Should you hedge your SPIA with a TIPS ladder?

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McQ
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Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

Perhaps the thread ought to have been titled, instead:

Should you hedge your TIPS ladder with an SPIA?

Arguably, the TIPS ladder is the more foundational product, and the life annuity is the more derived and secondary.

-TIPS are guaranteed by the full faith and credit of the US Treasury. Full stop. An SPIA is guaranteed by some financial intermediary whose financial statements, even though available for inspection, are probably beyond the capability of most annuitants to evaluate.

-A TIPS ladder guarantees a level stream of real income over a preset interval. An SPIA guarantees only a stream of fiat currency, and only for some unknown interval which could be quite short (=life).

Be that as it may, the two products do seem to have offsetting strengths and weaknesses, making it possible that some hedged combination of the two might be superior to either alone.

-The SPIA insures against excess life

-The TIPS ladder insures against excess inflation.

This thread examines various possible combinations.

“Hedge once and done” versus “Hedge as you go”

Hedge once and done means to take out the SPIA and set up the TIPS ladder at the same time in mutually calibrated amounts. It is the primary hedge examined in this thread.

Hedge as you go entails annuitizing a larger sum than needed for spending, and investing the excess income in TIPS each year, until inflation catches up and there is no longer an excess, after which point, the TIPS accumulation begins to be drawn down to sustain real spending power. It will be set out in a later post.

Any hedge has to be compared to BOTH of the two pure, unhedged alternatives:

1. All the funds placed in an unhedged SPIA
2. All the funds put into a TIPS ladder, no SPIA

The purpose of the thread is to explore such comparisons.

Let me acknowledge once, at the outset, that there are many, many ways to skin the annuity cat (see, for instance, StillGoing’s thread on deferred annuities viewtopic.php?t=433101). This thread confines itself to one approach.

Illustrative case

For the initial evaluation, a single illustrative case is held constant.

• Clients are a married couple in their early 70s (say, 74) with a joint life expectancy of 20 years.
• The crediting rate on the SPIA is about 5%, with a 10-year term certain guarantee
• Inflation is assumed to be 3%
• The real rate on TIPS is the difference, at 2%
• Given the assumed crediting rate and life expectancy, an SPIA in the amount of $125,000 will produce a fixed income stream of about $10,000 per year, guaranteed for the first ten years.

The next decision is how far out to hedge, i.e., to what age. Mortality tables, by current convention, have non-zero entries out to age 119. Going out to that age would imply a very expensive hedge that would almost certainly be in excess of what is needed.

Conversely, about half of any pool of 74-year-old couples will outlive their life expectancy of age 94, implying the need at least to hedge past that age.

For these illustrations I hedge out to age 100. About 11% of the pool will survive to 101 or older; these fortunate individuals will see the hedge come off and real income fall. However, the nominal payment will continue for life, which is part of the appeal of a hedged combination.

Couples of this age, convinced that one will prove to be a centenarian, can hedge past age 100, out to age 104, using the longest TIPS available in the US. There is only a 2.6% chance that that hedge will fall short (=survival to 105 and beyond). Preliminary tests showed no difference in the pattern of results for hedging 30 years instead of hedging to age 100, so no further discussion will be made.

Here’s how the setup looks in table form.

Table 1
Image

*If inflation were constant and every TIPS maturity yielded exactly 2.0% then the divisor should be 1.02 * 1.03 = 1.0506. Uncertainty on this score suggests using the sum instead.

The cost of the hedge is about $59,000, or 47% more than the $125,000 annuitized. Total amount available to put into either of the two pure alternatives is thus $183,890.

Tests of the hedge

The pure TIPS ladder alternative can be tested by means of the PMT function, entering the real return of 2%, the period of 26 years, and the total funds available. As shown at the bottom of the table, the pure ladder could only sustain real payments of $9,139 per year, decisively less than the $10,000 real sustained by the hedged combination.

I should note that $9,139 is not bad within a sustainable withdrawal rate frame; it corresponds to a withdrawal rate of almost 5% (albeit, not strictly comparable to the 4% rule, which assumed a 30-year span).

Score 1 for the hedge.

The pure SPIA alternative is a little more difficult to test. A second table will be of assistance.

Table 2
Image
table continues:
Image

If we annuitize all the available funds, the annual payment increases, no surprise, by about 47%, to $14,756. That is considerably more, in year 1, than the $10,300 paid under the combo.

Look next at the results after ten years. The SPIA is guaranteed through ten years, making this a good point for a preliminary evaluation. The all SPIA solution will have paid out over $147,500 in nominal terms, while the hedged combo has paid only $118,000. But, there remains almost $75,000 nominal in the TIPS hedge. If the annuitants were to die at ten years and a day, the combo leaves them better off by $45,000.

The next step is crucial. SPIA payments continue for life—but only for life. That is the key weakness or shortfall of the SPIA when evaluated over a long interval. Payments can stop in a heartbeat—or rather, as soon as the heartbeat stops.

Hence, after the guarantee expires, it is appropriate to apply survival weighting to the annuity amounts. The weighting applies to the $14,756 of the all-SPIA solution, and to the $10,000 SPIA component of the hedged combination. It does not apply to the TIPS payments, which are fixed over the interval and not contingent on continued life.

The survival probabilities are shown in red. Yellow highlights show the survival-weighted value of the all-SPIA payments. Blue cells show the survival weighted value of the $10,000 SPIA payments plus the TIPS top off for that year.

Note how by year 13, the all-SPIA annual payments fall below those of the combo. When the hedge ends at age 100, the sum of payments from the combo remains ahead of the all-SPIA solution.

Next, survival weighting continues out to age 119. Only the survival-weighted SPIA component of the combo continues. The all-SPIA payments catch up a little but not by much. Odds of survival to such an advanced age are simply too tiny to budge the needle.

Score 2 for the hedged combination.

Fine print
Survival weighting applied this way reflect the expectation at the level of a randomly chosen member of the annuitant pool. One could instead hold off on survival weighting until after life expectancy (=the expectation for the pool collectively). The combo advantage would then shrink to about $33,000.

Conclusion

1. Even moderate inflation of 3% severely erodes the value of a stream of fixed payments over a multi-decade period, thus motivating the search for a hedge.

2. The hedged combination pairs the annuity, which is no longer an investment, with TIPS, which are an investment. Appreciation on the investment, inflation plus the real return, is part of what gives the hedge its power.

Next steps

I have a variety of stress tests in mind but welcome suggestions. Upcoming posts will look at:

1. Inflation risk;
2. Interest rate risk;
3. Age-related variation in results.

And at some point I will adapt Table 2 to explore the Hedge As You Go strategy.
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2pedals
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by 2pedals »

How about a comparison with an SPIA that has a 3% escalation clause?
abc132
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by abc132 »

I think this is a reasonable approach if you want to spend more in early retirement, have inheritance and charity wants covered, and have little risk tolerance. I like that you are looking at the benefits of each instead of trying to choose the better one.

Some thoughts with no strong opinions...

I think it would be interesting to compare the lifetime spending to a historical 60/40 portfolio. What percentage of the time are we better off with this combination? Is it a 50% (50-50) outcome, a 10% outcome, or a 0.1% outcome that we benefit historically from this structuring?
AlwaysLearningMore
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by AlwaysLearningMore »

Interesting post by Wrench using I Bonds to bolster a SPIA.

viewtopic.php?p=6624151#p6624151
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er999
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by er999 »

McQ don’t most on here have social security deferred to 70 so have that as a hedge on extreme inflation? How should that factor into your reasoning?

Consider two extreme, unrealistic examples to illustrate the point.
Let’s say there’s an extremely bad run of inflation, like 7%. The annuity will inflate down to low levels (down to 48% in 10 years, 23% in 20 years) but increased social security payments will make up some of the difference.

Let’s say inflation is zero. The tips ladder has sacrificed quite of bit of spending compared to the annuity but no corresponding increase in social security. Affects early on spending too — most think they will live to 100 but most won’t. If you defer going on that special trip maybe not worth it — it could be the case in your numbers where the SPIA person is able to spend 47% more.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by 2pedals »

I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by retireIn2020 »

McQ wrote: Fri Jun 07, 2024 4:56 pm Illustrative case

For the initial evaluation, a single illustrative case is held constant.

• Clients are a married couple in their early 70s (say, 74) with a joint life expectancy of 20 years.
• The crediting rate on the SPIA is about 5%, with a 10-year term certain guarantee
• Inflation is assumed to be 3%
• The real rate on TIPS is the difference, at 2%
• Given the assumed crediting rate and life expectancy, an SPIA in the amount of $125,000 will produce a fixed income stream of about $10,000 per year, guaranteed for the first ten years.
Sorry, this makes zero sense to me. Perhaps you left out some details?
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dknightd
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by dknightd »

McQ wrote: Fri Jun 07, 2024 4:56 pm Perhaps the thread ought to have been titled, instead:

Should you hedge your TIPS ladder with an SPIA?

Arguably, the TIPS ladder is the more foundational product, and the life annuity is the more derived and secondary.

-TIPS are guaranteed by the full faith and credit of the US Treasury. Full stop. An SPIA is guaranteed by some financial intermediary whose financial statements, even though available for inspection, are probably beyond the capability of most annuitants to evaluate.
Or it could also be titled as "Using a TIPS fund to offset a pension with no COLA"

An SPIA is an insurance product, but it could also be considered an income stream - AKA a pension. When I buy an SPIA I consider it as buying a pension (I do not have a pension, so am buying it as needed).

My plan, which I think I have shared several times, is to have SPIA/pension combined with SS cover our basic expenses. If inflation is high then SS income will increase, but SPIA will loose spending power. So, I'll buy more SPIA/pension, as needed, from the "portfolio". I think the key for me is "I'll buy as needed." Sort of your hedge as you go plan.

Essentially I plan to hedge our SPIA by buying more as needed. So I'm hedging our SPIA with our portfolio balance. I've read somewhere that spending in retirement slowly decreases with age, then there might be a sudden increase in your final years. So, perhaps the SPIA slowly loosing spending power is not a problem, if my spending naturally decreases. As long as our "portfolio" has enough to cover those final few years, it will have enough to keep buying more SPIA if we need it. If we do not have expensive final few years, the kids will get a nice inheritance.

My "portfolio" is not "guaranteed by the full faith and credit of the US Treasury." Although some of it is invested that way.

I'm subject to many risks. Inflation. Interest. Market. Longevity (or lack there of). At least I do not have to worry about loosing my job ;) I'm 99% sure I will never have to return to work, but I suppose that risk still exists. Some people think of this in terms of diversifying investments. But really what they are doing is diversifying risk. Some people would never buy an SPIA, but in my mind that helps diversify risk.

For me buying TIPS directly is complicated (although doable), and perhaps unneeded. It would be interesting to see how TIPS compared to a 60/40 portfolio over 30 years. But that data is not available, since TIPS have not existed for 30 year. I have to admit, a guaranteed real return of 2% is pretty darn tempting.

I use spreadsheets for my planning. I'm not as good at it as you and others. They are good for doing what ifs. But there are so many unknowns.

One tiny quibble with your use of life expectancy. You seem to be using a constant table based on a 74 year old. The reality is the longer you are alive, the longer you should expect to be alive. My life expectancy is about 87. But If I live to 88 I should probably recalculate.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by IDpilot »

2pedals wrote: Fri Jun 07, 2024 9:19 pm I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
That's not really a good comparison since McQ is working with a 74-year-old couple.

Above McQ reports that buying a 10,000/year SPIA plus a TIP's ladder that protects that SPIA against 3% inflation for twenty twenty-six years would cost $183,890

New York Life would sell an inflation adjusted at 3% SPIA with ten years certain that pays out 10,000/year for $167,905.* This protection against inflation would last until death instead of going away at 20 26 years.

Seems to me that protecting a fixed SPIA against 3% inflation with a TIPS ladder would be a bad idea when you can get a better product for $15,985 less.

*All annuity quotes were from Blueprintincome.com for a 74-year-old couple in Pennsylvania with birthdates of 6/7/1950 and 100% continuation at first death

Edited to correct the length of the TIPS hedge to twenty-six years per McQ's original idea
Last edited by IDpilot on Sat Jun 08, 2024 12:58 pm, edited 2 times in total.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by dknightd »

McQ
You have been doing these analysis for years. I'm guessing mostly for academic purposes.
I'm guessing you are retired. What did you decide to do? Or, are you still considering your options.
I have a plan, I think it will work out, but I'm willing to reconsider my plan. I'm guessing you are in the same place. So, what is your current plan?
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Retired 2019. So far, so good. I want to wake up every morning. But I want to die in my sleep. Just another conundrum. I think the solution might be afternoon naps ;)
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by Svensk Anga »

er999 wrote: Fri Jun 07, 2024 9:11 pm McQ don’t most on here have social security deferred to 70 so have that as a hedge on extreme inflation? How should that factor into your reasoning?
The common advice here and on opesocialsecurity is for the higher earner to claim at 70 and the lower at 62 or retirement. Perhaps we should rethink that last bit. For a couple where both have a decent chance of exceeding average life expectancy, spend down some fixed income while deferring the lower SS benefit, still taking the higher at 70. While both are alive, that is currently the best low-risk inflation hedge available. It may preserve enough of the portfolio while both live, especially in early high inflation cases, to improve the income of the survivor when the lower benefit ceases.

For myself, the higher earner, I am sold on waiting until 70. I cannot decide when DW should claim. She is now 64. Deferring to make bracket space available for Roth conversions has won for now. Maybe deferring to improve inflation hedging should be the plan.

If one has already claimed and now regrets it, it is possible to start deferring again at full retirement age.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by dcabler »

Svensk Anga wrote: Sat Jun 08, 2024 9:03 am
er999 wrote: Fri Jun 07, 2024 9:11 pm McQ don’t most on here have social security deferred to 70 so have that as a hedge on extreme inflation? How should that factor into your reasoning?
The common advice here and on opesocialsecurity is for the higher earner to claim at 70 and the lower at 62 or retirement. Perhaps we should rethink that last bit. For a couple where both have a decent chance of exceeding average life expectancy, spend down some fixed income while deferring the lower SS benefit, still taking the higher at 70. While both are alive, that is currently the best low-risk inflation hedge available. It may preserve enough of the portfolio while both live, especially in early high inflation cases, to improve the income of the survivor when the lower benefit ceases.

For myself, the higher earner, I am sold on waiting until 70. I cannot decide when DW should claim. She is now 64. Deferring to make bracket space available for Roth conversions has won for now. Maybe deferring to improve inflation hedging should be the plan.

If one has already claimed and now regrets it, it is possible to start deferring again at full retirement age.
opensocialsecurity noted that optimal was me at 70 and she at 66. It also works for some other reasons we looked at as well. So, that's our plan.

Cheers.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by 2pedals »

IDpilot wrote: Sat Jun 08, 2024 8:15 am
2pedals wrote: Fri Jun 07, 2024 9:19 pm I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
That's not really a good comparison since McQ is working with a 74-year-old couple.

Above McQ reports that buying a 10,000/year SPIA plus a TIP's ladder that protects that SPIA against 3% inflation for twenty years would cost $183,890

New York Life would sell an inflation adjusted at 3% SPIA with ten years certain that pays out 10,000/year for $167,905.* This protection against inflation would last until death instead of going away at 20 years.

Seems to me that protecting a fixed SPIA against 3% inflation with a TIPS ladder would be a bad idea when you can get a better product for $15,985 less.

*All annuity quotes were from Blueprintincome.com for a 74-year-old couple in Pennsylvania with birthdates of 6/7/1950 and 100% continuation at first death
I missed the 74-year-old couple scenario.

Although, the annuity does not cover unexpected inflation and if the couple dies shortly after 10 years the insurance is over (no distribution for inheritors) I believe the annuity with an escalation clause is the simple approach that could be best for most. They don't have to build out a TIPS ladder or worry about living longer than expected. They may worry about unexpected inflation but that could be covered by other sources from the portfolio.

Trade studies showing different unexpected inflation rates and different death scenarios might be appropriate for using an annuity with a 3% escalation clause. What happens if unexpected inflation happens early? What happens compared to a 3% fixed COLA (expected inflation) annuity? 4% fixed COLA annuity for that couple is $184,566 (New York Life, Joint 74 yo GA 10 year in Washington State) costs about the same as the hybrid Annuity TIPS ladder approach.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by IDpilot »

2pedals wrote: Sat Jun 08, 2024 10:15 am
IDpilot wrote: Sat Jun 08, 2024 8:15 am
2pedals wrote: Fri Jun 07, 2024 9:19 pm I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
That's not really a good comparison since McQ is working with a 74-year-old couple.

Above McQ reports that buying a 10,000/year SPIA plus a TIP's ladder that protects that SPIA against 3% inflation for twenty twenty-six years would cost $183,890

New York Life would sell an inflation adjusted at 3% SPIA with ten years certain that pays out 10,000/year for $167,905.* This protection against inflation would last until death instead of going away at 20 26 years.

Seems to me that protecting a fixed SPIA against 3% inflation with a TIPS ladder would be a bad idea when you can get a better product for $15,985 less.

*All annuity quotes were from Blueprintincome.com for a 74-year-old couple in Pennsylvania with birthdates of 6/7/1950 and 100% continuation at first death

Edited to correct the length of the TIPS hedge to twenty-six years per McQ's original idea
I missed the 74-year-old couple scenario.

Although, the annuity does not cover unexpected inflation and if the couple dies shortly after 10 years the insurance is over (no distribution for inheritors) I believe the annuity with an escalation clause is the simple approach that could be best for most. They don't have to build out a TIPS ladder or worry about living longer than expected. They may worry about unexpected inflation but that could be covered by other sources from the portfolio.

Trade studies showing different unexpected inflation rates and different death scenarios might be appropriate for using an annuity with a 3% escalation clause. What happens if unexpected inflation happens early? What happens compared to a 3% fixed COLA (expected inflation) annuity? 4% fixed COLA annuity for that couple is $184,566 (New York Life, Joint 74 yo GA 10 year in Washington State) costs about the same as the hybrid Annuity TIPS ladder approach.
You are correct does not cover unexpected inflation but neither does the TIPS hedged fixed SPIA. When you build the TIPS hedge you have to size it for how much inflation you want to hedge against. If inflation comes in above the amount you used to size your hedge, then you are exposed to that inflation.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by 2pedals »

IDpilot wrote: Sat Jun 08, 2024 12:50 pm You are correct does not cover unexpected inflation but neither does the TIPS hedged fixed SPIA. When you build the TIPS hedge you have to size it for how much inflation you want to hedge against. If inflation comes in above the amount you used to size your hedge, then you are exposed to that inflation.
Sorry, I didn’t want to give the impression that the TIPS hedged fixed SPIA gave complete coverage for unexpected inflation. I don’t think I implied that, only the portion invested in TIPS does that with some additional amount above expected inflation if one invested in annuity that has a fixed COLA above expected inflation. There are sequence of inflation risks as well with a fixed COLA annuity.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

AlwaysLearningMore wrote: Fri Jun 07, 2024 8:17 pm Interesting post by Wrench using I Bonds to bolster a SPIA.

viewtopic.php?p=6624151#p6624151
Helpful, thanks!
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

er999 wrote: Fri Jun 07, 2024 9:11 pm McQ don’t most on here have social security deferred to 70 so have that as a hedge on extreme inflation? How should that factor into your reasoning?

Consider two extreme, unrealistic examples to illustrate the point.
Let’s say there’s an extremely bad run of inflation, like 7%. The annuity will inflate down to low levels (down to 48% in 10 years, 23% in 20 years) but increased social security payments will make up some of the difference.

Let’s say inflation is zero. The tips ladder has sacrificed quite of bit of spending compared to the annuity but no corresponding increase in social security. Affects early on spending too — most think they will live to 100 but most won’t. If you defer going on that special trip maybe not worth it — it could be the case in your numbers where the SPIA person is able to spend 47% more.
Regrets--every fiber of my being cries out against the plausibility of zero percent inflation, annualized, over the 26-year planning horizon assumed, 2024 - 2050.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

dknightd wrote: Sat Jun 08, 2024 8:04 am
McQ wrote: Fri Jun 07, 2024 4:56 pm Perhaps the thread ought to have been titled, instead:

Should you hedge your TIPS ladder with an SPIA?

Arguably, the TIPS ladder is the more foundational product, and the life annuity is the more derived and secondary.

-TIPS are guaranteed by the full faith and credit of the US Treasury. Full stop. An SPIA is guaranteed by some financial intermediary whose financial statements, even though available for inspection, are probably beyond the capability of most annuitants to evaluate.
Or it could also be titled as "Using a TIPS fund to offset a pension with no COLA"

An SPIA is an insurance product, but it could also be considered an income stream - AKA a pension. When I buy an SPIA I consider it as buying a pension (I do not have a pension, so am buying it as needed).

...
One tiny quibble with your use of life expectancy. You seem to be using a constant table based on a 74 year old. The reality is the longer you are alive, the longer you should expect to be alive. My life expectancy is about 87. But If I live to 88 I should probably recalculate.
Absolutely--I say "SPIA' throughout but the analysis applies to any fixed income stream guaranteed for life, aka the traditional pension.

On #2: that's correct. But the analysis thus far assumes everything set into place at age X, with its life expectancy.

A different analysis, with multiple annuitization points, would have to take into account the lengthening of life expectancy as greater and greater age is attained.

After 65, the effect is real but small. Per the IRS tables I'm using:

-a 65-year-old couple has joint life expectancy to 93;
-a 75-year-old couple has joint LE to 93.9;
-an 80-year-old couple to 94.7;
-an 85-year-old couple to 96.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

IDpilot wrote: Sat Jun 08, 2024 8:15 am
2pedals wrote: Fri Jun 07, 2024 9:19 pm I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
That's not really a good comparison since McQ is working with a 74-year-old couple.

Above McQ reports that buying a 10,000/year SPIA plus a TIP's ladder that protects that SPIA against 3% inflation for twenty twenty-six years would cost $183,890

New York Life would sell an inflation adjusted at 3% SPIA with ten years certain that pays out 10,000/year for $167,905.* This protection against inflation would last until death instead of going away at 20 26 years.

Seems to me that protecting a fixed SPIA against 3% inflation with a TIPS ladder would be a bad idea when you can get a better product for $15,985 less.

*All annuity quotes were from Blueprintincome.com for a 74-year-old couple in Pennsylvania with birthdates of 6/7/1950 and 100% continuation at first death

Edited to correct the length of the TIPS hedge to twenty-six years per McQ's original idea
Thanks for running those numbers. Keep in mind that TIPS were yielding 2.3x% in May, not the 2% assumed; and that an intermediate corporate bond yielded about 5.40%. No surprise a real life insurance company could beat my quote :-).

Also, the problem with any all-SPIA solution is that it lasts for life, or, more pointedly, until death. The hit from an early demise is greater with an escalator clause, since the payments are back loaded.
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

dknightd wrote: Sat Jun 08, 2024 8:20 am McQ
You have been doing these analysis for years. I'm guessing mostly for academic purposes.
I'm guessing you are retired. What did you decide to do? Or, are you still considering your options.
I have a plan, I think it will work out, but I'm willing to reconsider my plan. I'm guessing you are in the same place. So, what is your current plan?
dknightd
Thanks for asking, dknightd, and for not a few enlightening posts in response to mine over the years.

Yes I am retired; and yes, I am still figuring out what to do.

I expect to annuitize some or all of my TIAA traditional, beginning when I hit RMD age in 2026, hedged by TIPS in DW's 401(k).

But the devil is in the details, which is part of what motivates these sorta-maybe-academic treatments.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
2pedals
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by 2pedals »

My future older self thinks a SPIA without a COLA clause is front loaded.
Nahtanoj
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by Nahtanoj »

2pedals wrote: Sun Jun 09, 2024 10:08 pm My future older self thinks a SPIA without a COLA clause is front loaded.
Yes, and because it is front loaded, it is likely LESS exposed to unexpected inflation that could occur in the out years. If you take your higher payments in the early years, you get the higher payments before unexpectedly high inflation has eroded their value. If you take your higher payments in the out years, unexpected inflation has a a greater chance to erode your higher payments before you get them.
IDpilot
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by IDpilot »

McQ wrote: Sun Jun 09, 2024 9:53 pm
IDpilot wrote: Sat Jun 08, 2024 8:15 am
2pedals wrote: Fri Jun 07, 2024 9:19 pm I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
That's not really a good comparison since McQ is working with a 74-year-old couple.

Above McQ reports that buying a 10,000/year SPIA plus a TIP's ladder that protects that SPIA against 3% inflation for twenty twenty-six years would cost $183,890

New York Life would sell an inflation adjusted at 3% SPIA with ten years certain that pays out 10,000/year for $167,905.* This protection against inflation would last until death instead of going away at 20 26 years.

Seems to me that protecting a fixed SPIA against 3% inflation with a TIPS ladder would be a bad idea when you can get a better product for $15,985 less.

*All annuity quotes were from Blueprintincome.com for a 74-year-old couple in Pennsylvania with birthdates of 6/7/1950 and 100% continuation at first death

Edited to correct the length of the TIPS hedge to twenty-six years per McQ's original idea
Thanks for running those numbers. Keep in mind that TIPS were yielding 2.3x% in May, not the 2% assumed; and that an intermediate corporate bond yielded about 5.40%. No surprise a real life insurance company could beat my quote :-).

Also, the problem with any all-SPIA solution is that it lasts for life, or, more pointedly, until death. The hit from an early demise is greater with an escalator clause, since the payments are back loaded.
The problem with the all-SPIA solution only lasting until death only exits if you have a concern about leaving funds for your heirs.
2pedals
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by 2pedals »

Nahtanoj wrote: Mon Jun 10, 2024 6:12 am
2pedals wrote: Sun Jun 09, 2024 10:08 pm My future older self thinks a SPIA without a COLA clause is front loaded.
Yes, and because it is front loaded, it is likely LESS exposed to unexpected inflation that could occur in the out years. If you take your higher payments in the early years, you get the higher payments before unexpectedly high inflation has eroded their value. If you take your higher payments in the out years, unexpected inflation has a a greater chance to erode your higher payments before you get them.
On the other hand, If you don't buy a SPIA with an escalation clause you don't even cover expected inflation (currently somewhere between 2% and 3%). A SPIA without a fixed COLA that covers expected inflation will reduce the expected present value of the mortality credits that an SPIA will purchase. For this 74-year-old couple, McQ and IDPilot has shown that a hybrid SPIA and TIPS ladder costs more than the SPIA. The lower cost SPIA covers more than expected inflation (3% COLA) and lasts the lifetime of either spouse without any residual value after 10 years. How much is the residual value worth? Only your future self will know for sure.
StillGoing
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by StillGoing »

Two technical notes:

From the very small print below your first table (my eyes are, I think, about a decade younger than yours, but my optician would have been pleased that I could read that)
*If inflation were constant and every TIPS maturity yielded exactly 2.0% then the divisor should be 1.02 * 1.03 = 1.0506. Uncertainty on this score suggests using the sum instead.
Mathematically it should be the product not the sum, but I agree that in practical terms (given that yields vary from day to day), the difference will tend to be small.

Are the 'odds of survival' you've calculated for a couple using the life tables for annuitants or those for the general population?


As others have mentioned, 'With the hedge once and be done' approach, a guess (we could dignify this as a prediction or estimate instead) as to what inflation is required. If you underestimate future inflation, the hedge will not allow the total income to fully increase with inflation, while if you overestimate inflation, then the outcome is that, depending on your point of view, you will leave more unspent (bad) or a larger legacy (hurrah!). Once the hedge fails, there will be residual income from the annuity.

With 'hedge as you go' (which I've now implemented for the DIA/delayed SPIA case - thanks for triggering my thinking on that score), you do not have to guess what future inflation might be, but for any given initial conditions (annuity payout rate and TIPS yield) there will be a threshold inflation above which the hedge will fail. As might be expected, with the pure ladder case, income is sustained for length of the ladder and then falls to zero (with no more than one year where the income is non-zero but below that required). For the pure annuity case (with hedge as you go), the required income is sustained while the combined income from the annuity and that from the ladder is sufficient. Once the ladder is exhausted, the income reverts to annuity only (in other words, failure provides a slightly softer fall than the pure ladder case). One consideration is that 'hedge as you go' requires ongoing work that may be difficult to DIY as one ages.

An interesting question with this work is 'who needs a floor?' since, if social security is enough to support core expenditure, additional flooring (i.e., constant inflation adjusted income for 'life') is not required, while if social security does not support core expenditure only those with sufficient assets to construct a meaningful floor can actually do so.

cheers
StillGoing
rossington
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by rossington »

I suspect the only realistic hedge for either is a TSM/S&P 500 fund given the current/future multiple level increasing costs exceeding the CPI numbers significantly.
"Success is going from failure to failure without loss of enthusiasm." Winston Churchill.
GAAP
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by GAAP »

McQ wrote: Fri Jun 07, 2024 4:56 pm Any hedge has to be compared to BOTH of the two pure, unhedged alternatives:

1. All the funds placed in an unhedged SPIA
2. All the funds put into a TIPS ladder, no SPIA
What about duration-matched TIPS where the duration is adjusted to match the expected mortality rather than a pure, set-once ladder? That is easy to achieve with funds, somewhat more work to achieve with individual bonds.
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee
GAAP
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by GAAP »

Svensk Anga wrote: Sat Jun 08, 2024 9:03 am
er999 wrote: Fri Jun 07, 2024 9:11 pm McQ don’t most on here have social security deferred to 70 so have that as a hedge on extreme inflation? How should that factor into your reasoning?
The common advice here and on opesocialsecurity is for the higher earner to claim at 70 and the lower at 62 or retirement. Perhaps we should rethink that last bit. For a couple where both have a decent chance of exceeding average life expectancy, spend down some fixed income while deferring the lower SS benefit, still taking the higher at 70. While both are alive, that is currently the best low-risk inflation hedge available. It may preserve enough of the portfolio while both live, especially in early high inflation cases, to improve the income of the survivor when the lower benefit ceases.

For myself, the higher earner, I am sold on waiting until 70. I cannot decide when DW should claim. She is now 64. Deferring to make bracket space available for Roth conversions has won for now. Maybe deferring to improve inflation hedging should be the plan.

If one has already claimed and now regrets it, it is possible to start deferring again at full retirement age.
The wording for the "non-standard" both-wait method is usually something along the lines of "Only maximizes income while both are alive". However, the analysis changes if different longevity assumptions are used. I would think that anyone seriously contemplating an annuity for longevity protection should also evaluate SS using the same mortality assumptions -- not the general population SS assumptions.
“Adapt what is useful, reject what is useless, and add what is specifically your own.” ― Bruce Lee
Topic Author
McQ
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

StillGoing wrote: Tue Jun 11, 2024 4:06 am Two technical notes:

From the very small print below your first table (my eyes are, I think, about a decade younger than yours, but my optician would have been pleased that I could read that)
*If inflation were constant and every TIPS maturity yielded exactly 2.0% then the divisor should be 1.02 * 1.03 = 1.0506. Uncertainty on this score suggests using the sum instead.
Mathematically it should be the product not the sum, but I agree that in practical terms (given that yields vary from day to day), the difference will tend to be small.

Are the 'odds of survival' you've calculated for a couple using the life tables for annuitants or those for the general population?


As others have mentioned, 'With the hedge once and be done' approach, a guess (we could dignify this as a prediction or estimate instead) as to what inflation is required. If you underestimate future inflation, the hedge will not allow the total income to fully increase with inflation, while if you overestimate inflation, then the outcome is that, depending on your point of view, you will leave more unspent (bad) or a larger legacy (hurrah!). Once the hedge fails, there will be residual income from the annuity.

With 'hedge as you go' (which I've now implemented for the DIA/delayed SPIA case - thanks for triggering my thinking on that score), you do not have to guess what future inflation might be, but for any given initial conditions (annuity payout rate and TIPS yield) there will be a threshold inflation above which the hedge will fail. As might be expected, with the pure ladder case, income is sustained for length of the ladder and then falls to zero (with no more than one year where the income is non-zero but below that required). For the pure annuity case (with hedge as you go), the required income is sustained while the combined income from the annuity and that from the ladder is sufficient. Once the ladder is exhausted, the income reverts to annuity only (in other words, failure provides a slightly softer fall than the pure ladder case). One consideration is that 'hedge as you go' requires ongoing work that may be difficult to DIY as one ages.

An interesting question with this work is 'who needs a floor?' since, if social security is enough to support core expenditure, additional flooring (i.e., constant inflation adjusted income for 'life') is not required, while if social security does not support core expenditure only those with sufficient assets to construct a meaningful floor can actually do so.

cheers
StillGoing
quick answer: I always use annuitant life expectancy and 100% to survivor. I get annuitant life expectancy from the IRS RMD tables, as the IRS is statutorily required to update these for changes in mortality. This Federal Register piece contains a nice primer on mortality with live footnotes to the actuarial literature: https://www.federalregister.gov/documen ... ng-minimum
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
Topic Author
McQ
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

McQ wrote: Sun Jun 09, 2024 9:53 pm
IDpilot wrote: Sat Jun 08, 2024 8:15 am
2pedals wrote: Fri Jun 07, 2024 9:19 pm I checked immediateannuities.com for a 74 yo male, cost for SL and 10 year GA with 3% COLA New York Life is $136,857. Without the COLA it’s $111,239 for a monthly income of $833 (annual 10k)
That's not really a good comparison since McQ is working with a 74-year-old couple.

Above McQ reports that buying a 10,000/year SPIA plus a TIP's ladder that protects that SPIA against 3% inflation for twenty twenty-six years would cost $183,890

New York Life would sell an inflation adjusted at 3% SPIA with ten years certain that pays out 10,000/year for $167,905.* This protection against inflation would last until death instead of going away at 20 26 years.

Seems to me that protecting a fixed SPIA against 3% inflation with a TIPS ladder would be a bad idea when you can get a better product for $15,985 less.

*All annuity quotes were from Blueprintincome.com for a 74-year-old couple in Pennsylvania with birthdates of 6/7/1950 and 100% continuation at first death

Edited to correct the length of the TIPS hedge to twenty-six years per McQ's original idea
Thanks for running those numbers. Keep in mind that TIPS were yielding 2.3x% in May, not the 2% assumed; and that an intermediate corporate bond yielded about 5.40%. No surprise a real life insurance company could beat my quote :-).

Also, the problem with any all-SPIA solution is that it lasts for life, or, more pointedly, until death. The hit from an early demise is greater with an escalator clause, since the payments are back loaded.
oops. Missed the big problem with the New York Life comparison :oops:

Like all SPIAs, NY Life uses life expectancy,* about 20 years for a 74-year-old couple (=annuitant life expectancy).

I'm hedging a full 26 years, out to age 100.

If I only hedged 3% inflation out to age 94, the cost would be $164,500 or so, or ... a wash between me and NY Life. Which is rather reassuring.

*Technically, the mortality weighted discounted future values out to age 119 (see the tables in Pfau) which the PMT function with LE *approximates*.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
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McQ
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by McQ »

Here is a short aside to cue up some of the issues that StillGoing and others are pursuing, i.e., the postponement of an SPIA and the potential payoffs thereto. (I won’t otherwise be returning to these.)

Here is a table showing:

1. Payments on an SPIA of $125,000 with a 5% crediting rate, joint life expectancy, for a couple of the stated age
2. The joint life expectancy (annuitants) for each age per the IRS
3. Reduction in the payment for taking a 10-year guarantee; this climbs non-linearly with age.
4. The payments by age
5. How much the payments with guarantee increase with each year’s deferral. These rates of increase themselves increase.

Image

*red values are interpolated, black values as observed at immediateannuities.com in early June 2024.

And here is how it looks on a chart.

Image

Delay?

The dicey element with any decision to delay is the unknown course of future crediting (interest) rates—which no one can predict. I thought it would be interesting to see how long one would have to delay the SPIA to overcome a drop in crediting rate and still receive about the same dollar payment (emphasis on “about”).

Or equivalently, how much interest rates would have to drop to wipe out the effect of delaying the SPIA for N years.

Image

I find the results somewhat grim at these younger ages. Delay a year, and hope to heck interest rates don’t drop by 1/8th of a percentage point.

However, results look better when a 70-something or 75-something delays a year or two. A ¼% drop in rates after a year—no problem!

Image

Last, sometimes a naïve approach is taken to the benefits of SPIA delay (not here on the forum, of course).

The (confused) reasoning runs something like this, as best as I can reconstruct:

1. Every year I wait to annuitize my payment increases

2. If I am still alive a year from now, then my life expectancy should still be about the same as before.* I’ve won another round of mortality roulette.

3. Higher payment multiplied by approximately the same LE means I receive more payments over my lifetime for delay.

*False--LE does drop typically by less than 1.0 years, but still drops .9, or .8, or .7 years, per the table above

Unfortunately, although payments do increase with each year of delay, the real value of those future payments drops as well, when viewed from year zero.

Here is another table to make that point.

Image

Conclusion

If you’ve decided an SPIA makes sense for you, and you judge today’s crediting rate to be historically attractive, then … you should probably jump on it. Get it done.

Unless you’ve found a good investment which will reliably increase and thus fund a larger SPIA amount later, should you decide to pull the trigger at some later date.

Which does call into question whether you need an SPIA at all. Why not just stick with that attractive investment until so little life expectancy remains that you can begin heavy withdrawals--to fund the expenses you didn't need to fund in the interim!

Or, maybe you should just keep investing and investing and investing?? That is the question for forum members contemplating delaying their SPIA.
You can take the academic out of the classroom by retirement, but you can't ever take the classroom out of his tone, style, and manner of approach.
StillGoing
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by StillGoing »

McQ wrote: Tue Jun 11, 2024 10:39 pm Here is a short aside to cue up some of the issues that StillGoing and others are pursuing, i.e., the postponement of an SPIA and the potential payoffs thereto. (I won’t otherwise be returning to these.)

[snip]

Conclusion

If you’ve decided an SPIA makes sense for you, and you judge today’s crediting rate to be historically attractive, then … you should probably jump on it. Get it done.

Unless you’ve found a good investment which will reliably increase and thus fund a larger SPIA amount later, should you decide to pull the trigger at some later date.

Which does call into question whether you need an SPIA at all. Why not just stick with that attractive investment until so little life expectancy remains that you can begin heavy withdrawals--to fund the expenses you didn't need to fund in the interim!

Or, maybe you should just keep investing and investing and investing?? That is the question for forum members contemplating delaying their SPIA.
Since there has been a discussion and calculations around DIA/delayed SPIA at viewtopic.php?t=433101 it is probably more appropriate to take it over to that thread

However, I think you may have underplayed the potential effect of changes in yields since yields can change by a lot. The following table shows historical annuity quotes (drawn from https://www.immediateannuities.com/annu ... chive.html) for a hypothetical female retiree in the cohort of 2000 (assumed to be 65 in January 2000) for various years between 2000 and 2020 (i.e. where the retiree was aged 65, 70, ... 85). The column labelled 'now' is the payout rate (in %) for purchasing the annuity immediately at the relevant age (no guarantee period). The column labelled 'delay' was the contemporaneous payout rate that could be potentially obtained by waiting until 85 years old (not to be confused with a deferred income annuity). The nominal and real yields of 20 year treasuries are shown for information (TIPS yields from 2000 are not available at FRED).

Code: Select all

				20 year yields	
Year	Age	Now	Delay	Nominal	Real
2000	65	7.7	16.4	6.72	
2005	70	8.0	14.4	4.64	1.96
2010	75	9.1	13.9	4.38	2.04
2015	80	10.0	12.7	2.04	0.61
2020	85	12.1	12.1	1.83	0.32
So, at the start of retirement our retiree could consider an annuity paying out 7.7% (just a touch more than rates are now) with the prospect of 16.4% if they waited 20 years until they are 85. By the time 20 years have elapsed (i.e. in 2020), assuming our retiree survived, the actual payout rate fell to 12.1% (i.e., by about 25% from what was expected 20 years beforehand). This is largely because of the fall in nominal yields, but will also result from increased longevity. Had the retiree waited another 4 years (i.e., until now), they would be able to purchase their annuity with a payout rate of about 18.4% (they are now 89 and yields have recovered).

So, at the start of retirement, the example retiree might have three options (four if you count, not buying an annuity at all!)
1) Buy immediately (the payout rate and nominal income is known, but future real income is not - hence McQ's thread!)
2) Delay purchase and hope that yields are similar or higher later on and either your set-aside premium holds its real value (I note that purchasing a TIPS maturing in 20 years would give a known real premium after 20 years) or enough of your stock/bond portfolio has survived to enable the annuity to be bought. Historical retirements with poor real returns do not support a delay in annuity purchase.
3) Defer purchase by buying a DIA (giving a known nominal income in 20 years, but an unknown real income after 20 years of inflation).

A somewhat unboglehead contemplation of whether current payout rates are high or low (as alluded to by McQ), might allow some options to be ruled out (i.e. if yields are 'high', then buy now or defer, if they are 'low' then delay - as with all active approaches, there is no guarantee that you'll get that decision right).

Enough asides - back to the main thread!

cheers
StillGoing
IDpilot
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by IDpilot »

StillGoing wrote: Wed Jun 12, 2024 7:10 am
McQ wrote: Tue Jun 11, 2024 10:39 pm Here is a short aside to cue up some of the issues that StillGoing and others are pursuing, i.e., the postponement of an SPIA and the potential payoffs thereto. (I won’t otherwise be returning to these.)

[snip]

Conclusion

If you’ve decided an SPIA makes sense for you, and you judge today’s crediting rate to be historically attractive, then … you should probably jump on it. Get it done.

Unless you’ve found a good investment which will reliably increase and thus fund a larger SPIA amount later, should you decide to pull the trigger at some later date.

Which does call into question whether you need an SPIA at all. Why not just stick with that attractive investment until so little life expectancy remains that you can begin heavy withdrawals--to fund the expenses you didn't need to fund in the interim!

Or, maybe you should just keep investing and investing and investing?? That is the question for forum members contemplating delaying their SPIA.
Since there has been a discussion and calculations around DIA/delayed SPIA at viewtopic.php?t=433101 it is probably more appropriate to take it over to that thread

However, I think you may have underplayed the potential effect of changes in yields since yields can change by a lot. The following table shows historical annuity quotes (drawn from https://www.immediateannuities.com/annu ... chive.html) for a hypothetical female retiree in the cohort of 2000 (assumed to be 65 in January 2000) for various years between 2000 and 2020 (i.e. where the retiree was aged 65, 70, ... 85). The column labelled 'now' is the payout rate (in %) for purchasing the annuity immediately at the relevant age (no guarantee period). The column labelled 'delay' was the contemporaneous payout rate that could be potentially obtained by waiting until 85 years old (not to be confused with a deferred income annuity). The nominal and real yields of 20 year treasuries are shown for information (TIPS yields from 2000 are not available at FRED).

Code: Select all

				20 year yields	
Year	Age	Now	Delay	Nominal	Real
2000	65	7.7	16.4	6.72	
2005	70	8.0	14.4	4.64	1.96
2010	75	9.1	13.9	4.38	2.04
2015	80	10.0	12.7	2.04	0.61
2020	85	12.1	12.1	1.83	0.32
So, at the start of retirement our retiree could consider an annuity paying out 7.7% (just a touch more than rates are now) with the prospect of 16.4% if they waited 20 years until they are 85. By the time 20 years have elapsed (i.e. in 2020), assuming our retiree survived, the actual payout rate fell to 12.1% (i.e., by about 25% from what was expected 20 years beforehand). This is largely because of the fall in nominal yields, but will also result from increased longevity. Had the retiree waited another 4 years (i.e., until now), they would be able to purchase their annuity with a payout rate of about 18.4% (they are now 89 and yields have recovered).

So, at the start of retirement, the example retiree might have three options (four if you count, not buying an annuity at all!)
1) Buy immediately (the payout rate and nominal income is known, but future real income is not - hence McQ's thread!)
2) Delay purchase and hope that yields are similar or higher later on and either your set-aside premium holds its real value (I note that purchasing a TIPS maturing in 20 years would give a known real premium after 20 years) or enough of your stock/bond portfolio has survived to enable the annuity to be bought. Historical retirements with poor real returns do not support a delay in annuity purchase.
3) Defer purchase by buying a DIA (giving a known nominal income in 20 years, but an unknown real income after 20 years of inflation).

A somewhat unboglehead contemplation of whether current payout rates are high or low (as alluded to by McQ), might allow some options to be ruled out (i.e. if yields are 'high', then buy now or defer, if they are 'low' then delay - as with all active approaches, there is no guarantee that you'll get that decision right).

Enough asides - back to the main thread!

cheers
StillGoing
You could modify option 2 to buy a duration matched TIP instead of one that matures in 20 years. This would negate the issue of real income and changes in interest rates.
NoblesvilleIN
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by NoblesvilleIN »

Not sure if this is the proper place to ask. For those concerned about an early demise after purchasing a SPIA and also concerned about the effects of inflation on a current SPIA for a person age 65 or 70:

Would calculating what a SPIA would cost today for an 80 yo for a given monthly "payment" and then purchasing a 15 year TIP or a 10 year TIP for that amount make sense? At age 80, purchase the SPIA using the proceeds from the TIP. Hopefully the proceeds from the TIP would be sufficient to provide an inflation adjusted "payment" equivalent (in inflation terms) to the original desired "payment".

E.G. $100,000 would purchase $1,029 monthly income for an 80 yo male in Indiana. At age 65, purchase a $100k 15 year TIP and use the proceeds to purchase a SPIA at age 80. The goal is to produce an inflation adjusted income stream at age 80 equivalent to the $1,029. If you die before age 80, your heirs would get the TIP. If you live to 80, you get the inflation adjusted income. This is assuming you would use the rest of your portfolio to get to age 80.
NiceUnparticularMan
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by NiceUnparticularMan »

Just a high level observation.

Basically, every dollar you stick in TIPS is a dollar not being used to buy longevity insurance.

And every dollar you stick in a nominal annuity (SPIA, DIA, etc.) is a dollar not being used to buy unexpected inflation insurance.

So if you are going to want to buy a combination of both to deal with those different risks, you are going to need more dollars than you would if you could spend each dollar on both.

This is why Social Security is so nice, a secure COLA pension is also nice if you can get it, and an efficiently-priced COLA annuity WOULD be nice, if it existed.

But again if Social Security alone won't meet your long-term needs, you didn't get a COLA pension, and efficiently-priced COLA annuities are not available . . . you are going to need more dollars. Oh well.

As a final thought, I think this helps explain why some people rationally start looking to equities instead of TIPS for their possible very long-term unexpected inflation insurance, indeed why smart cookies like DFA or the TSP still have a chunk of equities in their terminal Retirement Income funds despite mostly relying on a type of TIPS ladder (DFA) or the G Fund (TSP). This is a very complicated argument to flesh out in full detail, but the basic idea is over long enough periods it does appear like diversified equities might actually be the most efficient solution to the unexpected inflation problem, at an acceptable level of risk, which means you need to divert fewer dollars from longevity insurance.

If you see things that way, it then becomes a question of when you choose to switch over to an "equity ladder" rather than a TIPS ladder. And I think you can make a decent argument for around 20 years, possibly 15, maybe even less. Which happens to be where the G Fund is also somewhat competitive with a TIPS ladder.

And personally, I do tend to think the efficient solution (this is for personal-use real income planning, not considering heirs and such) is going to involve some combination of Social Security, probably deferred annuities, a short-to-medium TIPS ladder/G (including a bridge to Social Security), and diversified equities for longer-term unexpected inflation insurance.

And then you can treat the equities like part of the TIPS ladder in that you would periodically buy more medium TIPS out of equities to keep your ladder rolling.
MtnBiker
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by MtnBiker »

NoblesvilleIN wrote: Wed Jun 12, 2024 8:39 am Not sure if this is the proper place to ask. For those concerned about an early demise after purchasing a SPIA and also concerned about the effects of inflation on a current SPIA for a person age 65 or 70:

Would calculating what a SPIA would cost today for an 80 yo for a given monthly "payment" and then purchasing a 15 year TIP or a 10 year TIP for that amount make sense? At age 80, purchase the SPIA using the proceeds from the TIP. Hopefully the proceeds from the TIP would be sufficient to provide an inflation adjusted "payment" equivalent (in inflation terms) to the original desired "payment".

E.G. $100,000 would purchase $1,029 monthly income for an 80 yo male in Indiana. At age 65, purchase a $100k 15 year TIP and use the proceeds to purchase a SPIA at age 80. The goal is to produce an inflation adjusted income stream at age 80 equivalent to the $1,029. If you die before age 80, your heirs would get the TIP. If you live to 80, you get the inflation adjusted income. This is assuming you would use the rest of your portfolio to get to age 80.
What you are describing makes sense to me, but I have an additional suggestion for how to do it better. When the time comes to buy the SPIA in the future (at age 80, or whenever), the cost of the SPIA may have risen (or fallen), depending on whether interest rates have fallen (or risen). If you don't want to accept the risk that you could only get a smaller SPIA in the case where interest rates fall between now and that time, you should duration-match the TIPS purchase (as IDpilot suggested), rather than buying a TIPS that matures at age 80. If interest rates fall, the value of the duration-matched TIPS would rise by a similar amount as the cost of the SPIA would rise, so that you would have enough money (in real dollars) at that future time to buy the same amount of SPIA that you could buy today (in today's dollars).

For example, I am targeting a SPIA purchase at age 85. The average duration (a measure of interest-rate sensitivity) of a SPIA purchased by an 85-year-old person is about five years. Thus, my TIPS holdings that I have targeted for the deferred SPIA purchase will have a duration of about five years when I am 85. Such a TIPS is a low-coupon issue maturing at my age 90. I plan to sell that stash of TIPS five years prior to maturity to buy the SPIA if I am still around and have sufficient health to justify the need for longevity insurance. Since I am planning to sell the TIPS before maturity, the value when sold will rise or fall with changes in interest rates. But the cost of the SPIA should rise or fall by a similar amount, so the interest rate fluctuations have little effect on the amount of SPIA that can be purchased.
StillGoing
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by StillGoing »

IDpilot wrote: Wed Jun 12, 2024 7:46 am
StillGoing wrote: Wed Jun 12, 2024 7:10 am
So, at the start of retirement, the example retiree might have three options (four if you count, not buying an annuity at all!)

2) Delay purchase and hope that yields are similar or higher later on and either your set-aside premium holds its real value (I note that purchasing a TIPS maturing in 20 years would give a known real premium after 20 years) or enough of your stock/bond portfolio has survived to enable the annuity to be bought. Historical retirements with poor real returns do not support a delay in annuity purchase.
You could modify option 2 to buy a duration matched TIP instead of one that matures in 20 years. This would negate the issue of real income and changes in interest rates.
In order not to derail McQ's thread (since this aside is irrelevant to SPIA purchase without a delay), I've responded to your point in the DIA thread instead at viewtopic.php?p=7910429#p7910429

cheers
StillGoing
Stormbringer
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Re: Should you hedge your SPIA with a TIPS ladder?

Post by Stormbringer »

I'm somewhat partial to a 30-year TIPS ladder with a lump sum in the final rung. When the final rung matures, if you are still alive, the lump sum can then be annuitized to maximum effect when the mortality credits are large, and you have a short enough time horizon that inflation isn't as much of a worry.
“The greatest shortcoming of the human race is our inability to understand the exponential function.” - Albert Allen Bartlett
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