Annuity article by Wade Pfau

[ReadyOne]

https://www.protectedincome.org/wp-cont ... _final.pdf

If you dislike annuities, I would ignore the article. If you are open to annuities, it is an interesting read.

I personally do not own any annuities, however, I see the usefulness of them (turn asset into income) and the downside ("sold not bought").

The author seems like a honest person interested in solutions.

[Rex66]

Annuities can be fine but you can search the author on this site

You will see when his articles are slanted to the insurance industry whom he is closely associated this is in particular with the use of whole life.

[David Jay]

Few here are opposed to the use of SPIAs in retirement for consistent income.

Any use of insurance (other than MYGA) for accumulation is probably less than optimal. I can’t believe that Wade has sunk so far that he is hawking Fixed Index Annuities (that’s right - read the article if don’t believe me)

[JoMoney]

The problem with annuities are the expenses. It's not that they don't offer interesting and potentially useful risk/return dynamics, the biggest issue is their cost (which aren't always fully disclosed in their expenses/fees), and other investments and ways of structuring a portfolio can be done at much lower cost - which means more return (at less risk) going back to the owner.
Simple fixed-income type annuities like MYGA's and SPIA's are a sometimes exception to the general rule of just say no to annuities, and even those need to be shopped around, and considered on a case by case basis (including tax considerations) for each individual situation.

[thedaybeforetoday]

https://www.protectedincome.org/wp-cont ... _final.pdf

If you dislike annuities, I would ignore the article. If you are open to annuities, it is an interesting read.

I personally do not own any annuities, however, I see the usefulness of them (turn asset into income) and the downside ("sold not bought").

The author seems like a honest person interested in solutions.

I'm open to the concept of annuities, but, given his obvious conflicts of interest, not interested in Mr. Pfau being the one to guide me in that decision making process.

[Stinky]

https://www.protectedincome.org/wp-cont ... _final.pdf

If you dislike annuities, I would ignore the article. If you are open to annuities, it is an interesting read.

I personally do not own any annuities, however, I see the usefulness of them (turn asset into income) and the downside ("sold not bought").

The author seems like a honest person interested in solutions.

I’m a fan of certain types of annuities.

MYGAs can be excellent for “accumulation” purposes. And SPIAs and DIAs can provide guaranteed lifetime income.

But I’m not a fan of fixed indexed annuities (FIAs) that are the primary point of the linked article, when used for “accumulation” purposes. If someone wants to use an annuity as an accumulations vehicle, I’d much rather see them in a MYGA than in a FIA. There are several reasons for my preference -

—- MYGAs have crediting rates that are fixed and guaranteed for the entire initial term, while FIA crediting is at the discretion of the insurance company after the first policy year.

—- Insurance companies have been known to use “teaser” or “bonus” interest rates to lure consumers into a FIA, and then trap them for up to a decade or more with high surrender charges

—- in general, MYGAs pay lower commissions to the agent than FIAs. This should leave more interest over time for the policyholder. There are only 100 cents in every dollar, and if the agent gets more, the policyholder is likely to get less over time.

Of course, there are many other choices for fixed income beyond annuities. But, if buying an annuity for accumulation, I’d choose a MYGA over a FIA.

EDITED TO ADD - ReadyOne, I saw that you also sent me a private message on this topic. I’m not able to respond to it, since it looks like your BH profile doesn’t allow the receipt of private messages. But if I could respond to your message, I would say just what I said above.

Best to you.

[L84SUPR]

Let's assume we are setting up a corporation to provide annuities and we are going to provide the fairest annuities to ever be offered. We want our company to be solid as a rock, we want our employees well provided for, and we want our shareholders to espouse the virtues of our well run company. What percentage of the theoretical optimum (50 percent chance of exceedence) return should we PROMISE to our customers. Even if we sell direct to market with no commission we need to cover expenses, pay shareholders, and have a safety factor. I suggest, for your consideration, we would be embarrassed by the amount of return that made it through to the customer and would disband the exploratory committee.

That doesn't mean there aren't people who would benefit from these products. But if a personal advisor takes 20 percent of withdrawals (you take 4 percent they take 1) what percentage do you think a huge risk adverse corporation will take.

[ReadyOne]

https://www.protectedincome.org/wp-cont ... _final.pdf

If you dislike annuities, I would ignore the article. If you are open to annuities, it is an interesting read.

I personally do not own any annuities, however, I see the usefulness of them (turn asset into income) and the downside ("sold not bought").

The author seems like a honest person interested in solutions.

I’m a fan of certain types of annuities.

MYGAs can be excellent for “accumulation” purposes. And SPIAs and DIAs can provide guaranteed lifetime income.

But I’m not a fan of fixed indexed annuities (FIAs) that are the primary point of the linked article, when used for “accumulation” purposes. If someone wants to use an annuity as an accumulations vehicle, I’d much rather see them in a MYGA than in a FIA. There are several reasons for my preference -

—- MYGAs have crediting rates that are fixed and guaranteed for the entire initial term, while FIA crediting is at the discretion of the insurance company after the first policy year.

—- Insurance companies have been known to use “teaser” or “bonus” interest rates to lure consumers into a FIA, and then trap them for up to a decade or more with high surrender charges

—- in general, MYGAs pay lower commissions to the agent than FIAs. This should leave more interest over time for the policyholder. There are only 100 cents in every dollar, and if the agent gets more, the policyholder is likely to get less over time.

Of course, there are many other choices for fixed income beyond annuities. But, if buying an annuity for accumulation, I’d choose a MYGA over a FIA.

EDITED TO ADD - ReadyOne, I saw that you also sent me a private message on this topic. I’m not able to respond to it, since it looks like your BH profile doesn’t allow the receipt of private messages. But if I could respond to your message, I would say just what I said above.

Best to you.

Thank you!

[ncbill]

The problem with annuities are the expenses. It's not that they don't offer interesting and potentially useful risk/return dynamics, the biggest issue is their cost (which aren't always fully disclosed in their expenses/fees), and other investments and ways of structuring a portfolio can be done at much lower cost - which means more return (at less risk) going back to the owner.
Simple fixed-income type annuities like MYGA's and SPIA's are a sometimes exception to the general rule of just say no to annuities, and even those need to be shopped around, and considered on a case by case basis (including tax considerations) for each individual situation.

I'd also like to know where one can buy an equity-linked annuity with a 12% cap.

All I've been offered have had a 7% cap (which was also the return for illustration presented) & they keep all the dividend.

[Tdubs]

The problem with annuities are the expenses. It's not that they don't offer interesting and potentially useful risk/return dynamics, the biggest issue is their cost (which aren't always fully disclosed in their expenses/fees), and other investments and ways of structuring a portfolio can be done at much lower cost - which means more return (at less risk) going back to the owner.
Simple fixed-income type annuities like MYGA's and SPIA's are a sometimes exception to the general rule of just say no to annuities, and even those need to be shopped around, and considered on a case by case basis (including tax considerations) for each individual situation.

I'd also like to know where one can buy an equity-linked annuity with a 12% cap.

All I've been offered have had a 7% cap (which was also the return for illustration presented) & they keep all the dividend.

There's this one.
https://www.brighthousefinancial.com/co ... -Sheet.pdf

[Rex66]

It doesn’t matter since 100% of these policies have had reductions in caps and participation rates after purchase.

[David Jay]

It doesn’t matter since 100% of these policies have had reductions in caps and participation rates after purchase.

Welcome to "Insurance Land". A bizarre place, indeed.

[Stinky]

It doesn’t matter since 100% of these policies have had reductions in caps and participation rates after purchase.

Welcome to "Insurance Land". A bizarre place, indeed.

Look at it from the insurance company’s point of view.

Once they have the consumer locked into a high surrender charge product, what incentive do they have to sweeten the deal for the consumer?

[David Jay]

It doesn’t matter since 100% of these policies have had reductions in caps and participation rates after purchase.

Welcome to "Insurance Land". A bizarre place, indeed.

Look at it from the insurance company’s point of view.

Once they have the consumer locked into a high surrender charge product, what incentive do they have to sweeten the deal for the consumer?

I understand. I just can't believe that a retail facing company is allowed to do that. I negotiated a slew of contracts over the decades in the capital equipment business. I wish I could have inserted a clause which said I could unilaterally modify the terms of the contact after signing and the other party couldn't challenge.

[Rex66]

They aren’t modifying the terms

The terms say they can do it

[Harmanic]

They aren’t modifying the terms

The terms say they can do it

In other words, read the fine print before signing anything.

[Stinky]

It doesn’t matter since 100% of these policies have had reductions in caps and participation rates after purchase.

Welcome to "Insurance Land". A bizarre place, indeed.

Look at it from the insurance company’s point of view.

Once they have the consumer locked into a high surrender charge product, what incentive do they have to sweeten the deal for the consumer?

I understand. I just can't believe that a retail facing company is allowed to do that. I negotiated a slew of contracts over the decades in the capital equipment business. I wish I could have inserted a clause which said I could unilaterally modify the terms of the contact after signing and the other party couldn't challenge.

The caps and participation rates are set for only the first policy year when the policy is issued. In subsequent years, the insurer has wide discretion.

Beyond the “bait and switch” tactics employed by some companies, there’s also the misleading illustrations that are given. Showing how much money accumulated using an “x%” interest rate leaves a false impression about how the interest crediting will actually develop.

Entirely legal. But substantially unsavory.

[Tdubs]

It doesn’t matter since 100% of these policies have had reductions in caps and participation rates after purchase.

Welcome to "Insurance Land". A bizarre place, indeed.

Look at it from the insurance company’s point of view.

Once they have the consumer locked into a high surrender charge product, what incentive do they have to sweeten the deal for the consumer?

I understand. I just can't believe that a retail facing company is allowed to do that. I negotiated a slew of contracts over the decades in the capital equipment business. I wish I could have inserted a clause which said I could unilaterally modify the terms of the contact after signing and the other party couldn't challenge.

The caps and participation rates are set for only the first policy year when the policy is issued. In subsequent years, the insurer has wide discretion.

Beyond the “bait and switch” tactics employed by some companies, there’s also the misleading illustrations that are given. Showing how much money accumulated using an “x%” interest rate leaves a false impression about how the interest crediting will actually develop.

Entirely legal. But substantially unsavory.

The policy I posted above locks the caps and participation rate for six years.

[Rex66]

I didn’t review the above but if the surrender period is greater than 6 years then it’s near meaningless

[Sandtrap]

Annuities can be fine but you can search the author on this site

You will see when his articles are slanted to the insurance industry whom he is closely associated this is in particular with the use of whole life.

Good points.
Always consider the source.

thanks for the reminder.
j

[Tdubs]

I didn’t review the above but if the surrender period is greater than 6 years then it’s near meaningless

I don't think it is. The promotional materials are a bit vague, but it appears renewal is optional after six years.

https://www.brighthousefinancial.com/co ... ochure.pdf

[Gronkismy muse]

[merged into existing thread - moderator prudent]

Wondering what all of you think of Dr. Pfau's recent article "Protection as an Asset Class" https://www.protectedincome.org/wp-cont ... _final.pdf. In it, he assesses the substitution of a Fixed Index Annuity as an alternative for bonds in a retirement account - and concludes that the FIA outperforms bonds for almost all but the most conservative retirement portfolios. The signature quote (p 10) is "Bonds are not on the efficient frontier. They do not serve a useful role for meeting spending goals in the optimal retirement income portfolio."

Looking for more learned opinions - what say you Bogleheads?

[Stinky]

I'd also like to know where one can buy an equity-linked annuity with a 12% cap.

All I've been offered have had a 7% cap (which was also the return for illustration presented) & they keep all the dividend.

There's this one.
https://www.brighthousefinancial.com/co ... -Sheet.pdf

Yes, there’s a 12% annual cap rate listed on this six year contract. The performance is summed over the six years, with each year limited to a maximum of 12%.

But negative years are also added into the mix, with a maximum of -10%.

So let’s say the gross index performance was this for each year of a six year period, was 5%, 30%, 15%, (10%), 18%, (5%)

—- The compounded return is 58% over the six years
—- The sum of the six yearly returns is 53%
—- The sum of the six yearly returns, capped at 12% positive and floored at 10% negative, is 26%. That’s what I believe you’d make over 6 years on this contract.

And, of course, you’re not collecting dividends on the equity index. All you get is the sum of the price changes, capped and without a zero floor.

As for me, I’m not buying this contract…….

And one more thing. This product is COMPLEX. And, in the insurance business, complexity rarely works in favor of the consumer.

[arcticpineapplecorp.]

Few here are opposed to the use of SPIAs in retirement for consistent income.

Any use of insurance (other than MYGA) for accumulation is probably less than optimal. I can’t believe that Wade has sunk so far that he is hawking Fixed Index Annuities (that’s right - read the article if don’t believe me)

yeah, i'm surpised by that too. he does go as far as to talk about "paying for downside protection" and says twice you only get a portion of the return of the stock market, which is not how these products are sold "You get the return of the stock market with none of the risk!"

He talks about an added fee for a rider but doesn't talk at all about how expensive these products are in general (without any riders). That's a shame. But perhaps he doesn't consider the commission paid to the salesman a cost if you hold through the entire surrender period?

[petulant]

Plenty of problems with these products and how they are sold, but is there an actual argument that they won't at least beat bonds? I mean that's his argument--stocks and annuities beats stocks and bonds. And there are some good reasons I can think of that he might be right in fair circumstances.

[Tdubs]

[merged into existing thread - moderator prudent]

Wondering what all of you think of Dr. Pfau's recent article "Protection as an Asset Class" https://www.protectedincome.org/wp-cont ... _final.pdf. In it, he assesses the substitution of a Fixed Index Annuity as an alternative for bonds in a retirement account - and concludes that the FIA outperforms bonds for almost all but the most conservative retirement portfolios. The signature quote (p 10) is "Bonds are not on the efficient frontier. They do not serve a useful role for meeting spending goals in the optimal retirement income portfolio."

Looking for more learned opinions - what say you Bogleheads?

It is interesting that in this thread (and just about any thread about Pfau) that no one has addressed Pfau's main point, as noted by Gronkismy muse. A FIA is beats bonds in just about any retiree portfolio. You get better returns and less volatility.

[Stinky]

It is interesting that in this thread (and just about any thread about Pfau) that no one has addressed Pfau's main point, as noted by Gronkismy muse. A FIA is beats bonds in just about any retiree portfolio. You get better returns and less volatility.

Exhibit 4 of Pfau's paper (page 4) makes the bold assertion that that bonds earn an arithmetic average of 3.8% over 100,000 Monte Carlo trials, while indexed annuities earn 6.1%.

Something doesn't compute in that assertion, for me at least.

The assets backing index annuities are substantially invested in bonds by insurance companies. Not a lot of pick up there, unless insurance companies are going way out on the risk curve in the asset mix backing index annuities.

And index annuities bear expenses of roughly 2% per year (1% for commissions, 1% for everything else) that aren't borne by bonds. That's another handicap for index annuities compared to bonds.

So, given that index annuities are mostly invested in bonds and index annuities have higher expenses than bonds, how in the world can index annuities beat bonds by 2.3% per year? Pfau gives no back-up for that statement (except that he ran "100,000 Monte Carlo trials").

If you build an argument with a flawed premise, of course you can get to a flawed conclusion.

[thedaybeforetoday]

[merged into existing thread - moderator prudent]

Wondering what all of you think of Dr. Pfau's recent article "Protection as an Asset Class" https://www.protectedincome.org/wp-cont ... _final.pdf. In it, he assesses the substitution of a Fixed Index Annuity as an alternative for bonds in a retirement account - and concludes that the FIA outperforms bonds for almost all but the most conservative retirement portfolios. The signature quote (p 10) is "Bonds are not on the efficient frontier. They do not serve a useful role for meeting spending goals in the optimal retirement income portfolio."

Looking for more learned opinions - what say you Bogleheads?

It is interesting that in this thread (and just about any thread about Pfau) that no one has addressed Pfau's main point, as noted by Gronkismy muse. A FIA is beats bonds in just about any retiree portfolio. You get better returns and less volatility.

In my mind, bonds and annuities are apples and oranges, so I don't compare the two.

One provides reliable monthly income in exchange for control over a chunk of $, fees and minimal risk while the other returns your funds after a set period of time, generally many years to decades, with interest, and has a large risk continuum.

For me an annuity is another option comparable to a pension or social security. If a pension or social security isn't a benefit, than an individual has to go onto the private, for profit market if they want a comparable product, and pay accordingly.

Again, open to the concept of annuities, just don't like the messenger mentioned in this thread, nor the execution of most annuity products.

[stinkycat]

Is there any source of data out there that looks under the hood as to what these products are actually investing in? My guess is that it probably a combination of treasuries and options, but I cannot find much detailed information on these products. I have a couple of elder aunts who invested in these and unless I look at their exact documents, I cannot find much information on these products other than sales brochures.

[Rex66]

It is interesting that in this thread (and just about any thread about Pfau) that no one has addressed Pfau's main point, as noted by Gronkismy muse. A FIA is beats bonds in just about any retiree portfolio. You get better returns and less volatility.

Exhibit 4 of Pfau's paper (page 4) makes the bold assertion that that bonds earn an arithmetic average of 3.8% over 100,000 Monte Carlo trials, while indexed annuities earn 6.1%.

Something doesn't compute in that assertion, for me at least.

The assets backing index annuities are substantially invested in bonds by insurance companies. Not a lot of pick up there, unless insurance companies are going way out on the risk curve in the asset mix backing index annuities.

And index annuities bear expenses of roughly 2% per year (1% for commissions, 1% for everything else) that aren't borne by bonds. That's another handicap for index annuities compared to bonds.

So, given that index annuities are mostly invested in bonds and index annuities have higher expenses than bonds, how in the world can index annuities beat bonds by 2.3% per year? Pfau gives no back-up for that statement (except that he ran "100,000 Monte Carlo trials").

If you build an argument with a flawed premise, of course you can get to a flawed conclusion.

That’s one of the problems with all these works done by request of insurance companies….the assumptions are ridiculous. On the WL similar article he put a crazy high investment fee for the non WL example way beyond industry average , assumed a zero lapse rate for WL even though 85% do lapse but still the insurance company delivers on illustrated non guaranteed returns and others. As stinky alluded to, he assumes bonds do poorly but amazingly index annuities do over 2% better.

Most Index annuities have 94-98% of the investment in the insurance company’s general account with the rest in options. Need to subtract all the insurance expenses like commissions, regulations, Super Bowl commercials, costs of options, etc. Is that going to beat just straight bonds? Not on a guarantee basis. Will it happen though…maybe but given all the non guaranteed items they can change and have changed historically ever time, i wouldn’t bet on it.

[Tdubs]

It is interesting that in this thread (and just about any thread about Pfau) that no one has addressed Pfau's main point, as noted by Gronkismy muse. A FIA is beats bonds in just about any retiree portfolio. You get better returns and less volatility.

Exhibit 4 of Pfau's paper (page 4) makes the bold assertion that that bonds earn an arithmetic average of 3.8% over 100,000 Monte Carlo trials, while indexed annuities earn 6.1%.

Something doesn't compute in that assertion, for me at least.

The assets backing index annuities are substantially invested in bonds by insurance companies. Not a lot of pick up there, unless insurance companies are going way out on the risk curve in the asset mix backing index annuities.

And index annuities bear expenses of roughly 2% per year (1% for commissions, 1% for everything else) that aren't borne by bonds. That's another handicap for index annuities compared to bonds.

So, given that index annuities are mostly invested in bonds and index annuities have higher expenses than bonds, how in the world can index annuities beat bonds by 2.3% per year? Pfau gives no back-up for that statement (except that he ran "100,000 Monte Carlo trials").

If you build an argument with a flawed premise, of course you can get to a flawed conclusion.

That’s one of the problems with all these works done by request of insurance companies….the assumptions are ridiculous. On the WL similar article he put a crazy high investment fee for the non WL example way beyond industry average , assumed a zero lapse rate for WL even though 85% do lapse but still the insurance company delivers on illustrated non guaranteed returns and others. As stinky alluded to, he assumes bonds do poorly but amazingly index annuities do over 2% better.

Most Index annuities have 94-98% of the investment in the insurance company’s general account with the rest in options. Need to subtract all the insurance expenses like commissions, regulations, Super Bowl commercials, costs of options, etc. Is that going to beat just straight bonds? Not on a guarantee basis. Will it happen though…maybe but given all the non guaranteed items they can change and have changed historically ever time, i wouldn’t bet on it.

I think it is also a matter that Pfau has selected ideal ground on which to take a stand for FIA. As noted, this sounds like a great, too great FIA. The example he uses a 65 year old woman who plans on living to 100. What annuity can't win over bonds in that example where a portfolio will be strained to such a maximum?

Whether it is a FIA or a SPIA, there seems to be something to the basic point that annuities provide stability to a portfolio, and that stability allows retirees to more aggressively allocate their remaining investments toward stocks while limiting volatility and risk.

The dreaded FIA aside, should we dump some bonds for annuities?

[JoMoney]

...
The dreaded FIA aside, should we dump some bonds for annuities?

When interest rates on bonds were lower, there was a bigger spread between what MYGA's and SPIA's were offering compared to bonds. Now that rates have risen, the rates being offered on these insurance products seems more competitive to what bonds are offering but less of a bargain.
A lot depends on the individuals tax situation, there need for the current income, and how much they care about leaving an estate behind.
For myself, I've long thought that in a withdrawal phase I'd rather have a SPIA than a nominal bond portfolio. When looking at bond rates laddered/amortized over my expected life span, most of the time the SPIA shows both a higher distribution and has the guarantee that it will continue to pay even if I live longer than modeled. Some of that result depends on the expected lifespan used, I've tended to use the 'IRS Single Life Table' which has a longer life expectancy than what Social Security 'actuarial life table' suggests. For males, the SS life table might not make the case for a SPIA over a bond ladder as much of an obvious deal.

https://www.immediateannuities.com/ suggests a 60yo male can get $6,588 in annual income per $100k
IRS life table suggests 60yo has 27.1 year life expectancy, using the Total Bond YTM rate of 4.43% I get $6,410 amortized across 27.1 years
SS life table suggests 60yo male has 20.47 years, using same BND rate amortized out I get $7,530.97

For 60yo female, immediate annuities quotes $6,372 per $100k
Using SS life table, and BND interest rate amortized across 23.7 years I get $6,905

Using Blueprintincome.com (instead of immediateannuities.com) I get quotes for
60yo Male (life only) $7,134.84
60yo Female (life only) $6,858.24

[Lastrun]

The dreaded FIA aside, should we dump some bonds for annuities?

Merton has been talking about this for years.

https://mitsloan.mit.edu/ideas-made-to- ... retirement

https://hbr.org/2014/07/the-crisis-in-r ... t-planning

FIA's aside.

[Glen Davenport]

I have had the privilege of discussing this subject with both Merton and Pfau, and when you look at the average retiree, as an investor who will pay high fees, high taxes due to investment turnover, and often overspend, products like annuities can make good sense.

However here in the Boglehead community we are just way to smart, and our philosophy and the use of Asset Location, would provide an expectation of vastly superior results over almost all market cycles including the tax efficient transfer of assets upon death.

This is really an apples and oranges comparison on this website and I am pretty sure even Wade will avoid bothering to make a comment.

And by the way Merton is working on “Selfies” which would be annuity like products issued by the US government which would be better than annuities issued by Insurance Companies. If those products do become available, it would be worth a discussion at that time.

As a community we have hashed and rehashed annuities ad nauseam. I think it’s time for us to constructively move on…..please!

[Rex66]

All those things are true except he never lists them in his paper. He never says for those of you who are just going to pay crazy high fees and do stupid stuff. Instead the impression is given that these apply to everyone.

The topic will always come up. Every topic has already been discussed to death.

[Glen Davenport]

I agree Rex and that’s his Job. It’s not our job. Our posting on this website is to get people educated so that they can manage their investments themselves, and not purchase bad products.

[Nahtanoj]

I am not “way too smart” to know if annuities beat bonds in a retirement income portfolio, so I ran the numbers a couple of years ago.

Over my planning horizon (which is longer than my life expectancy), a commercially available SPIA purchased after retirement would produce more money for me to spend than a Vanguard nominal bond fund of the appropriate duration. (Of course, there is a chance that the nominal bond portfolio could produce more money for my heirs to spend, but that’s the secret sauce that makes annuities work.)

Since I ran the numbers, both interest rates and SPIA payouts have gone up, but I doubt the basic conclusion has changed.

Now, you might legitimately ask why anyone should hold nominal bonds in a retirement income portfolio, instead of TIPS, and that’s a fair question.

But if you are going to have nominal bonds, my conclusion was that you should replace at least some of them with a SPIA at some point after retirement.

I am definitely not smart enough to figure out if FIAs would be advantageous for me, so I will avoid them.

My only remaining question is whether people with a relatively low “burn rate” (e.g., 2 - 3% of starting asset value) should look at this question differently because of the high likelihood that they will have assets left over at the time of death.

[smectym]

As to the general FIA pitch about protecting against loss by foregoing some stock upside, it’s difficult to see how this same goal isn’t more simply and cheaply achieved in a (more or less) conservative stock/bonds/cash balanced portfolio. And that way, the investor needn’t forfeit stock dividends, which over time are a significant component of equity return. The tax deferred accumulation piece can be addressed by parking the corpus in an IRA. The 2% plus annual expenses for FIA are an obvious deal-killer. One might object that the simple, cheap balanced portfolio lacks the contractual *guarantee* against loss of principal offered by an insurance company; but especially over longer time periods such guarantees (paid for by that guaranteed 2% hit to the portfolio each and every year) are less and less likely to be needed anyway.

[Glen Davenport]

Nohtanoj,

First our philosophy is to view our assets as part of a total portfolio that is built on the efficient frontier. In addition with Asset location we can boost after tax returns by a substantial amount, and deliver a large inheritance to any heirs very tax efficiently.

If someone is taking a small withdrawal of 2 to 3 percent they can simply adjust their portfolio to have a larger portion of fixed income and still be highly efficient.

There is no real need or benefit to buying very expensive insurance products. We already shun active management and most annuities are not much different in that they are actually active management with even higher fees and with no hope of beating the market whatsoever! A SPIA may be appropriate for someone who is willing to bet that their longevity is worth betting on, and if they do live long enough the mortality credits will eventually be rewarded, and yet even that is not a guarantee that the SPIA will outperform the portfolio.

How many bets would a retiree be willing to place when all the future outcomes including inflation are so variable? Annuities come with expensive guarantees but what is really guaranteed?

[Nate79]

All those things are true except he never lists them in his paper. He never says for those of you who are just going to pay crazy high fees and do stupid stuff. Instead the impression is given that these apply to everyone.

The topic will always come up. Every topic has already been discussed to death.

The insurance industry sure wouldn't want him disclosing all those assumptions in his paper would they? Instead of educating people to get rid of these high expense investing and doing other stupid stuff he instead pitches an insurance product to pile on more stupid stuff.

[AllMostThere]

I would give anything Wade Pfau says about annuities with a grain of salt. While he offers a different perspective, he has made his career evolve around this type of annuity product, so he is somewhat biased with his opinions adding few details on costs to the consumer and commissions to the sales agent. IMHO, Stinky's comments above gives a more transparent analysis of annuity products with a leaning towards "customer" benefit rather than "industry/sales" benefit. Since a bad experience making a beneficiary claim on an Index Annuity, I am somewhat anti-annuity leaning (annuity = swear word ), but Stinky's excellent analysis in the MYGA mega thread has me doing additional due diligence.

[bsteiner]

I have had the privilege of discussing this subject with both Merton and Pfau, and when you look at the average retiree, as an investor who will pay high fees, high taxes due to investment turnover, and often overspend, products like annuities can make good sense.
...

Some do but some don't. I'm not sure where the average is.

[Stinky]

I have had the privilege of discussing this subject with both Merton and Pfau….

When you see Dr Pfau again, please ask him for the peer reviewed research showing that indexed annuities beat bonds by 2.3% per year.

Boglehead Nation eagerly awaits your report.

[Tdubs]

I have had the privilege of discussing this subject with both Merton and Pfau….

When you see Dr Pfau again, please ask him for the peer reviewed research showing that indexed annuities beat bonds by 2.3% per year.

Boglehead Nation eagerly awaits your report.

Maybe he needs to be on the BH podcast and get a BH peer review.

[Rex66]

Hasn’t he been on one?

That’s a “friendly” conversation and it wouldn’t work out. For better and worse this site doesn’t allow grilling.

[petulant]

I agree that 6.1% vs. 3.8% is a pretty aggressive spread assuming the FIA is net of fees. For the record, I could see 6.1% as a tad aggressive but reasonable for a forward-looking gross return on a FIA. A 100% participation rate and cap rate of 9% could do that. A cap rate of 9% seems a tad high but could be realistic. At the time of writing this post, ATM SPY call options at 450 are about 36; 9% above that would be a strike price about 490, which would gain about 13, for a needed options budget around 23. That would imply a portfolio interest rate around 5% to set the options budget. This is realistically possible but a bit aggressive; if an insurance company priced a FIA this way, which is possible, it would be because they make money on the fees/actuarial elements and hardly at all on the investment spread. A 9% cap can reasonably support an expected return of ~6.1% per year. Then, something like 4% net of fees would pop out. Like others, I interpret the article as saying that 6.1% IS net of fees, implying something closer to 8% as the gross, which would be deeply unrealistic (implying a cap rate of 12% or more and an options budget based on a bond interest rate of 6.2%).

In my mind, it's one thing to say that Dr. Pfau is showing the FIA to be significantly better to bonds with some unrealistic assumptions. It's another thing to claim that FIAs couldn't perform at least as well as or a bit better than bonds if they have similar returns and less volatility with reasonable GLWB or annuitization features. I would like to see Dr. Pfau's modeling if the net FIA return was dropped to 4%.

[petulant]

I have had the privilege of discussing this subject with both Merton and Pfau….

When you see Dr Pfau again, please ask him for the peer reviewed research showing that indexed annuities beat bonds by 2.3% per year.

Boglehead Nation eagerly awaits your report.

Maybe he needs to be on the BH podcast and get a BH peer review.

Yes, he was on one. He got mostly softball questions and fair critical questions were avoided. I say that as probably one of the most pro-Pfau posters on the board. It's just true that the interview did not address any of the regular criticisms of his work.

[afan]

In this ad, Pfau does indicate that he uses pure index returns without fees. But he assumes the initial cap and participation rates persist for the life of the annuity.

Individual insurance companies will know the actual rates they use for each year after issue. I don't know whether anyone knows the averages across the industry. With Pfau's connections with the industry, he could find out the rates used for at least one company maybe for a sample of multiple companies.

It would be fascinating to see a more real world illustration using a set of actual rates. Of course, the companies would have to be willing to share that information.

The performance of the annuity will be worse the lower those rates are. Assuming they will stay high looks like another thumb on the scale for the insurance industry that we have come to expect.

[afan]

I have had the privilege of discussing this subject with both Merton and Pfau….

When you see Dr Pfau again, please ask him for the peer reviewed research showing that indexed annuities beat bonds by 2.3% per year.

Boglehead Nation eagerly awaits your report.

Maybe he needs to be on the BH podcast and get a BH peer review.

Yes, he was on one. He got mostly softball questions and fair critical questions were avoided. I say that as probably one of the most pro-Pfau posters on the board. It's just true that the interview did not address any of the regular criticisms of his work.

As I recall, some of those questions were suggested before the interview but they were not asked.

[Tdubs]

I have had the privilege of discussing this subject with both Merton and Pfau….

When you see Dr Pfau again, please ask him for the peer reviewed research showing that indexed annuities beat bonds by 2.3% per year.

Boglehead Nation eagerly awaits your report.

Maybe he needs to be on the BH podcast and get a BH peer review.

Yes, he was on one. He got mostly softball questions and fair critical questions were avoided. I say that as probably one of the most pro-Pfau posters on the board. It's just true that the interview did not address any of the regular criticisms of his work.

Yes, I remember that. I think what is different about this article is that it is pretty much an unqualified endorsement of FIAs. At least in his previous books, he has acknowledged that there were bad FIAs. In this article, there is no mention of the high fees, hidden commissions, or any nod toward other annuity products that could do the same job at a cheaper price. I'd like to see him answer a question about that. That shouldn't be considered a grilling.