.

Levett
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Re: Deferred Immediate Annuities

Post by Levett » Tue Sep 24, 2013 4:31 pm

"Sounds to me like a traditional DB (Defined Benefit) pension ... ?"

No. It's the backbone of TIAAs DC plan since 1918.

Lev.

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Re: Deferred Immediate Annuities

Post by Alan S. » Wed Sep 25, 2013 7:59 pm

Seems like the longevity insurance should otherwise be referred to a "SPDA", since an individual contract is paid up front (SP) and the annuity payout is deferred to age 85 or so. The insuror is meanwhile investing that up front premium which enables a higher payout than an immediate annuity due to the deferral period.

If purchased in an IRA, the IRS proposed Regs allow the annuity amount to be excluded from the IRA balance for RMD calculation purposes. This reduces the RMD for around 15 years, and therefore income taxes. However, once the annuity enter payout stage, you are in your mid 80s, your RMDs are considerably higher and the annuity payout is added to your taxable income. Once the payout begins it becomes a partial answer to self insuring LTC since your less likely to run out of money due to LT care expenses. And since your LTC expenses will be deductible in excess of 10% of AGI, there will be permanent tax savings from having the reduced RMDs until the annuity payments begin, and then a large write off for the much larger distributions. Of course, not many will be able to time their LT care expenses to coincide with the the start of the annuity payout, but the chance of this eventually happening increases considerably after 85.

Main point is that longevity insurance may be more attractive if you don't have LTC insurance than if you do.

umfundi
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Re: Deferred Immediate Annuities

Post by umfundi » Wed Sep 25, 2013 10:47 pm

Alan S. wrote:Seems like the longevity insurance should otherwise be referred to a "SPDA", since an individual contract is paid up front (SP) and the annuity payout is deferred to age 85 or so. The insuror is meanwhile investing that up front premium which enables a higher payout than an immediate annuity due to the deferral period.

If purchased in an IRA, the IRS proposed Regs allow the annuity amount to be excluded from the IRA balance for RMD calculation purposes. This reduces the RMD for around 15 years, and therefore income taxes. However, once the annuity enter payout stage, you are in your mid 80s, your RMDs are considerably higher and the annuity payout is added to your taxable income. Once the payout begins it becomes a partial answer to self insuring LTC since your less likely to run out of money due to LT care expenses. And since your LTC expenses will be deductible in excess of 10% of AGI, there will be permanent tax savings from having the reduced RMDs until the annuity payments begin, and then a large write off for the much larger distributions. Of course, not many will be able to time their LT care expenses to coincide with the the start of the annuity payout, but the chance of this eventually happening increases considerably after 85.

Main point is that longevity insurance may be more attractive if you don't have LTC insurance than if you do.
Alan,

Thank you, you expressed what I was thinking. I like the term "SPDA".

Up to now, I was looking to SPIAs to ensure my minimum ("floor") income needs, with longevity insurance as a secondary factor. An SPDA allows you to emphasize the longevity part.

Keith
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MIretired
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Re: Deferred Immediate Annuities

Post by MIretired » Thu Sep 26, 2013 10:13 pm

Up to now, I was looking to SPIAs to ensure my minimum ("floor") income needs, with longevity insurance as a secondary factor. An SPDA allows you to emphasize the longevity part.

Keith
Doesn't the deferred thing even worry you? As far as the company going bunk, etc.? But, there is a limited state guarantee on it, isn't there?
I've been scared of signing over anything, let alone deferred.

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Re: Deferred Immediate Annuities

Post by umfundi » Fri Sep 27, 2013 12:31 am

MIpreRetirey wrote:
Up to now, I was looking to SPIAs to ensure my minimum ("floor") income needs, with longevity insurance as a secondary factor. An SPDA allows you to emphasize the longevity part.

Keith
Doesn't the deferred thing even worry you? As far as the company going bunk, etc.? But, there is a limited state guarantee on it, isn't there?
I've been scared of signing over anything, let alone deferred.
MIpre,

I guess I got over it (seriously) when I had to choose between GM's offer to buy out my pension for a lump sum. When I said no to the lump sum, they forced me to an annuity (SPIA) from Prudential.

One of the best things I ever did was to put the exact numbers of my GM offer here on the Bogleheads site. They analyzed it six ways from Sunday. I realized then that SPIAs are actually quite a good deal, in some circumstances.

I did a lot of reading, and was persuaded by Michael Zwecher and Jim Otar, and influenced (not persuaded) by Zvi Bodie. Later, I realized that William Bernstein is saying the same thing, with his liability matched portfolios. Then, the good people at Boston College convinced me of the idea to delay claiming Social Security.

The issue is, you need a certain base level of income in retirement, a stream of income which will last as long as you live. However long that is. That you should assure. An SPIA is a very good way to do that.

The point is not that you may die young and the money is gone. What do you care, you're dead? The point is you may live long beyond your life expectancy of 82 or so, and run out of money.

The other danger, which not many talk about, is that you may be too frugal, deny yourself many pleasures, and die as the richest man in the graveyard. Roof racks on your hearse, and all that.

Assuring the floor takes care of it. Buy the Single Premium annuity, you are done. What's left over is mad money, to spend on yourself or leave as a legacy. (Yes, I know. We still have to talk about inflation.)

The deferred Single Premium thing is interesting because suppose (like me) you are pretty much set for now. What I will need in about ten years, is a way to goose my fixed income by about $12,000 per year to compensate for inflation. Should I wait and spend about $171k on an SPIA then, or should I buy an SPDA now? I don't' know, I have not looked at the numbers.

So far as the guarantee is concerned, I would not worry about it. Of course, check out your provider. There is no state guarantee: There is an industry guarantee governed by state law. Insurance companies understand very well that their business is predicated on the confidence their customers have in them.

Best wishes,

Keith
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MIretired
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Re: Deferred Immediate Annuities

Post by MIretired » Fri Sep 27, 2013 1:01 am

Yes, Keith, I agree with you, and I'm there.
I was being somewhat facetious, as I know I can't be scared to do what makes legitimate sense. But, yah, the annuity thing is a recent pondering for me.
Besides current low interest rates, which make them, possibly, less attractive right now (SPIAs), I'd need to check if a SPDA makes more sense in waiting or not as far as price. Or waiting on an SPIA for the longevity insurance. Right. I agree, an ounce of 'income floor' is worth a pound of discretionary income. I should research some William Bernstein ideas, too. The liability matching for longevity. These threads about negative glide paths got me eyeing stacking up cash to pay for later safety, and buying the income ins. in steps. Annuities?
Thanks for answering my ?s.
Steve MI-pre-retiree

umfundi
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Re: Deferred Immediate Annuities

Post by umfundi » Fri Sep 27, 2013 1:28 am

MIpreRetirey wrote:Yes, Keith, I agree with you, and I'm there.
I was being somewhat facetious, as I know I can't be scared to do what makes legitimate sense. But, yah, the annuity thing is a recent pondering for me.
Besides current low interest rates, which make them, possibly, less attractive right now (SPIAs), I'd need to check if a SPDA makes more sense in waiting or not as far as price. Or waiting on an SPIA for the longevity insurance. Right. I agree, an ounce of 'income floor' is worth a pound of discretionary income. I should research some William Bernstein ideas, too. The liability matching for longevity. These threads about negative glide paths got me eyeing stacking up cash to pay for later safety, and buying the income ins. in steps. I thought I was becoming an annuity salesman. Me?
Thanks for answering my ?s.
MIpre,

Which would you call market timing:

Buy an SPDA now.
Buy an SPIA later.

I have no idea. If the market is efficient, they should be roughly similar, right?

One thing I have looked at is nominal (constant dollars) vs. real (inflation-protected) SPIAs. In my opinion, real SPIAs are not worth the cost. My intent is to buy nominal SPIAs over time, as our needs and inflation dictate.

(Of course, my hope is that if this is a really dumb idea, some smart Boglehead will tell me so.)

Best wishes,

Keith
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MIretired
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Re: Deferred Immediate Annuities

Post by MIretired » Fri Sep 27, 2013 2:49 am

A prior post of mine. I was on the nefarious cusp:

[quoteRe: NYTimes Article: Timing of Returns in Retirement
by MIpreRetirey » Sun Sep 15, 2013 10:24 pm

It seems that the paper would be right if you allocated your portfolio to accommodate holding a starting portion in safe assets that progressively becomes smaller as your life expectancy falls. So, starting with ten years of safe assets; the rest in a balance (50/50?) Then at 80 years old you can be 5 years safe and the rest at 60/40? Or from such an effect.
Also the same as buying a small SPIA every year to support a 'floor' of safe assets to live off, and investing the rest in a fixed allocation of 40/60? The result, if instead you set aside the future costs of these SPIA purchases from the beginning, would be a cash heavy initial port., which became more aggressive as you aged.


Edit: I totally was rambling and not thinking on the 2nd paragraph; to purchase equal SPIAs every year makes no sense. Also, the 5 years safe at age 80 yrs. makes no sense.
I guess, just the idea that your port. doesn't have to last as long, the older you are; outside of safe/floor assets.
Pardon me.

Also, I think 1210 has the gist:
Jim Otar (from Canada) feels that the first four years of retirement are the key. If at the end of four years your portfolio is higher you
will likely not run out of money. (and vice versa)

I guess by having a lower stock allocation at the start of retirement you are attempting to reduce the probability of a really bad experience at the beginning.

1210
Last edited by MIpreRetirey on Mon Sep 16, 2013 1:45 pm, edited 6 times in total.
MIpreRetirey

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][/quote]
http://www.bogleheads.org/forum/viewtop ... 0&t=123070

This forum is kind of rich, intellectually. See how I was looking at that path?
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Delayed life annuities

Post by bobcat2 » Fri Sep 27, 2013 1:25 pm

I suspect the results of this study depend crucially on the assumptions being true or close to true.
I assumed investments are made in underlying indices for the S&P 500 and intermediate-term U.S. government bonds, each with a 0.2% administrative fee. Capital market expectations are aimed to better match current market conditions (including inflation-adjusted arithmetic returns for stocks and bonds of 5.7% and 0.9%, respectively, and inflation of 2.1%, with historical assumptions for volatility and cross-correlations).
Going forward, however, these assumptions may not only not be true, they may not be close to being true. :( It's not that the assumptions are unreasonable, they could very well be close to the true means, but the future still might play out quite differently. Because even if they are the means, they are still only the means.

Sometimes these annuities are called delayed life annuities, which seems to me to be a more descriptive title than the torturous phrase "deferred immediate annuities". :wink:

Something that strikes me as peculiar about the discussion of delayed life annuities is how counterparty risk is rarely brought up. People tend to worry about insurance companies going bankrupt and thus not being able to receive all their life annuity benefits in the future when buying an immediate life annuity. I think most of these misgivings are misplaced, but these delayed life annuities are the one place where this concern has to be taken into consideration by everyone. After all, you are only getting benefits for a period 15-35 years into the future when you purchase this product.

BobK
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Re: Deferred Immediate Annuities

Post by bobcat2 » Fri Sep 27, 2013 1:57 pm

umfundi wrote:One thing I have looked at is nominal (constant dollars) vs. real (inflation-protected) SPIAs. In my opinion, real SPIAs are not worth the cost. My intent is to buy nominal SPIAs over time, as our needs and inflation dictate.

(Of course, my hope is that if this is a really dumb idea, some smart Boglehead will tell me so.)

Keith
That's a really dumb idea. :wink:

Because as you yourself noted,
If the market is efficient, they should be roughly similar [priced fairly], right?
OTOH, you may have really taken it to heart that a foolish consistency is the hobgoblin of little minds. :D

BobK
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Re: Deferred Immediate Annuities

Post by dpbsmith » Fri Sep 27, 2013 4:31 pm

umfundi wrote:One thing I have looked at is nominal (constant dollars) vs. real (inflation-protected) SPIAs. In my opinion, real SPIAs are not worth the cost.
I think this is incorrect. People are disappointed because they were somehow hoping or expecting that they could get inflation protection for some tiny token increase in premium.

But even the roughest back-of-the-envelope calculations will show that if you assume, say, 3% inflation and, let us say, 25 years of payouts, an inflation-adjusted annuity is going to have to pay out a total of almost half again as much as a level-payout annuity, so it shouldn't be surprising that it might cost half again as much.

Online quotations showed me that inflation-adjusted annuities have premiums that are very comparable to annuities that increase by 3% per year. And some amateur actuary stuff with a spreadsheet convinced me that the premiums for 3%-increasing annuities are just about what you'd expect from the math. No evidence that insurers are overcharging for the increasing or the inflation-adjusted annuities. They about as good a "deal" as the level payout annuities; they cost more because they pay out more, that's all.

At 3% inflation, if the annuity is paying just enough at the start of the period, it's only going to be paying half what's needed after 25 years.

Since any annuity that has increasing payouts over time does mean the insurer is paying less now and more later, in effect the "center of gravity" of the payments is being pushed out farther and to the extent that you are worried about insurer insolvency, you'd be a little more worried because you're trusting them a little longer.

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Re: Deferred Immediate Annuities

Post by umfundi » Fri Sep 27, 2013 5:02 pm

dpbsmith wrote:
umfundi wrote:One thing I have looked at is nominal (constant dollars) vs. real (inflation-protected) SPIAs. In my opinion, real SPIAs are not worth the cost.
I think this is incorrect. People are disappointed because they were somehow hoping or expecting that they could get inflation protection for some tiny token increase in premium.

But even the roughest back-of-the-envelope calculations will show that if you assume, say, 3% inflation and, let us say, 25 years of payouts, an inflation-adjusted annuity is going to have to pay out a total of almost half again as much as a level-payout annuity, so it shouldn't be surprising that it might cost half again as much.

Online quotations showed me that inflation-adjusted annuities have premiums that are very comparable to annuities that increase by 3% per year. And some amateur actuary stuff with a spreadsheet convinced me that the premiums for 3%-increasing annuities are just about what you'd expect from the math. No evidence that insurers are overcharging for the increasing or the inflation-adjusted annuities. They about as good a "deal" as the level payout annuities; they cost more because they pay out more, that's all.

At 3% inflation, if the annuity is paying just enough at the start of the period, it's only going to be paying half what's needed after 25 years.

Since any annuity that has increasing payouts over time does mean the insurer is paying less now and more later, in effect the "center of gravity" of the payments is being pushed out farther and to the extent that you are worried about insurer insolvency, you'd be a little more worried because you're trusting them a little longer.
dpbsmith,

Nice counterpoint, thank you.

When I looked at this closely, over a year ago, I could get a nominal SPIA that paid 7%, and a real (inflation indexed) SPIA that paid 4%. Big difference. There are two factors for me:

We are doing quite fine on a cash flow that is equal to SS plus my nominal (non-indexed) pension. At some point inflation will erode the pension and I will want to compensate with an SPIA. But also, our spending should have settled down and I will have a much better idea of what our actual needs for a floor are. So, when and how much we will need from an SPIA are open questions right now. The common wisdom seems to be that spending goes down with age. If that is true, it seems that a real SPIA would be over insurance for your future needs.

The elephant in the room is, of course, the future level of inflation. Many (you included) use 3% as an expected rate. But, I have also seen estimates of 1.5% trending down to 1% over the next decade. That is a huge difference. My personal expectation is less than 2%, but what do I know?

Given all of that, it seems more prudent for me to buy a nominal SPIA, and to assess the situation in 7 - 10 years.

Best wishes,

Keith
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Re: Deferred Immediate Annuities

Post by magellan » Fri Sep 27, 2013 7:03 pm

IMO, a 20 year plus deferred annuity product without inflation protection isn't worth a whole lot if the goal is to put a guaranteed floor on your standard of living.

Let's say you need a $30k guaranteed income floor (in today's purchasing power dollars) that starts in 20 years. For a start, maybe you'd use average historical data and decide to adjust the payment for inflation at an average rate of 2-3% a year. That would suggest maybe a nominal $50k annual payment is needed to provide the required purchasing power.

But we're not average. We get only one path through retirement, so we decide to make our "guaranteed income" strategy a little more robust than just average. We apply the methodology of the 4% safe-max rule and use historical back-testing to see what would have been needed in the worst-case period using recent real-world data.

The graphic below shows a back-of-the-envelop example of the range of possibilities based on data from http://inflationdata.com/Inflation/Infl ... lation.asp
Image

The calculations in the spreadsheet are a little rough, but they indicate that planning on $50k to get $30k in purchasing power would have come up very short in some instances. In particular, if we started in 1970, our guaranteed income floor would only offer $15k of purchasing power instead of the needed $30k. In 4 out of the 9 periods evaluated, we end up short 30% or more.

So to make the annuity really offer a safe-max type floor and handle the worst-case (recent) historical scenario, you have to purchase an annuity with a $100k annual nominal payment. That assures that the starting annuity payout will offer at least $30k worth of purchasing power under the known/tested historical scenarios.

If you don't double up the annuity to handle the worst-case inflation, then you could end up having to live with only half the purchasing power you thought you'd have. If a plan completely unravels under back-testing using data from within the last 50 years, I'm not sure how anyone can call it a sound and responsible retirement income strategy.

My hunch is that instead of overbuying a nominal deferred annuity to handle inflation volatility, you'd probably end up better off foregoing the 20 years of mortality credits and just buying a 20 year TIPS bond that you later roll into a SPIA at age 80 or 85. That doesn't even factor in the credit risk, which as BobK points out, could be significant.

Jim

(edited for typo)
Last edited by magellan on Fri Sep 27, 2013 7:44 pm, edited 1 time in total.

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Re: Deferred Immediate Annuities

Post by bobcat2 » Fri Sep 27, 2013 7:29 pm

magellan wrote:IMO, a 20 year plus deferred annuity product without inflation protection isn't worth a whole lot if the goal is to put a guaranteed floor on your standard of living. ...

My hunch is that instead of overbuying a nominal deferred annuity to handle inflation volatility, you'd probably end up better off foregoing the 20 years of mortality credits and just buying a 20 year TIPS bond that you later roll into a SPIA at age 80 or 85.
Jim
:thumbsup :thumbsup

Yes, and at those advanced ages you are better off getting an inflation-protected life annuity because you don't have a lot of other options if inflation takes off.

BobK
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Re: Deferred Immediate Annuities

Post by less » Fri Sep 27, 2013 8:41 pm

I felt the paper had too many problems to accept any of its conclusions.

1) The same author just published another paper a few weeks ago concluding that equity % should increase during retirement (withdrawals from debt at the start) because the time factor overcomes sequence-of-returns risk. So you would expect this paper to conclude that the purchase of an immediate annuity would trump the deferred annuity (because over time the flat payments become worth less and because their benefits can fund most all current withdrawals leaving the equity to grow - reducing s-o-r-risk.

You would expect the author to explain WHY the conclusion of this paper (better to defer) was the exact opposite of his last. But he didn't

2) The pricing of the annuities reflects the bond yield curve. The steady-state-return you would have to earn to not care between the current annuity and the ..
5 yr deferred = 2.05%
10 yr deferred = 2.8%
20 yr deferred = 3.6%
25 yr deferred = 3.9%
But the author's model set the alternate portfolio to be exactly the same in all situations. In reality the person having to fund 20 years before the annuity kicked in would opt to buy longer term bonds with higher yields. Adjusting this would have the effect of making the longer-term deferrals look better.

3) The author continues to make the same error regarding inflation. He models portfolio returns to be correlated with inflation so he can use real-returns instead of nominal returns. Then he talks about "A shorter deferral period leaves more time for inflation to erode the value of the annuity ". But in real life inflation will also increase the discount rate used to price equity and the portfolio returns would also fall . He models them to rise. If you change the portfolio to include the longer-term debt for the longer deferral options, inflation would reduce the value of that part of the portfolio as well.

4) The choices are apples and oranges. The $$ benefits of the different choices are different. Eg. the immediate annuity is set to deliver benefits of $3,999 per $100,000 for the rest of his life (say 35 years), but the 20 year deferral choice has 15 years of $6,066 benefits. The results may be explainable simply because of this increase in the level of annuitization. And nothing at all to do with deferrals.

It would have made more sense to have the deferred choices all deliver the same flat $3,999. Changing the annuitized benefits 'just because' of inflation is yet another instance where academics are always inflation-adjusting things that should not be adjusted.

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