The New Retirement Challenge

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
User avatar
bobcat2
Posts: 5247
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

The New Retirement Challenge

Post by bobcat2 » Thu Jun 26, 2008 9:20 am

Here are some excerpts from The New Retirement Challenge, a retirement white paper by economist Jeff Brown.
Financial security in retirement is a topic of perennial importance, but never has the topic received more popular attention than over the past few years. With the baby boom generation now on the cusp of retirement age, renewed public attention has been placed on the adequacy of household savings to provide for a secure and stable source of retirement income....

While the increased attention on retirement security is a welcome development, only half of the retirement security equation has received adequate attention. In particular, workers, retirees, employers, policymakers and the media have all placed renewed emphasis on issues relating to saving, portfolio choice, and wealth accumulation.

By comparison, too little attention has been paid to the other important part of the retirement security equation – how a retiree converts her nest egg into a sustainable stream of retirement income that will last as long as she lives. Indeed, building a nest egg for retirement is necessary for retirement security, but it is not sufficient. One must also plan for how to get the most out of that nest egg by ensuring that it lasts as long as one lives....

Longer lives and longer retirements are certainly welcome developments, but they bring with them a new set of financial challenges. Perhaps the most important of these challenges is how to provide an adequate lifelong stream of income that will last for two, three, or even four or more decades after one has left the formal labor market....

This uncertainty means that there is a real risk of experiencing a substantial reduction in living standard at older ages, even if one carefully saved and invested throughout one’s career. In other words, being a careful saver is not sufficient to ensure retirement security. One must also be a careful “dis-saver,” meaning one must be a careful manager and spender of one’s savings.

Figuring out a way to ensure that one’s retirement nest egg can provide adequate income for an entire lifetime, without knowing how long that lifetime will last, is the new retirement challenge. The retirement security of millions of Americans will ultimately depend on how well they face this challenge....


THE SOLUTION TO LONGEVITY RISK

Economists and public policymakers have long understood that an adequate source of guaranteed lifetime income is a retiree’s antidote to he financial risk he or she faces from not knowing how long he or she will live. Fortunately, financial products exist in the market place that are designed precisely for the purpose of helping to solve the financial planning problem that arises due to uncertainty about length of life. A life annuity is an insurance product that allows a retiree to exchange a lump sum of wealth for a flow of income that is guaranteed to last for life. In this sense, a life annuity contract can provide a steady stream of monthly income in the same way as a DB pension or Social Security. Even if a retiree lives to be 110 years old or older, the check will continue to arrive every month.

Equally important, a life annuity has the potential to provide a higher level of sustainable income than can be achieved with other financial assets. This is because a life annuity is an insurance product that pools resources across a large number of annuity buyers, essentially using the resources of those who die earlier than expected to pay higher benefits to those who live longer than expected. The “cost” of this approach is that assets that are converted into a life annuity stream are no longer available to leave as a bequest. In exchange, however, the life annuity provides surviving individuals with a higher rate of return than the individual could get on an otherwise similar, but unannuitized, portfolio.

The extra rate of return that a life annuity can pay is sometimes called a “mortality premium” because it is essentially an extra rate of return that annuitants can earn in return for giving up their claim on their assets at death.
Link to paper:
http://www.business.uiuc.edu/jbrown/Myp ... papers.pdf

Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

User avatar
Taylor Larimore
Advisory Board
Posts: 27621
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

Immediate Fixed Lifetime Annuities ?

Post by Taylor Larimore » Thu Jun 26, 2008 10:19 am

Hi Bob:
Thank you for the link.

Although I am skeptical of most annuities, I am a believer in Immediate Fixed Lifetime Annuities for many retirees. We bought two for ourselves several years ago.

Unlike other annuities, immediate fixed lifetime annuities offer several advantages:

* They offer the highest guaranteed lifetime income of any investment.

* No worry about stock market volatility.

* They can reduce the size of the estate for tax purposes.

* They are easy to understand. Much simpler than an insurance policy. Our Genworth Annuity Contract is 3 pages. In contrast, I kept an Equitable Prospectus for a Variable Deferred Annuity containing 176 pages which neither the salesman nor I could understand.

* Unlike most annuities which are different between and within companies, immediate life income fixed annuities are nearly all identical. This allows accurate price comparisons.

* There is strong and open competition among immediate life-income annuity providers. This keeps costs down. "ImmediateAnnuities.com" compares premiums and company strength among the lowest cost companies.

* Contrary to common opinion, immediate life income annuities do not necessarily mean that heirs receive nothing. In exchange for a reduced income, annuity owners can guarantee a joint life income for spouses; a guaranteed return of premium; or payments guaranteed for a period of time regardless of an early death.

* Some immediate lifetime annuities, including Vanguard, offer inflation riders.
-----------------------------------------------------

Immediate lifetime annuities are not for everyone--especially young investors. They should be only a portion of investments because once purchased the premium cannot be touched. Consider only the strongest insurance companies (although most states guarantee payments up to $100,000).

Be skeptical, but keep an open mind about immediate lifetime fixed annuities.

Best wishes.
Taylor

User avatar
bob90245
Posts: 6511
Joined: Mon Feb 19, 2007 8:51 pm

Re: Immediate Fixed Lifetime Annuities ?

Post by bob90245 » Thu Jun 26, 2008 10:44 am

Taylor Larimore wrote:Consider only the strongest insurance companies (although most states guarantee payments up to $100,000).
This one of several important considerations. Investors buying annuity are trading one risk (outliving their money) for another (outliving the solvency of their annuity provider). It may be wise to diversify that risk.

User avatar
bobcat2
Posts: 5247
Joined: Tue Feb 20, 2007 3:27 pm
Location: just barely Outside the Beltway

mortality premium

Post by bobcat2 » Thu Jun 26, 2008 11:18 am

Hi Taylor,

I believe the aspect of life annuities that is least understood by most people is the mortality premium, i.e. the extra rate of return that annuitants can earn in return for giving up their claim on their assets at death.

I suspect most people think life annuities have rates of return similar to fixed income, and that they could instead get a higher safe payout by making withdrawals from a retirement portfolio with significant equity exposure.

I used to think that. :lol:

Best,
Bob K
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.

Levett
Posts: 4177
Joined: Fri Feb 23, 2007 2:10 pm
Location: upper Midwest

Post by Levett » Thu Jun 26, 2008 1:10 pm

Taylor,

I nominate your post about IAs to be included as a "gem."

Bob,

Since there are any number of quants at this site, maybe someone could figure out the odds of an IA provider becoming insolvent (draw the line at multiple AA ratings or higher) versus the odds of outliving one's portfolio without an IA.

Funny how when the market appears to be in a downturn (possibly prolonged) how IAs receive a bit more attention. Don't want to overstate the matter, though: the market for IAs is hardly taking off, to the bewilderment of any number of economists. Bob U.

Disclosure: have had an IA + VA since 2000-01. Totally uncorrelated with my equity investments. :D

User avatar
bolivia
Posts: 330
Joined: Mon Jul 02, 2007 9:11 pm

Post by bolivia » Thu Jun 26, 2008 1:33 pm

Taylor,

I nominate your post about IAs to be included as a "gem."
Agreed! This is the kind of information that proves invaluable to those struggling with the vast assortment of retirement options. Nice work Taylor.

bozo
Posts: 1038
Joined: Wed May 28, 2008 2:07 am

Still unconvinced

Post by bozo » Thu Jun 26, 2008 1:53 pm

Any way you slice it, or dice it, an annuity is still a life insurance product. Face it, folks, those life insurance companies have to get paid somehow.

You can build your own self-directed annuity with little effort. If you are 60, for example, build a CD ladder that goes out 10 years, then build another ladder when you hit 70, etc.

I'd be somewhat leery in these times to hand over $500K or such to a life insurance company in exchange for an unsecured promise to pay annuity benefits. Give me the FDIC or NCUA any day over that.

Just my $.02.

Yours,

Bozo

PS: That having been said, my Mom (who is 93) has been collecting an annuity like clockwork for many, many years. When my Dad retired, he set it up. So, it can be a good deal for folks with modest retirement assets who live really, really, long. It also helps if the company paying the annuity stays in business longer than the person receiving the annuity lives.

User avatar
AzRunner
Posts: 991
Joined: Mon Feb 19, 2007 6:18 pm
Location: Phoenix

Post by AzRunner » Thu Jun 26, 2008 2:14 pm

Another idea is to delay the start of Social Security payments as late as age 70 as a means of increasing this inflation protected annuity. This may be an attractive option if you do not need Social Security income to meet living expenses. It may also be beneficial if you want to move some traditional IRA dollars to a Roth since it will enable you to move more dollars in a lower tax bracket. Finally, in a number of ways, Social Security is a second to die policy, so delaying the start of payments helps the surviving spouse down the road.

Norm

baldeagle
Posts: 61
Joined: Sun Mar 04, 2007 6:23 pm
Location: Portland, OR

Post by baldeagle » Thu Jun 26, 2008 2:24 pm

Taylor, thank you for that informative post about annuities. Could you share a bit more of your decision-making process? For example:
  • What coverage were you seeking to annuitize? Just routinr living expenses?
    Did you chose single or joint annuity?
    Did you chose inflation-adjusted annuity?
Thanks!

MP173
Posts: 1935
Joined: Fri Dec 07, 2007 6:03 pm

Post by MP173 » Thu Jun 26, 2008 3:04 pm

Taylor and others:

Thanks for input on this. At what age would you start planning for the "distribution" aspect of retirement? At age 53 I am still aways off from r-day, and am primarily concerned about the accumulation side of the equation.

Yes, I would also be interested to know how one apportions a segment of retirement funding to annuities.

Thanks,

ed

User avatar
Taylor Larimore
Advisory Board
Posts: 27621
Joined: Tue Feb 27, 2007 8:09 pm
Location: Miami FL

More about our annuities.

Post by Taylor Larimore » Thu Jun 26, 2008 4:18 pm

baldeagle wrote:Taylor, thank you for that informative post about annuities. Could you share a bit more of your decision-making process? For example:
  • What coverage were you seeking to annuitize? Just routinr living expenses?
    Did you chose single or joint annuity?
    Did you chose inflation-adjusted annuity?

Thanks!


Hi:
I'll try to answer each of your questions:

What coverage were you seeking to annuitize? Just routine living expenses?


We annuitized about one-quarter of our investment portfolio to assure that our portfolio does not run out of money before we run out of life. Our premium return (principal and yield) is about 10% as long as either my wife or I are alive. This added income allows us to feel comfortable giving our children a part of their inheritance now.

Did you chose single or joint annuity?


Joint annuity. I received a 2-year medical age benefit because of a prior larynx (voicebox) cancer.

Did you chose inflation-adjusted annuity?


No. I figured that at our age (early 80s) the 20%+ additional premium (or reduction in benefit) was not worth the price.

Best wishes.
Taylor

User avatar
mas
Posts: 1461
Joined: Tue Feb 20, 2007 12:54 pm

Re: Still unconvinced

Post by mas » Thu Jun 26, 2008 4:56 pm

bozo wrote:You can build your own self-directed annuity with little effort. If you are 60, for example, build a CD ladder that goes out 10 years, then build another ladder when you hit 70, etc.
Sorry bozo (it feels wrong to call you that), but what you have described is not an alternate to an annuity. Individuals CANNOT build an annuity themselves, the point is risk pooling from many individuals with different lifespans.

It is true that annuities are insurance (with fees built in), and credit risk if you go above state limits. There is no point in them if you do not need the insurance, but if you do, the method you described MAY fail when it comes time to buy the next 10 yr CD ladder. People buy insurance when the consequences of an event are larger than the cost.

User avatar
White Coat Investor
Posts: 13594
Joined: Fri Mar 02, 2007 9:11 pm
Location: Greatest Snow On Earth

Re: Immediate Fixed Lifetime Annuities ?

Post by White Coat Investor » Thu Jun 26, 2008 5:35 pm

Taylor Larimore wrote:
Unlike other annuities, immediate fixed lifetime annuities offer several advantages:

* They offer the highest guaranteed lifetime income of any investment.

"ImmediateAnnuities.com" compares premiums and company strength among the lowest cost companies.
I see what you mean Taylor. For a 65 year old you can go from a 4% SWR to an 8.1% SWR.

Perhaps a wise course would be to annuitize 1/4 of your next egg every 5 years starting at retirement, say at 65, 70, 75, and 80. While inflation will erode the value of the annuity bought at 65 significantly, you get a "withdrawal rate" of 13.2% off that last annuity. An inflation indexed 4% SWR is unlikely to overcome that, even if you live to 100.

This strategy would minimize the risk of a bad market those first few years of retirement (since theoretically you wouldn't have to touch the nest egg much as you could live off of SS and the annuity plus maybe a 2 or 3% withdrawal rate) and about the time you need more cash due to inflation or medical expenses, you are annuitizing another chunk.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

User avatar
tadamsmar
Posts: 7885
Joined: Mon May 07, 2007 12:33 pm

Post by tadamsmar » Fri Jun 27, 2008 3:07 pm

I looked at annuities a while back. Did not seem like that good a deal.

I recall that a Vanguard inflation-adjusted annuity paid about 4% per year of the premium. I probably used late 50s or so as the starting age.

I concluded that the hoped-for mortality premium was cancelled out by self-selection bias.

Did I miss something?

User avatar
mas
Posts: 1461
Joined: Tue Feb 20, 2007 12:54 pm

Post by mas » Fri Jun 27, 2008 8:15 pm

tadamsmar wrote:I concluded that the hoped-for mortality premium was cancelled out by self-selection bias.

Did I miss something?
Maybe that the mortality premium it grows with age. Toward "the end", significantly. Also, inflation adjusted annuities do not have a very competitive market place yet. Nominal annuities seem to have less built in "costs" from what I was able to determine.

For a 50 year old, they probably are not that great of a deal, but still they provide a level of certainty that does not exists with investments.

baldeagle
Posts: 61
Joined: Sun Mar 04, 2007 6:23 pm
Location: Portland, OR

Post by baldeagle » Sat Jun 28, 2008 5:10 pm

Taylor -- Thanks for the answers to my questions. Much appreciated.

Post Reply