No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

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GoWithTheCashFlow
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No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

A more informative title might be "Mean-Variance Optimization of Equities and Zero-Coupon Annuities Using Volatility and Correlation Term Structures", but it wouldn't be as provocative.


Background:

This is a follow up post to The Deferred Annuity (DIA), Not the SPIA, Should Be the Default

In that post I argued that deferred income annuities (DIAs), rather than single premium immediate annuities (SPIAs), should be the default recommendation when considering annuitization. My argument relied on the concept of the "zero-coupon annuity". A 20-year zero-coupon bond, when held to maturity and assuming no default risk, guarantees a specific payment in 20 years. Similarly, a 20-year zero-coupon annuity guarantees a specific payment in 20 years, contingent on the annuitant's survival. Since the payment is contingent on the survival of the annuitant, a fairly priced zero-coupon annuity will be cheaper than a zero-coupon bond of the same maturity and, therefore, will have a higher return. The difference in the returns of the zero-coupon bond and the zero-coupon annuity is often referred to as a "mortality credit". The less likely the annuitant is to survive to the maturity date, the higher the mortality credit, and the higher the return of the zero-coupon annuity relative to the return of the zero-coupon coupon bond.

Annuities, as we typically think of them, are specific bundles of zero-coupon annuities based on the payment dates of the annuity. A SPIA, which begins monthly payments immediately, consists of a series of zero-coupon annuities maturing each month, starting in one month and continuing indefinitely. Similarly, a 10-year DIA, which starts payments after a 10-year deferral, consists of zero-coupon annuities maturing each month from year 10 onward. Essentially, a DIA is just a SPIA without the zero-coupon annuities maturing during the deferral period.

Although more complicated than this, my previous argument was that DIAs are more attractive than SPIAs because zero-coupon annuities with later maturities offer higher mortality credits than those with earlier maturities.

The strongest1 objection to my argument was that investors' spending goals are real, but the annuities actually available are nominal. Additionally, the risk of inflation is increasing over time. So, despite the higher returns, zero-coupon annuities with later maturities are likely less attractive than those which mature earlier.

My response to this objection was that, while the risk of inflation is increasing over time, at some point the benefit of the higher mortality credits outpaces this risk enough to justify the DIA over the SPIA.

My attempt with this post is to give a (very) rough quantification of these two competing effects.


Mean-Variance Optimization of Equities and Zero-Coupon Annuities:

John Campbell and Luis Viceira's The Term Structure of the Risk-Return Tradeoff describes how the risks of stocks and nominal bonds changes depending on the investment horizon. In this case, risk is defined as the variation around the real return at the end of the investment horizon, rather than the volatility. This means that the risk-free rate depends on the investment horizon and is given by the real yield curve derived from TIPS.

Campbell and Viceira produce the graph below which shows the annualized standard deviation of the real-return over different investment horizons for both equities and nominal bonds held to maturity. Keep in mind that, because the bonds are held to maturity and assumed not to default, the entire risk for these bonds is due to inflation.

Image

Notice that the annualized risk for equities starts high and declines as the investment horizon increases. This pattern is representative of the mean reversion of equity returns. This mean reversion suggests that the optimal allocation to equities for spending goals with longer horizons is larger than the equity allocation for spending goals with a shorter horizon.

Turning our attention to nominal bonds held to maturity, we see the annualized risk actually increases with the investment horizon. If we assume the TIPS break-even inflation rate represents expected inflation, then a K-year nominal treasury bond has an expected excess return over the K-year risk-free rate of 0%. Since the real return is risky and there is no expected excess return, there is no reason to hold nominal treasury bonds instead of TIPS.

Although we are assuming that nominal treasuries have no excess return, a fairly priced nominal zero-coupon annuity will have an excess expected return equal to the size of the mortality credit. Thus, adding a zero-coupon annuity to equities may improve the risk-return trade-off for a particular investment horizon, depending on its Sharpe ratio as well as its correlation to equities.

Luckily, Campbell and Viceria also produce the graph below showing how the correlation of the real returns for nominal bonds held to maturity and equities rises and then falls as the investment horizon increases.

Image

Now, the linked paper is 20 years old at this point. It may not be representative of the current market environment. Additionally, it may not capture the long-run and deep risk associated with inflation. However, I still think it is worthwhile to derive the tangency portfolios for nominal zero-coupon annuities and stocks to see how the portfolio weights change based on the horizon. As long as a similar volatility and correlation term structure holds, then it will be informative. To be clear, I am not attempting to derive an optimal annuity purchasing strategy. I'm merely trying to demonstrate that later maturing zero-coupon annuities are likely more attractive than those that mature earlier.

To derive the portfolio weights, we need three things for both equities and zero-coupon annuities. We need their expected excess returns, the standard deviations of those returns, and, finally, the correlation between those returns.

For the expected return of equities, I use Damodoran's current month estimate of 8.91%. To get the expected excess return for a particular horizon, I subtract the nominal treasury rate for the associated maturity as of 1/27/2025 (using linear interpolation and setting the rate for maturities > 30 years to the 30-year rate).

As stated previously, the expected excess return of the zero-coupon annuity is equal to the mortality credit for that particular maturity. I use the 2012 IAM Basic mortality tables with the G2 projection scale applied in order to estimate the mortality credits.

The graph below displays the annualized expected excess returns for equities and zero-coupon annuities across different investment horizons for a 65-year-old couple.

Image

The equity excess return curve is roughly flat due to the relatively flat yield curve and assumed constant return for equities. Meanwhile, there is hardly any excess return for the zero-coupon annuities at the earlier maturities, but the exponential growth in mortality rates causes the mortality credits to grow exponentially as well.

To estimate the annualized standard deviations of equities and nominal bonds held to maturity, I simply eyeball the graph given by Campbell and Viceira. I do the same or the correlation, except I set the minimum correlation to 0.

Similar to the nominal bond held to maturity, the risk of a nominal zero-coupon annuity (contingent on the annuitant being alive at maturity) is entirely due to inflation. Thus, we can calculate the standard deviation of a zero-coupon annuity from the standard deviation of the nominal bond with the same maturity by scaling it by (1 + mortality credit). Additionally, since correlation is scale-invariant, the correlation between equities and the zero-coupon annuity is the same as for the equities and the nominal bond of the same maturity.

The graph below shows the annualized standard deviations of real returns for equities and zero-coupon annuities across different investment horizons for a 65-year-old couple.

Image

The curve for equities has already been discussed while the curve for the zero-coupon annuities looks similar to that of nominal bonds, only it is growing faster due to the scaling by (1 + mortality credit).

Finally, the graph below displays the Sharpe ratios for equities and zero-coupon annuities available to a 65-year-old couple, along with their correlations.

Image

We now have enough information to calculate the optimal equity and zero-coupon annuity portfolio weights for each investment horizon. I plot the weights for each zero-coupon annuity by the investment horizon, assuming no short-selling.

Image

The allocation between equities and zero-coupon annuities follows expected patterns based on their Sharpe ratios. Early-maturity zero-coupon annuities provide little excess return, making them unattractive compared to TIPS, especially given equities' higher expected returns. However, as mortality credits increase, zero-coupon annuities become more appealing despite their rising risk over longer horizons. This trend is even more pronounced for joint annuitants at older ages, as shown in the graph below for an 80-year-old couple.

Image

This looks like a clear win for DIAs over SPIAs. However, a surprising pattern occurs for older individual annuitants. Consider the allocation to zero-coupon annuities for an age 65 male given by the graph below.

Image

Prior to the more familiar pattern on the right of the graph, the allocation to zero-coupon annuities begins at 100% and falls dramatically to 0%. An inspection of the Sharpe ratios and correlation to equities reveals the cause of this pattern.

Image

The mortality credits at the early maturities for individual annuities are large enough to result in a high Sharpe ratio. However, this is mostly due to the low risk associated with them. Moreover, that risk increases fairly quickly with horizon, while the mortality credits take a little more time to gain momentum. This causes a decline in the Sharpe ratio of zero-coupon annuities and the growing Sharpe ratio of equities overtakes it. Since mean-variance optimization is highly sensitive to the inputs, especially when correlations are far from zero, we get the dramatic swings in allocation shown previously.

For even older individual annuitants, the Sharpe ratio of equities never overtakes that of the zero-coupon annuities. Consider the allocation below for a 75 year old male.

Image

While I am surprised by this result, it does not change my belief that DIAs are superior to SPIAs for several reasons. First, I don't think the regions where mean-variance optimization is highly sensitive to the inputs are particularly informative. You'd probably be better off just applying equal weights, that is, assuming your desired risk-return characteristics are met. Which brings me to the second point. Going 100% zero-coupon annuities for earlier maturities likely isn't generating enough excess return to meet an investor's required return. Equities would be needed to get you there. Finally, one of the main benefits of DIAs is that they do not reduce liquidity as much as SPIAs. The mean-variance analysis above does not take this into account. Still, I concede there may be some situations where SPIAs and DIAs are roughly equally attractive.

Overall, I believe the mean-variance analysis above gives strong support to my claim that DIAs are superior to SPIAs, despite inflation risk increasing over time.


1A common objection in the previous thread was to point out that it would be better to delay the annuitization decision rather than purchase a DIA. However, whether or not to delay annuitization is a separate question from whether to choose a SPIA or a DIA as the annuitization method. It may be the case that it is optimal for someone to delay annuitization until the last possible age, at which point a DIA will likely not be available, but that is not an argument for a choosing a SPIA over a DIA at the time of annuitization.
Last edited by GoWithTheCashFlow on Tue Jan 28, 2025 10:47 pm, edited 1 time in total.
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blimp
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by blimp »

Interesting post.

Another way to do this is to compare actual quotes

I went to immediateannuities.com and put in $1,000,000 for a SPIA for a 65 year old man in Arizona lifetime annuity, and it gives me a monthly income of $6,383. To get the same income with a DIA deferred 10 years, I have to pay $455,701, so I would have an extra $544,299 to invest for 10 years of income. If I did not invest it at all, I only would get $4,536 per month (dividing into 120 months). I turns out I would need a 6.75% nominal return to break exactly even between the two strategies.

So while your theoretical arguments are valid, current market pricing suggests a SPIA is a more defensive strategy if you are concerned about generating a specific income in retirement. Both strategies have the same inflation risk in my view.
Hebell
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Hebell »

I appreciate the rigor of your analysis and have to chew on this, once I get my head out of TurboTax. Thank you for posting.
Northern Flicker
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

blimp wrote: Tue Jan 28, 2025 10:40 pm Interesting post.

Another way to do this is to compare actual quotes

I went to immediateannuities.com and put in $1,000,000 for a SPIA for a 65 year old man in Arizona lifetime annuity, and it gives me a monthly income of $6,383. To get the same income with a DIA deferred 10 years, I have to pay $455,701, so I would have an extra $544,299 to invest for 10 years of income. If I did not invest it at all, I only would get $4,536 per month (dividing into 120 months). I turns out I would need a 6.75% nominal return to break exactly even between the two strategies.

So while your theoretical arguments are valid, current market pricing suggests a SPIA is a more defensive strategy if you are concerned about generating a specific income in retirement. Both strategies have the same inflation risk in my view.
I got a required return of 7.225% CAGR-- an online loan amortizer shows that if the principal saved by buying a DIA with 10-year deferral instead of a SPIA were invested by making an amortizing loan at 7.225%, the loan would amortize to zero in 10 years and provide $6383.07 of monthly income. But if the annuitant dies in the first 10 years, the estate will get the residual principal of the loan, so that strategy should be compared to a SPIA quote with a 10-year certain clause.
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blimp
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by blimp »

Northern Flicker wrote: Tue Jan 28, 2025 11:25 pm
blimp wrote: Tue Jan 28, 2025 10:40 pm Interesting post.

Another way to do this is to compare actual quotes

I went to immediateannuities.com and put in $1,000,000 for a SPIA for a 65 year old man in Arizona lifetime annuity, and it gives me a monthly income of $6,383. To get the same income with a DIA deferred 10 years, I have to pay $455,701, so I would have an extra $544,299 to invest for 10 years of income. If I did not invest it at all, I only would get $4,536 per month (dividing into 120 months). I turns out I would need a 6.75% nominal return to break exactly even between the two strategies.

So while your theoretical arguments are valid, current market pricing suggests a SPIA is a more defensive strategy if you are concerned about generating a specific income in retirement. Both strategies have the same inflation risk in my view.
I got a required return of 7.225% CAGR-- an online loan amortizer shows that if the principal saved by buying a DIA with 10-year deferral instead of a SPIA were invested by making an amortizing loan at 7.225%, the loan would amortize to zero in 10 years and provide $6383.07 of monthly income. But if the annuitant dies in the first 10 years, the estate will get the residual principal of the loan, so that strategy should be compared to a SPIA quote with a 10-year certain clause.
Yes you make a fair point about the certain clause.
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Stinky
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Stinky »

blimp wrote: Tue Jan 28, 2025 10:40 pm Interesting post.

Another way to do this is to compare actual quotes

I went to immediateannuities.com and put in $1,000,000 for a SPIA for a 65 year old man in Arizona lifetime annuity, and it gives me a monthly income of $6,383. To get the same income with a DIA deferred 10 years, I have to pay $455,701, so I would have an extra $544,299 to invest for 10 years of income. If I did not invest it at all, I only would get $4,536 per month (dividing into 120 months). I turns out I would need a 6.75% nominal return to break exactly even between the two strategies.

So while your theoretical arguments are valid, current market pricing suggests a SPIA is a more defensive strategy if you are concerned about generating a specific income in retirement. Both strategies have the same inflation risk in my view.
That’s an interesting way of looking at it.
Retired life insurance company financial executive who sincerely believes that ”It’s a GREAT day to be alive!”
JBTX
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by JBTX »

I read about the first 1/3 of the OP. Didn’t get beyond that post.

This seems to me to be an apples are better than oranges argument. Comparing a fixed period annuity to an indefinite period annuity that flows as long as you live. Now I suppose you could look at the comparative rates and conclude that the reduced premium of the SPIA is not worth the guaranteed lifetimes payment but that is kind of subjective. In other words the longevity insurance isn’t worth the price. I’d have to compare some numbers but I’m hesitant to just accept that is true.

This is really an insure vs self insure argument.

I’d be more inclined to do a TIPS ladder than a DPIA.

Taylor Larimore has mentioned he has purchased SPIAs many years ago and by all accounts the longevity insurance is paying off big time.
Northern Flicker
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

One point about DIAs is that they can have a long enough duration that the liability cannot be matched with a bond portfolio. The insurer may manage this by absorbing the DIA into an actuarial pool and managing to the duration of liabilities of the pool in aggregate. This provides the annuitant with an option that they could not implement on their own. That hits at the core of why we use insurance products.

But the insurer also could choose to overprice the risk to be sure that they don't end up with an uncovered liability. This would make a DIA expensive.
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GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

blimp wrote: Tue Jan 28, 2025 10:40 pm Interesting post.

Another way to do this is to compare actual quotes

I went to immediateannuities.com and put in $1,000,000 for a SPIA for a 65 year old man in Arizona lifetime annuity, and it gives me a monthly income of $6,383. To get the same income with a DIA deferred 10 years, I have to pay $455,701, so I would have an extra $544,299 to invest for 10 years of income. If I did not invest it at all, I only would get $4,536 per month (dividing into 120 months). I turns out I would need a 6.75% nominal return to break exactly even between the two strategies.

So while your theoretical arguments are valid, current market pricing suggests a SPIA is a more defensive strategy if you are concerned about generating a specific income in retirement. Both strategies have the same inflation risk in my view.
There are several things going on. Let me try to break them down.

My Claim:
The claim in my original post was that given fairly priced and inflation adjusted annuities, unless one is willing to annuitize 100% of their wealth, then a DIA is preferable to a SPIA since, per dollar spent on annuities, DIAs provide larger spending increases than SPIAs.

This post focused on the relaxation of the "inflation adjusted" assumption. But, as you point out, we need to relax the "fairly priced" assumption as well.

Relative Fairness:
There are two reasons why DIAs may be less fairly priced than SPIAs. First, the market for DIAs is less competitive than the market for SPIAs. Second, per dollar spent on the annuity, insurers take on more reinvestment risk with DIAs than with SPIAs.

The method you and NorthernFlicker describe of isolating the return offered by a SPIA from the mortality credits during the first 10 years is pretty clever. If this return is higher than the return on MYGAs, then it provides evidence that the SPIA is more favorably priced than the DIA.

I ran two quotes from https://www.stantheannuityman.com:

Quote 1:
  • Annuitant(s): Age 65 Male
  • State: Texas
  • Product: SPIA with a 10-year period certain
  • Purchase Price: $100,000
  • Monthly Payout: $636.86
Quote 2:
  • Annuitant(s): Age 65 Male
  • State: Texas
  • Product: DIA with a 10-year deferral period
  • Purchase Price: $100,000
  • Monthly Payout: $1,524.15
Based on the above quotes, purchasing a DIA for $41,784.60 would yield the same $636.86 payout as the $100,000 SPIA, leaving $58,215.40 to fund the next 10 years. With the way I ran the quotes, the SPIA provides 119 payments that the DIA does not provide (not 120). Amortizing the $58,215.40 down to $0 with 119 monthly payments of $636.86 implies a return of 5.68%. This is a little bit higher than the rates available with MYGAs. The best MYGA rates I found by investment period are given below:

2-year: 5.10%
3-year: 5.20%
4-year: 5.50%
5-year: 5.60%
6-year: 5.65%
7-year: 5.45%
8-year: 5.20%
9-year: 5.10%
10-year: 5.65%

So, yes, I believe there is some evidence that the SPIA is more favorably priced than the DIA. But, at least in this case, the difference is not drastic. The deferral period was only for 10 years though. A longer deferral period could result in an even less favorable pricing.

Should You Purchase a SPIA?
As to the question of whether or not it makes sense to purchase a SPIA (without the 10-year period certain) given market prices, I need to run an additional quote for such a SPIA.

Quote 3:
  • Annuitant(s): Age 65 Male
  • State: Texas
  • Product: SPIA
  • Purchase Price: $100,000
  • Monthly Payout: $647.89
Based on the above quotes, purchasing a DIA for $42,508.28 would yield the same $647.89 payout as the $100,000 SPIA, leaving $57,491.72 to fund the next 10 years. With the way I ran the quotes, the SPIA provides 119 payments that the DIA does not provide (not 120). Amortizing the $57,491.72 down to $0 with 119 monthly payments of $647.89 implies a return of 6.38%. For lack of a better method, using a flat expected return structure, this is an excess expected return over treasuries of about 2.1% (ranges from 1.83-2.24%). If I use those excess returns in the mean-variance optimization, I get the following allocation to the period-certain portion of the annuity:

Image

If we recall, my model yielded the zero-coupon annuity allocation for a 65 year old male below:

Image

The zero-coupon annuity allocation is going to drop to zero after the 10 year period before bouncing back up. So, the question is, do we want to keep the left part of the curve with the dramatic drop and before the bounce back? I personally don't think so. As I said before, this is a region where the mean-variance optimization is highly sensitive to the inputs. I would rather keep the liquidity and allocate to TIPS and equities. If I wanted to add risky fixed income, I would add MYGAs at the earlier end of the curve.

To reiterate, it's not surprising that the SPIA provides a greater spending boost than the DIA. That's what it's supposed to do since it implies a greater level of annuitization. However, a greater spending boost per dollar annuitized can be had by applying those dollars to a DIA. As long as you're not annuitizing all of your wealth, a DIA will be a more efficient use of annuitized dollars. Instead of comparing the spending boost of a $100,000 SPIA to a $50,000 DIA, we should be comparing to the spending boost of a $100,000 DIA.

FIAs as an Alternative:
Interestingly, the real advice was given by Rex66 in the last thread. For 10 year deferral periods, especially for joint annuities, you really want a fixed index annuity (FIA) with an income rider. The payouts are higher and they come with much more liquidity. The best FIA quote, with income beginning in 10 years, for an age 65 male is a monthly payout of $1,663. This knocks the excess return of the SPIA during the deferral period down under 5%. There's definitely no reason to keep the left part of the curve under that scenario.

Relative Inflation Risks:
Given the same monthly payment amount, a SPIA carries more inflation risk than a DIA since embedded within the SPIA is a DIA. However, per dollar spent on the annuity, a DIA carries more inflation risk than a SPIA since inflation risk increases over the investment horizon.
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blimp
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by blimp »

GoWithTheCashFlow wrote: Wed Jan 29, 2025 8:02 pm the SPIA provides 119 payments that the DIA does not provide (not 120).
I see.
GoWithTheCashFlow wrote: Wed Jan 29, 2025 8:02 pm Amortizing the $57,491.72 down to $0 with 119 monthly payments of $647.89 implies a return of 6.38%.
For a retired risk adverse person considering an annuity, I would consider 6.38% to be a good return.
GoWithTheCashFlow wrote: Wed Jan 29, 2025 8:02 pmGiven the same monthly payment amount, a SPIA carries more inflation risk than a DIA since embedded within the SPIA is a DIA. However, per dollar spent on the annuity, a DIA carries more inflation risk than a SPIA since inflation risk increases over the investment horizon.
But in terms of the risk of feeling the negative effects of inflation when spending the income 20-30 years later, they should be the same.

One other thing I would say is that comparing a SPIA now vs. DIA now + invest the difference with MYGAs/TIPS/3-fund-portfolio may be unreasonable. An alternative to purchasing a DIA is just delaying annuitization until you are older while investing in a 60/40 portfolio for instance. Then you gain information about your health. If you get a cancer or heart failure diagnosis between 65 and 75, you of course would not purchase a SPIA at 75. If you are healthy and fit like Taylor Larrimore, you purchase the SPIA. This would help mitigate the risk of inflation for those 10 years but could introduce other risks like changes in rates. To me, the risk of inflation over a 30+ year period is scary. 2% inflation over 30 years is only a 45.5% loss in spending power, but 5% inflation over 30 years is an 88.6% loss in spending power.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

I don't doubt the math but I don't believe "deferred income annuities (DIAs) are superior to SPIAs in every way". Here's why.
With the DIA, you have to pick the deferral period, and you may not know in advance what the best period is in your situation. With a SPIA, you could park the money in a MYGA and roll it into a SPIA when you're ready. In my case, our family situation is somewhat dynamic. There will be some income changes and lumpy spending over the next few years, so I have to be flexible. I plan to ladder in multiple SPIAs starting in about 2 years, but I won't know the exact date when I want to start those in advance. Now, in a different situation, it may be easier to predict cash flow much better.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

Excellent post. Intuitively, deferred annuities have always made more sense to me than immediate annuities, but the inflation risk looms too large in my mind

I’d love to see the same analysis but with real annuities. There’s no theoretical reason US insurers couldn’t sell them. If they did and I could get one for my wife, I could absolutely suitcase retirement. Here’s hoping
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GaryA505
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

ScubaHogg wrote: Thu Jan 30, 2025 9:43 am Excellent post. Intuitively, deferred annuities have always made more sense to me than immediate annuities, but the inflation risk looms too large in my mind

I’d love to see the same analysis but with real annuities. There’s no theoretical reason US insurers couldn’t sell them. If they did and I could get one for my wife, I could absolutely suitcase retirement. Here’s hoping
I think when inflation-protected (real) annuities were offered, they didn't sell very well so the companies stopped offering them. I think one of the things that killed sales was that with the inflation-protected SPIA the starting payments are significantly reduced. Insurance companies are in business to make money, so if there was demand there would likely be supply.

Personally, I feel that since spending tends to drop with age, not all sources of income need to be inflation-protected. For example, if 50% of income was from SS, 25% from a flat (not inflation-protected) SPIA, and 25% from cap gains on equities, I think that's good enough.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

GaryA505 wrote: Thu Jan 30, 2025 9:54 am
ScubaHogg wrote: Thu Jan 30, 2025 9:43 am Excellent post. Intuitively, deferred annuities have always made more sense to me than immediate annuities, but the inflation risk looms too large in my mind

I’d love to see the same analysis but with real annuities. There’s no theoretical reason US insurers couldn’t sell them. If they did and I could get one for my wife, I could absolutely suitcase retirement. Here’s hoping
I think when inflation-protected (real) annuities were offered, they didn't sell very well so the companies stopped offering them. I think one of the things that killed sales was that with the inflation-protected SPIA the starting payments are significantly reduced. Insurance companies are in business to make money, so if there was demand there would likely be supply.
Yes, apparently they didn’t work before. Doesn’t mean they will never work under any circumstances. People love SS and inflation adjusted pensions

Sometimes I think that they failed because it had been so long since the US had experienced inflation people just didn’t see the value. Even now on this board people cannot wrap their heads around the idea that inflation can be much worse than 2022-present
Personally, I feel that since spending tends to drop with age, not all sources of income need to be inflation-protected. For example, if 50% of income was from SS, 25% from a flat (not inflation-protected) SPIA, and 25% from cap gains on equities, I think that's good enough.
If you want to be protected against fatter tails in inflation, this only works if you are happy watching 25% of your spending go poof

At the end of the day there’s really no reason anything anywhere should be in nominal dollars other than ease of accounting. As Ben Mathew said about nominal bonds on the Rational Reminder they “don't make any sense. Why would you want a hundred dollars 30 years from now? I want to know how many loaves of bread or slices of pizza I can get 30 years from now.”
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Northern Flicker
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

blimp wrote: An alternative to purchasing a DIA is just delaying annuitization until you are older while investing in a 60/40 portfolio for instance. Then you gain information about your health.
The deferral period of the DIA provides a fixed, low risk return. Holding the 60/40 portfolio not only takes the risk of the 60/40 portfolio, but also takes the risk that interest rates fall making the annuity expensive when you are ready to purchase it.

The income annuity premium will fund out to the age of life expectancy for the actuarial pool. Self-selection based on health status is a strategy available to everyone buying the annuity, and will be an input to the insurer's estimate of life expectancy of the actuarial pool. So it is a driver of higher premiums. Likewise, the age of life expectancy of someone who already reached say age 70 is higher than when that individual had reached say age 60.

Delaying the purchase of the income annuity to wait to learn health outcomes means funding more years in total if health outcome is good, as there will be fewer years past the age of life expectancy that are funded by the actuarial pool.

Said another way, annuitizing earlier with the DIA will lead to funding fewer years in total. This would be a win if the return of the deferral is competitive. The problem is that the expense ratio of the annuity is not transparent. Paying the insurance company admin cost for more years is a detriment that could make the return on the deferral uncompetitive.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by RyeBourbon »

blimp wrote: Thu Jan 30, 2025 12:17 am
GoWithTheCashFlow wrote: Wed Jan 29, 2025 8:02 pm Amortizing the $57,491.72 down to $0 with 119 monthly payments of $647.89 implies a return of 6.38%.
For a retired risk adverse person considering an annuity, I would consider 6.38% to be a good return.
Maybe I misunderstand, but the retired risk-averse person isn't getting this return from an annuity; for the DIA to be competitive, they have to find an investment that provides this return to fund the first ten years, and I don't think they're going to find a low-risk investment that does it. Or perhaps, does this mean that the SPIA option implies a 6.38% return? Is that a CAGR or IRR? Can one compare them?
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GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

blimp wrote: Thu Jan 30, 2025 12:17 am For a retired risk adverse person considering an annuity, I would consider 6.38% to be a good return.
But the 6.38% is nominal and therefore risky in real terms. So, you need to compare it's risk-reward profile to the risk-reward profile of a TIPS + (equities + MYGAs) portfolio.
blimp wrote: Thu Jan 30, 2025 12:17 am But in terms of the risk of feeling the negative effects of inflation when spending the income 20-30 years later, they should be the same.
Agreed.
blimp wrote: Thu Jan 30, 2025 12:17 am To me, the risk of inflation over a 30+ year period is scary.
My intention with this thread was to compare equity risk and the inflation risk of nominal zero-coupon annuities. Campbell and Viceira's graph below implies these risks are roughly equivalent at the 30 year investment horizon. If a 4-5% equity risk premium is attractive, then an excess return on zero-coupon annuities of 4+% should be attractive as well.

Image


Delay vs Defer
blimp wrote: Thu Jan 30, 2025 12:17 am One other thing I would say is that comparing a SPIA now vs. DIA now + invest the difference with MYGAs/TIPS/3-fund-portfolio may be unreasonable. An alternative to purchasing a DIA is just delaying annuitization until you are older while investing in a 60/40 portfolio for instance. Then you gain information about your health.
GaryA505 wrote: Thu Jan 30, 2025 9:31 am With the DIA, you have to pick the deferral period, and you may not know in advance what the best period is in your situation. With a SPIA, you could park the money in a MYGA and roll it into a SPIA when you're ready.
I don't want to spend too much time on this since much of the last thread was spent discussing the delay vs defer distinction and I wanted this thread to focus on the inflation aspect.

If I claim that 2 > 1 and someone responds with, "2 < 5 + 1", then I'm not fazed, because I know that 5 + 2 > 5 + 1.

Similarly, when I claim that DIA > SPIA and people respond with "DIA < Delay + SPIA", my response is simple; Delay + DIA > Delay + SPIA.

I am not against delaying annuitization. I'm currently delaying annuitization. I'm young and married. Right now the benefits of annuitization are small and, as you guys describe, the costs are large. However, all of the arguments for delaying can be equally applied in favor of a DIA over a SPIA once annuitization becomes attractive enough to execute on. Why, as a 65 year old male, spend $154,000 on a SPIA which pays $1,000 a month, when you could get the same longevity protection for a little over $18,000 by purchasing a DIA with payments starting at age 85? Who knows what life is going to throw at you. It would be a good idea to keep the $136,000 invested and available to make any changes as needed.

I don't know what the optimal annuitization strategy is when factoring in the desire for liquidity and market prices, but my best guess is that it looks something like...
  • First, delay annuitization while the benefits are small and less is known about your personal situation.
  • Then, a DIA with a long deferral period becomes attractive enough to make a small purchase (keeping in mind future purchases will be made as well).
  • Then, additional small DIA purchases, with shorter and shorter deferral periods, are made whenever the plan needs updating (every 1-5 years or so).
  • Then, at some point it makes sense for purchases to include both a DIA and a SPIA.
  • Finally, the maximum age for annuitization is reached and a SPIA is purchased.

Note: The plan above ignores the existence of FIAs with income riders. My hunch is that a strategy using exclusively FIAs can dominate any DIA and SPIA strategy.
Last edited by GoWithTheCashFlow on Thu Jan 30, 2025 10:29 pm, edited 1 time in total.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

RyeBourbon wrote: Thu Jan 30, 2025 5:35 pm Maybe I misunderstand, but the retired risk-averse person isn't getting this return from an annuity; for the DIA to be competitive, they have to find an investment that provides this return to fund the first ten years, and I don't think they're going to find a low-risk investment that does it. Or perhaps, does this mean that the SPIA option implies a 6.38% return? Is that a CAGR or IRR? Can one compare them?
The SPIA option implies a 6.38% return over the first 10 years when compared to the alternative of purchasing a DIA with a 10 year deferral. It is the IRR from an initial outlay of $57,491.72 followed by 119 monthly payments of $647.89.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

ScubaHogg wrote: Thu Jan 30, 2025 9:43 am I’d love to see the same analysis but with real annuities.
If we ignore concerns regarding liquidity, as well as assume the real zero-coupon annuities are fairly priced and able to be purchased unbundled, then it would simply turn the risk-free rate, given a particular investment horizon and investor, into the TIPS rate + mortality credit. This means the equity risk premium would shrink with increases to the investment horizon. At some point, the equity risk premium would drop to zero and allocations for investment horizons greater than this would only consist of real zero-coupon annuities.

This is, of course, highly unrealistic. Allow me to speculate at what happens if we drop the "fairly priced" assumption.

What do I mean by "fairly priced"? Simply put, I mean that it follows my basic pricing model. The only two inputs in the model are the yield curve and the mortality curve. The yield curve I used was the U.S. Treasury yield curve, while the mortality curve I used was the basic one put out by the Society of Actuaries for annuitants. The analysis in my original post "works" because this is a pretty decent assumption for nominal annuities available in the U.S. Using this model, I get money's worth ratio's (MWRs) of around 100% when I run various quotes. However, based on the analysis upthread, the model likely understates the return of the shorter duration zero-coupon annuities and overstates the return of longer duration zero-coupon annuities.

For real annuities, the model would break down completely as the MWRs would be quite low. Essentially, I would need a more sophisticated pricing model to truly perform the same analysis. My guess is that, while the returns would be lower for all zero-coupon annuities, they would only be slightly lower at shorter durations and much, much lower at longer durations. Frankly, it all comes back to inflation risk. You can't really escape its effects. You can either bear it, or pay a significant premium for someone else to. That isn't to say that real annuities would not be worth purchasing. They still might be, despite the premium paid.
Last edited by GoWithTheCashFlow on Thu Jan 30, 2025 11:19 pm, edited 1 time in total.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by RyeBourbon »

GoWithTheCashFlow wrote: Thu Jan 30, 2025 9:31 pm
RyeBourbon wrote: Thu Jan 30, 2025 5:35 pm Maybe I misunderstand, but the retired risk-averse person isn't getting this return from an annuity; for the DIA to be competitive, they have to find an investment that provides this return to fund the first ten years, and I don't think they're going to find a low-risk investment that does it. Or perhaps, does this mean that the SPIA option implies a 6.38% return? Is that a CAGR or IRR? Can one compare them?
The SPIA option implies a 6.38% return over the first 10 years when compared to the alternative of purchasing a DIA with a 10 year deferral. It is the IRR from an initial outlay of $57,491.72 followed by 119 monthly payments of $647.89.
Thanks. I guess I wasn't sure what blimp was getting at.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by StillGoing »

That is an interesting approach to answering the question, 'to defer or not to defer'

There are a number of possible approaches (some of which you have looked at)
1) Nominal SPIA plus residual portfolio
2) DIA with residual portfolio to supply income in deferral period
3) DIA with TIPS ladder to provide income in deferral period
4) Delayed SPIA with TIPS ladder to provide income in delay period

Although I was particularly interested in looking at providing an inflation protected income floor I found that (extract from abstract at https://papers.ssrn.com/sol3/papers.cfm ... id=4957553)
In this paper, a combination of an inflation protected bond (e.g., TIPS) ladder with a deferred or delayed nominal annuity purchase are compared with those from a TIPS ladder (without annuity) and a conventional stock and bond portfolio for a 35 year retirement starting at 65 years old. The approach that was the most robust was strongly dependent on TIPS yields. For yields above approximately 2.1%, the TIPS ladder provided the most robust solution (although there was an element of reinvestment risk), for TIPS yields of about 1.5% to 2.1%, a combination of a TIPS ladder and a delayed annuity was most robust, while for TIPS yields below about 1.5%, a TIPS ladder and deferred annuity provided the best, although relatively poor, solution.
Since the subject of real annuities has been raised, here in the UK we are lucky enough to still have access to RPI protected annuities. If interested, you can find payout rates at https://www.williamburrows.com/calculat ... ty-tables/, but to provide some example numbers, a single life annuity taken at 65yo currently pays out 7.2% for level payouts and 4.7% for RPI protection. Joint life (100% survivor benefits, same age annuitants) at 65yo pay 6.4% (level) and 4.0% (RPI). Since the UK 30-year historical 'safe' withdrawal rate is about 3.0-3.5%, such annuities represent an excellent adjunct/alternative to withdrawals from a portfolio of stocks and bonds but are still not popular (e.g., see full dataset linked at https://www.fca.org.uk/data/retirement- ... ta-2023-24). However, there are discussions on UK message boards on whether RPI annuities are really 'better' than level (of course, a priori, it is impossible to tell since the answer is 'it depends')

I note that inflation-linked gilts (the UK equivalent of TIPS) go out to maturities of 48 years which means the insurance company can match liabilities for virtually all annuitants (certainly those at 55yo and up), which may partially explain why inflation protected annuities are not offered in the US (although the same limit is true for nominal treasuries, although some corporates have longer maturities). In passing, I also note that, AFAIK, deferred annuities (of any flavour) are not available in the UK.

cheers
StillGoing
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

StillGoing wrote: Fri Jan 31, 2025 4:19 am If interested, you can find payout rates at https://www.williamburrows.com/calculat ... ty-tables/, but to provide some example numbers, a single life annuity taken at 65yo currently pays out 7.2% for level payouts and 4.7% for RPI protection. Joint life (100% survivor benefits, same age annuitants) at 65yo pay 6.4% (level) and 4.0% (RPI).
~2.5% initial hit for lifetime inflation protection sounds like a fantastic deal.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

ScubaHogg wrote: Fri Jan 31, 2025 6:24 am
StillGoing wrote: Fri Jan 31, 2025 4:19 am If interested, you can find payout rates at https://www.williamburrows.com/calculat ... ty-tables/, but to provide some example numbers, a single life annuity taken at 65yo currently pays out 7.2% for level payouts and 4.7% for RPI protection. Joint life (100% survivor benefits, same age annuitants) at 65yo pay 6.4% (level) and 4.0% (RPI).
~2.5% initial hit for lifetime inflation protection sounds like a fantastic deal.
I see it as a 35% reduction in initial payment. 4.7%/7.2% = .65

Personally, I'd rather have more money to spend in the early years of my retirement. I don't think I'll be travelling much or buying new cars when I'm 90. But that's just me, YMMV.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

GaryA505 wrote: Fri Jan 31, 2025 8:31 am
ScubaHogg wrote: Fri Jan 31, 2025 6:24 am

~2.5% initial hit for lifetime inflation protection sounds like a fantastic deal.
I see it as a 35% reduction in initial payment. 4.7%/7.2% = .65

Personally, I'd rather have more money to spend in the early years of my retirement. I don't think I'll be travelling much or buying new cars when I'm 90. But that's just me, YMMV.
I meant 2.5 percentage points

As for me, I’m interested in annuitizing a floor that I never want to go below. I can’t do that with nominal products without making unrealistic assumptions
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

ScubaHogg wrote: Thu Jan 30, 2025 10:39 am
GaryA505 wrote: Thu Jan 30, 2025 9:54 am I think when inflation-protected (real) annuities were offered, they didn't sell very well so the companies stopped offering them. I think one of the things that killed sales was that with the inflation-protected SPIA the starting payments are significantly reduced. Insurance companies are in business to make money, so if there was demand there would likely be supply.
Yes, apparently they didn’t work before. Doesn’t mean they will never work under any circumstances. People love SS and inflation adjusted pensions

Sometimes I think that they failed because it had been so long since the US had experienced inflation people just didn’t see the value. Even now on this board people cannot wrap their heads around the idea that inflation can be much worse than 2022-present
Personally, I feel that since spending tends to drop with age, not all sources of income need to be inflation-protected. For example, if 50% of income was from SS, 25% from a flat (not inflation-protected) SPIA, and 25% from cap gains on equities, I think that's good enough.
If you want to be protected against fatter tails in inflation, this only works if you are happy watching 25% of your spending go poof

At the end of the day there’s really no reason anything anywhere should be in nominal dollars other than ease of accounting.
At the end of the day, spending in retirement is not a uniform sequence of predictable real liabilities, and CPI-U is a mismatch to the inflation rate experienced by retirees.

And having 25% of assets in nominal fixed income does not imply that 25% of assets "go poof" in inflation. That would be a hyperinflation scenario. If we had 25% inflation, a 25% allocation to a nominal SPIA would contribute to about a 6% loss of overall spending power, and having 25% in stocks likely would offset some or all of that.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

Northern Flicker wrote: Fri Jan 31, 2025 1:26 pm That would be a hyperinflation scenario.
I don’t know what it is about this board that people can only conceive of very predictably mild inflation or hyperinflation. There’s galaxies of difference between the two and one doesn’t need to be anywhere near hyperinflation for the pain to set in. We went through this over and over on the asymmetric risk thread

10% inflation, which wouldn’t even be a blip on worldwide inflationary experiences over the past century, would virtually annihilate that 25% dedicated to a SPIA in 20 years.

Well, there are much simpler ways to spend all my money in 20 years. So if you think of a nominal SPIA as “longevity insurance” the more correct answer is “longevity insurance so long as scary inflation doesn’t pop up”

Interestingly once on the board I asked Wade Pfau about insurers selling real SPIAs again. He said they just couldn’t take on the risk. It’s pretty telling that the folks who specialize in selling nominal SPIAs claim that real SPIAs are too risky. I wonder what risk they are talking about…
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

Northern Flicker wrote: Fri Jan 31, 2025 1:26 pm …and CPI-U is a mismatch to the inflation rate experienced by retirees.
In a scary inflation environment one’s spending growth will much more highly correlate with CPI-U than with whatever other ex ante growth plan was conceived of
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

ScubaHogg wrote: Fri Jan 31, 2025 1:52 pm
Northern Flicker wrote: Fri Jan 31, 2025 1:26 pm …and CPI-U is a mismatch to the inflation rate experienced by retirees.
In a scary inflation environment one’s spending growth will much more highly correlate with CPI-U than with whatever other ex ante growth plan was conceived of
Here's a scary environment-- net deflation but health care, assisted living, memory care, and skilled nursing care continue to inflate.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

Northern Flicker wrote: Fri Jan 31, 2025 3:33 pm Here's a scary environment-- net deflation but health care, assisted living, memory care, and skilled nursing care continue to inflate.
Well yeah? But the chances of that are approximately zero
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

ScubaHogg wrote: Fri Jan 31, 2025 3:37 pm
Northern Flicker wrote: Fri Jan 31, 2025 3:33 pm Here's a scary environment-- net deflation but health care, assisted living, memory care, and skilled nursing care continue to inflate.
Well yeah? But the chances of that are approximately zero
Certainly very low inflation and health care costs inflating at a higher rate already has happened this century. Currently, there is a shortage of providers for health care, assisted living, memory care, and skilled nursing care, and housing is just over a 1/3 of CPI-U, so a major drop in housing cost and robust increases in the cost of health care, assisted living, memory care, and skilled nursing care certainly is possible. We would not have to have actual deflation for a significant deviation in outcomes for them to occur.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by StillGoing »

GaryA505 wrote: Fri Jan 31, 2025 8:31 am
ScubaHogg wrote: Fri Jan 31, 2025 6:24 am

~2.5% initial hit for lifetime inflation protection sounds like a fantastic deal.
I see it as a 35% reduction in initial payment. 4.7%/7.2% = .65

Personally, I'd rather have more money to spend in the early years of my retirement. I don't think I'll be travelling much or buying new cars when I'm 90. But that's just me, YMMV.
I'd agree that a level SPIA will potentially provide more income in the early years than either a RPI annuity (where available) or TIPS ladder (in the US). I note that since 1947, the cumulative CPI-U (expressed as a percentage) for different rolling periods in the US has been

Code: Select all

	5yr	10yr	15yr
Min	3.9	13.3	24.2
10th	6.9	18.3	32.4
Median	13.8	30.2	51.8
75th	22.8	53.1	111.6
90th	43.4	95.5	170.7
Max	61.6	133.3	191.9
In other words, if the initial inflation protected income was about 65% of the level income then the instantaneous real income stream would have exceeded that of the nominal one after 5 years in less than 10% of historical periods, in about 25% of cases after 10 years and about 50% of cases after 15 years. The 'breakeven' points will be different for a different initial ratio of real to nominal income.

Of course, future inflation is unknown.

To stay at least vaguely on topic, during the period of deferral inflation will act equally on the income of an SPIA and the deferred income of the DIA. The main difference between them is what happens to whatever is being used to provide income during the deferral period in the DIA case.

cheers
StillGoing
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Leesbro63 »

I read this post and the original one and it's still not exactly clear to me what this is about. I admit it...I don't get it! Maybe someone can summarize, without graphs and bells and whistles, what this is about. I thought a deferred income annuity was you buy now and annuitize to get the income later. But that doesn't seen to be what this is about. Thanks in advance for indulging my non-understanding of this.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

StillGoing wrote: Sat Feb 01, 2025 3:55 am
GaryA505 wrote: Fri Jan 31, 2025 8:31 am

I see it as a 35% reduction in initial payment. 4.7%/7.2% = .65

Personally, I'd rather have more money to spend in the early years of my retirement. I don't think I'll be travelling much or buying new cars when I'm 90. But that's just me, YMMV.
I'd agree that a level SPIA will potentially provide more income in the early years than either a RPI annuity (where available) or TIPS ladder (in the US). I note that since 1947, the cumulative CPI-U (expressed as a percentage) for different rolling periods in the US has been

Code: Select all

	5yr	10yr	15yr
Min	3.9	13.3	24.2
10th	6.9	18.3	32.4
Median	13.8	30.2	51.8
75th	22.8	53.1	111.6
90th	43.4	95.5	170.7
Max	61.6	133.3	191.9
In other words, if the initial inflation protected income was about 65% of the level income then the instantaneous real income stream would have exceeded that of the nominal one after 5 years in less than 10% of historical periods, in about 25% of cases after 10 years and about 50% of cases after 15 years. The 'breakeven' points will be different for a different initial ratio of real to nominal income.

Of course, future inflation is unknown.

To stay at least vaguely on topic, during the period of deferral inflation will act equally on the income of an SPIA and the deferred income of the DIA. The main difference between them is what happens to whatever is being used to provide income during the deferral period in the DIA case.

cheers
StillGoing
I'm good with that, thanks for the numbers. I plan to ladder in SPIAs at age 75-80 so I'm ok with that.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by hudson »

Leesbro63 wrote: Sat Feb 01, 2025 10:00 am Maybe someone can summarize, without graphs and bells and whistles, what this is about.
Please...short summary...thanks!
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

Leesbro63 wrote: Sat Feb 01, 2025 10:00 am I read this post and the original one and it's still not exactly clear to me what this is about. I admit it...I don't get it! Maybe someone can summarize, without graphs and bells and whistles, what this is about. I thought a deferred income annuity was you buy now and annuitize to get the income later. But that doesn't seen to be what this is about. Thanks in advance for indulging my non-understanding of this.
My view of the tradeoffs of buying a DIA now vs SPIA later (with the same start of payout) are as follows.

The DIA locks in the rate based on today's interest rate climate. The problem of matching the duration of assets to the duration of the liability is handed off to the insurer. With a future planned SPIA purchase, the annuitant takes the risk of interest rates falling, increasing the premium, unless the duration of the assets earmarked for the SPIA is matched to the duration of the annuity liability. By handing that off to the insurer with a DIA, the annuitant does not have to manage the portfolio for those assets.

Life expectancy increases with attained age. The DIA purchase thus has to fund fewer years to reach the age of life expectancy, beyond which the actuarial pool covers the liability. This lowers the cost, all else equal. The DIA annuitant also has less information about health outcomes with the earlier purchase, so the insurer does not have to price in as much for self-selection based on health status, lowering the cost vs a delayed SPIA purchase. But the annuitant can consider the health outcome with a delayed SPIA purchase.

The DIA annuitant may pay a higher de facto expense ratio as an admin fee built into the premium to manage the assets during the deferral period in comparison to self-administering a bond portfolio until a SPIA is purchased.

The insurer absorbs any credit and/or optionality risk of the bond portfolio used during the deferral period with the DIA vs the annuitant taking any such risks if delaying a SPIA purchase instead. It treasuries are used to eliminate these risks, return may be lower than the de facto return during the DIA deferral.

DIAs with a very long duration may be too long in duration for the insurer to match the liability with available bonds. These may be more expensive if the insurer overprices the risk to be safe from underpricing it.

There are QLAC DIAs that can defer some RMDs from a trad IRA.
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GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

Leesbro63 wrote: Sat Feb 01, 2025 10:00 am I thought a deferred income annuity was you buy now and annuitize to get the income later. But that doesn't seen to be what this is about.
You might be confusing deferred income annuities (DIAs) with accumulation annuities such as variable or fixed index annuities. Like with a SPIA, with a DIA you have no access or control over the funds used to purchase the annuity. When you die, nothing is left to your heirs (unless the refund on death option is selected). Unlike a SPIA, the payments don't begin in the first year. Instead, you defer payments until a date which is specified at the time of purchase.

hudson wrote: Sat Feb 01, 2025 11:51 am
Leesbro63 wrote: Sat Feb 01, 2025 10:00 am Maybe someone can summarize, without graphs and bells and whistles, what this is about.
Please...short summary...thanks!
I acknowledge I am not the best communicator. Here is my attempt at a summary.

DIAs are a more efficient means of providing longevity protection (i.e. lifetime income) than SPIAs. Instead of purchasing a SPIA to provide $1,000/month starting next month, you would be better off purchasing a DIA to provide $1,000 starting 20 years from now and using the money left over to invest and cover the 20 years until the payments from the DIA begins. This is unequivocally true if the annuities are inflation adjusted and fairly priced*. Let's say you have a 99% chance of being alive one year from now, but only a 50% chance of being alive 20 years from now. To insure your spending next year with an annuity would only cost 99% of what it costs to fund the spending yourself. However, to insure your spending 20 years from now with an annuity only costs 50% of what it costs to fund the spending yourself. Since you don't want to annuitize all of your wealth, you should get the most bang for your buck and insure the spending which is cheaper to insure first. This is done by purchasing a DIA. That was what the original thread was about.

For this thread, I tried to show that DIAs are better than SPIAs when they are fairly priced but no longer inflation adjusted. I provided evidence that, while inflation risk does increase with the investment horizon and this does diminish the case for DIAs over SPIAs, the case remains intact since the benefit of annuitization increases with the investment horizon faster than the inflation risk. However, it remains to be seen if this is still true after the "fairly priced" assumptions is relaxed.

Additionally, there has been much discussion about delaying vs deferring, but I think this is a distraction. It may be the case that SPIA later (delaying) is better than DIA now (deferring) for a particular situation. But, if that is the case, then DIA later (delaying and deferring) is better than SPIA later (delaying).


*By "fairly priced" I mean the insurance company receives no profit, has no expenses, and only invests the premiums in zero-coupon treasuries/TIPS, of which every maturity is available and carries no default risk.
Last edited by GoWithTheCashFlow on Sat Feb 01, 2025 6:25 pm, edited 2 times in total.
GaryA505
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

GoWithTheCashFlow, what about the case of a couple with a large age difference (let's say 25 years or so), how does that alter the math?
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

GaryA505 wrote: Sat Feb 01, 2025 3:45 pm GoWithTheCashFlow, what about the case of a couple with a large age difference (let's say 25 years or so), how does that alter the math?
It essentially turns it into an individual annuity for the younger person. The couple would likely delay annuitization until the older one has passed, at which point the survivor would assess their situation the same as any other individual.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by ScubaHogg »

hudson wrote: Sat Feb 01, 2025 11:51 am
Leesbro63 wrote: Sat Feb 01, 2025 10:00 am Maybe someone can summarize, without graphs and bells and whistles, what this is about.
Please...short summary...thanks!
DIAs are more efficient than SPIAs I believe is the claim
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hudson
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by hudson »

GoWithTheCashFlow wrote: Sat Feb 01, 2025 3:33 pm
Leesbro63 wrote: Sat Feb 01, 2025 10:00 am I thought a deferred income annuity was you buy now and annuitize to get the income later. But that doesn't seen to be what this is about.
You might be confusing deferred income annuities (DIAs) with accumulation annuities such as variable or fixed index annuities. Like with a SPIA, with a DIA you have no access or control over the funds used to purchase the annuity. When you die, nothing is left to your heirs (unless the refund on death option is selected). Unlike a SPIA, the payments don't begin in the first year. Instead, you defer payments until a date which is specified at the time of purchase.

hudson wrote: Sat Feb 01, 2025 11:51 am

Please...short summary...thanks!
I acknowledge I am not the best communicator. Here is my attempt at a summary.

DIAs are a more efficient means of providing longevity protection (i.e. lifetime income) than SPIAs. Instead of purchasing a SPIA to provide $1,000/month starting next month, you would be better off purchasing a DIA to provide $1,000 starting 20 years from now and using the money left over to invest and cover the 20 years until the payments from the DIA begins. This is unequivocally true if the annuities are inflation adjusted and fairly priced*. Let's say you have a 99% chance of being alive one year from now, but only a 50% chance of being alive 20 years from now. To insure your spending next year with an annuity would only cost 99% of what it costs to fund the spending yourself. However, to insure your spending 20 years from now with an annuity only costs 50% of what it costs to fund the spending yourself. Since you don't want to annuitize all of your wealth, you should get the most bang for your buck and insure the spending which is cheaper to insure first. This is done by purchasing a DIA. That was what the original thread was about.

For this thread, I tried to show that DIAs are better than SPIAs when they are fairly priced but no longer inflation adjusted. I provided evidence that, while inflation risk does increase with the investment horizon and this does diminish the case for DIAs over SPIAs, the case remains intact since the benefit of annuitization increases with the investment horizon faster than the inflation risk. However, it remains to be seen if this is still true after the "fairly priced" assumptions is relaxed.

Additionally, there has been much discussion about delaying vs deferring, but I think this is a distraction. It may be the case that SPIA later (delaying) is better than DIA now (deferring) for a particular situation. But, if that is the case, then DIA later (delaying and deferring) is better than SPIA later (delaying).


*By "fairly priced" I mean the insurance company receives no profit, has no expenses, and only invests the premiums in zero-coupon treasuries/TIPS, of which every maturity is available and carries no default risk.
Thanks! I'm not looking for the argument for a DIA. I'm not sure what exactly a DIA is. I don't see a DIA or a Deferred Income Annuity in the WIKI.
I know what a SPIA is. I know where to get a quote for a SPIA. A SPIA can be a good fit for some.
What is a DIA? Short and sweet...as possible.
Where do I get a quote?
GaryA505
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

hudson wrote: Sat Feb 01, 2025 7:25 pm
GoWithTheCashFlow wrote: Sat Feb 01, 2025 3:33 pm

You might be confusing deferred income annuities (DIAs) with accumulation annuities such as variable or fixed index annuities. Like with a SPIA, with a DIA you have no access or control over the funds used to purchase the annuity. When you die, nothing is left to your heirs (unless the refund on death option is selected). Unlike a SPIA, the payments don't begin in the first year. Instead, you defer payments until a date which is specified at the time of purchase.




I acknowledge I am not the best communicator. Here is my attempt at a summary.

DIAs are a more efficient means of providing longevity protection (i.e. lifetime income) than SPIAs. Instead of purchasing a SPIA to provide $1,000/month starting next month, you would be better off purchasing a DIA to provide $1,000 starting 20 years from now and using the money left over to invest and cover the 20 years until the payments from the DIA begins. This is unequivocally true if the annuities are inflation adjusted and fairly priced*. Let's say you have a 99% chance of being alive one year from now, but only a 50% chance of being alive 20 years from now. To insure your spending next year with an annuity would only cost 99% of what it costs to fund the spending yourself. However, to insure your spending 20 years from now with an annuity only costs 50% of what it costs to fund the spending yourself. Since you don't want to annuitize all of your wealth, you should get the most bang for your buck and insure the spending which is cheaper to insure first. This is done by purchasing a DIA. That was what the original thread was about.

For this thread, I tried to show that DIAs are better than SPIAs when they are fairly priced but no longer inflation adjusted. I provided evidence that, while inflation risk does increase with the investment horizon and this does diminish the case for DIAs over SPIAs, the case remains intact since the benefit of annuitization increases with the investment horizon faster than the inflation risk. However, it remains to be seen if this is still true after the "fairly priced" assumptions is relaxed.

Additionally, there has been much discussion about delaying vs deferring, but I think this is a distraction. It may be the case that SPIA later (delaying) is better than DIA now (deferring) for a particular situation. But, if that is the case, then DIA later (delaying and deferring) is better than SPIA later (delaying).


*By "fairly priced" I mean the insurance company receives no profit, has no expenses, and only invests the premiums in zero-coupon treasuries/TIPS, of which every maturity is available and carries no default risk.
Thanks! I'm not looking for the argument for a DIA. I'm not sure what exactly a DIA is. I don't see a DIA or a Deferred Income Annuity in the WIKI.
I know what a SPIA is. I know where to get a quote for a SPIA. A SPIA can be a good fit for some.
What is a DIA? Short and sweet...as possible.
Where do I get a quote?
With a SPIA, you start income 1 to 13 months from the date of purchase.

With a DIA, you start income more than 13 months from the date of purchase. Since you are deferring the start of income, the payments are higher than for a SPIA.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
Topic Author
GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

hudson wrote: Sat Feb 01, 2025 7:25 pm Thanks! I'm not looking for the argument for a DIA. I'm not sure what exactly a DIA is. I don't see a DIA or a Deferred Income Annuity in the WIKI.
I know what a SPIA is. I know where to get a quote for a SPIA. A SPIA can be a good fit for some.
What is a DIA? Short and sweet...as possible.
Where do I get a quote?
Stan the Annuity Man is a great resource for understanding all kinds of annuities:

https://www.stantheannuityman.com/annuity-types/dia


For quotes:

https://www.stantheannuityman.com/annui ... lators/dia

Or

https://www.immediateannuities.com/

Or

https://www.blueprintincome.com/income- ... /longevity
iim7V7IM7
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by iim7V7IM7 »

There is a cost to financial flexibility…

DIAs are indeed more efficient than SPIAs. But looking across a lengthy retirement horizon, it is difficult to know what will actually happen. For us, I see insurance contracts as an important part of our essential expense income floor in the future when inflation associated with these expenses outstrips the income from our Social Security and nominal company pension benefits. Today, out projections sees this happening in our late 70s and again in our 80s. We could buy DIAs or QLACs at retirement, but many things can change across 10-15 year horizon.

For us, the less efficient option of SPIAs allows for flexibility is preferred. What we are doing is projecting income short falls using a very conservative Social Security COLA and a higher personal inflation rate for essential expenses (influenced by healthcare costs) to estimate when and how much income we might need later in retirement. We then price SPIAs for a couple of that age using today’s prices to see how much money one needs to buys a contract from a A++ insurance company today. We then look at the time from retirement to when we think we will need to purchase a SPIA in the future and determine a PV of funds today using a conservative 3% discount rate. We keep these funds conservatively invested in an equity/fixed income portfolio for that horizon.

This is far less efficient than simply buying a DIA at retirement, but it provides flexibility. Health can change. One or both of us can die etc. We could decide not to buy a SPIA at that time. The invested assets may have greatly outstripped our targets across that time period. Flexibility has its cost, but also some benefits to consider when deciding to buy contractual income as part of a retirement income plan.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by hudson »

GoWithTheCashFlow wrote: Sat Feb 01, 2025 7:50 pm
hudson wrote: Sat Feb 01, 2025 7:25 pm Thanks! I'm not looking for the argument for a DIA. I'm not sure what exactly a DIA is. I don't see a DIA or a Deferred Income Annuity in the WIKI.
I know what a SPIA is. I know where to get a quote for a SPIA. A SPIA can be a good fit for some.
What is a DIA? Short and sweet...as possible.
Where do I get a quote?
Stan the Annuity Man is a great resource for understanding all kinds of annuities:

https://www.stantheannuityman.com/annuity-types/dia


For quotes:

https://www.stantheannuityman.com/annui ... lators/dia

Or

https://www.immediateannuities.com/

Or

https://www.blueprintincome.com/income- ... /longevity
Thanks GoWithTheCashFlow!
So a DIA is not one of those steal-your-money type ugly annuities that Larry Swedroe talked about in his 2008 book.
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viewtopic.php?p=23364#p23364

In a DIA, (A fixed annuity) One pays say $300K and say 10 years later, the monthly payments start.
It's just a deferred version of the SPIA; so for some, it's an OK investment.

Would I buy a SPIA or a DIA? Probably not?
Why? I wouldn't want to lose control of those dollars. I'd rather just draw down and take my chances.
I sure am glad SPIAs and DIAs exist; I might change my mind and go for it. Of course I'd stay under my state guarantee association's limits.
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GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

A DIA is more flexible than a SPIA because of the smaller financial commitment to annuitization. At a particular point in time, delaying and then purchasing a SPIA may be more flexible than a DIA, but delaying and purchasing a DIA is more flexible still. The first moment the benefits of an annuitization strategy outweighs the costs of its inflexibility, it will be a strategy involving the purchase of a DIA. At that same moment, the benefits of a SPIA will not outweigh the cost of its greater inflexibility. Similarly, if the benefits of a SPIA outweigh the costs of its inflexibility, the benefits of a DIA, relative to its costs, will be greater still.

One note about holding assets for a planned annuity purchase. You want the duration of the assets you're holding to match the duration of the annuity itself and not the horizon of the planned purchase date. In other words, if you plan to make an annuity purchase 10 years from now, the duration of your assets held for that purpose should not be 10 years, but something longer than that. Otherwise, you would unnecessarily be taking on reinvestment risk.
Last edited by GoWithTheCashFlow on Sun Feb 02, 2025 12:55 pm, edited 2 times in total.
GaryA505
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GaryA505 »

iim7V7IM7 wrote: Sun Feb 02, 2025 7:01 am There is a cost to financial flexibility…

DIAs are indeed more efficient than SPIAs. But looking across a lengthy retirement horizon, it is difficult to know what will actually happen. For us, I see insurance contracts as an important part of our essential expense income floor in the future when inflation associated with these expenses outstrips the income from our Social Security and nominal company pension benefits. Today, out projections sees this happening in our late 70s and again in our 80s. We could buy DIAs or QLACs at retirement, but many things can change across 10-15 year horizon.

For us, the less efficient option of SPIAs allows for flexibility is preferred. What we are doing is projecting income short falls using a very conservative Social Security COLA and a higher personal inflation rate for essential expenses (influenced by healthcare costs) to estimate when and how much income we might need later in retirement. We then price SPIAs for a couple of that age using today’s prices to see how much money one needs to buys a contract from a A++ insurance company today. We then look at the time from retirement to when we think we will need to purchase a SPIA in the future and determine a PV of funds today using a conservative 3% discount rate. We keep these funds conservatively invested in an equity/fixed income portfolio for that horizon.

This is far less efficient than simply buying a DIA at retirement, but it provides flexibility. Health can change. One or both of us can die etc. We could decide not to buy a SPIA at that time. The invested assets may have greatly outstripped our targets across that time period. Flexibility has its cost, but also some benefits to consider when deciding to buy contractual income as part of a retirement income plan.
This is precisely my thinking. I can't give up the flexibility now, so will wait. I'll admit that my situation is very unusual due to getting married in my 50's, and having 2 kids still in high school. I suspect I will need a LOT of flexibility.

There are situations where spending needs can be predicted fairly well, where a DIA could be useful in providing predictable income. Still, health can change and people can die, so there's that. One way to deal with the mortality issue is to get a DIA or SPIA with a partial percentage payout if one partner passes. These can usually be set up for 70% or 50%, and when doing so the initial payment (when both are alive) is higher. If you run some numbers on blueprintincome.com you can see the affect of that.
Get most of it right and don't make any big mistakes. All else being equal, simpler is better. Simple is as simple does.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

There also are planning considerations. If all one wants is longevity insurance, a DIA provides that. Using a SPIA provides both longevity insurance and current income.

If trying to implement an income floor, a SPIA is easier to implement. As an example of what is proposed by the OP, one could implement an income floor by purchasing a DIA with payout to start in N years, and put the savings over buying a SPIA into a TIPS ladder to cover the N years not covered by the DIA.
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by bertilak »

Northern Flicker wrote: Sat Feb 01, 2025 2:52 pm
Leesbro63 wrote: Sat Feb 01, 2025 10:00 am I read this post and the original one and it's still not exactly clear to me what this is about. I admit it...I don't get it! Maybe someone can summarize, without graphs and bells and whistles, what this is about. I thought a deferred income annuity was you buy now and annuitize to get the income later. But that doesn't seen to be what this is about. Thanks in advance for indulging my non-understanding of this.
My view of the tradeoffs of buying a DIA now vs SPIA later (with the same start of payout) are as follows.
...
I bought a DIA because I didn't need the income at the time but was planning for the future, so a deferral was possible.

With a DIA my planning was based on known numbers. Waiting to buy an SPIA at the time the income was needed, I was subject to market fluctuations between current and future market realities. With a DIA my planning did not need to take into account the uncertainty of those fluctuations.

A DIA made my planning less uncertain. I could say to myself "Yes, I've got cost and return nailed down."
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by Northern Flicker »

GoWithTheCashFlow wrote: Sun Feb 02, 2025 7:52 am
One note about holding assets for a planned annuity purchase. You want the duration of the assets you're holding to match the duration of the annuity itself and not the horizon of the planned purchase date. In other words, if you plan to make an annuity purchase 10 years from now, the duration of your assets held for that purpose should not be 10 years, but something longer than that. Otherwise, you would unnecessarily be taking on reinvestment risk.
It needs to incorporate both into the match. A SPIA has some duration at the time of purchase. If you will purchase it in the future, the delay increases the duration that needs to be matched.

If at some age A, one has N years until reaching the conditional age of life expectancy (conditioned on having attained age A), then I think (N+1)/2 is a reasonable estimate for the required asset duration. This is because the SPIA is funded out to the age of life expectancy, with subsequent years funded from the actuarial pool, and the annuitant delaying the SPIA purchase is funding the years leading up to the SPIA purchase.

The management of the asset is complicated by the fact that conditional life expectancy increases as attained age increases as a conditioning event. The DIA addresses that, and the benefit for the annuitant should be more than just ease of administration (handing portfolio management for that asset off to the insurer). The DIA premium should be set based on life expectancy at time of purchase, so the DIA will fund any creep up in life expectancy from the actuarial pool. This generates some extra mortality credits for the DIA return.
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GoWithTheCashFlow
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Re: No, really. Deferred income annuities (DIAs) are superior to SPIAs in every way.

Post by GoWithTheCashFlow »

Northern Flicker wrote: Sun Feb 02, 2025 6:01 pm It needs to incorporate both into the match. A SPIA has some duration at the time of purchase. If you will purchase it in the future, the delay increases the duration that needs to be matched.

If at some age A, one has N years until reaching the conditional age of life expectancy (conditioned on having attained age A),
Of course. I didn't mean to imply otherwise. When I said the assets need to match the duration of the annuity, I wasn't talking about an annuity purchased today. I meant it needs to match the duration of the expected, conditional on surviving to the purchase date, cash flows of the anticipated annuity. If the anticipated purchase date is 10 years from now, then the first cash flow to be to matched must be at least 10+ years from now. That's all I was getting at.
Northern Flicker wrote: Sun Feb 02, 2025 6:01 pm The management of the asset is complicated by the fact that conditional life expectancy increases as attained age increases as a conditioning event. The DIA addresses that, and the benefit for the annuitant should be more than just ease of administration (handing portfolio management for that asset off to the insurer). The DIA premium should be set based on life expectancy at time of purchase, so the DIA will fund any creep up in life expectancy from the actuarial pool. This generates some extra mortality credits for the DIA return.
I like your mental model. My mental model (bundles of zero-coupon annuities) is a little different, but I'm trying to incorporate yours into my thinking more and more.
Northern Flicker wrote: Sun Feb 02, 2025 1:45 pm There also are planning considerations. If all one wants is longevity insurance, a DIA provides that. Using a SPIA provides both longevity insurance and current income.

If trying to implement an income floor, a SPIA is easier to implement.
It may be perfectly reasonable to pay an insurance company to manage one's assets for current income, just like it may be perfectly reasonable to pay an advisor to manage one's assets. As long as one understands that is what is happening, then who am I to say they shouldn't? I'm just trying to make the case that it is indeed what is happening when a SPIA is purchased. It is also fair to point out that the amount you would pay is likely small when the deferral period is relatively short (10 years or less). Of course, it makes more sense to use an FIA with an income rider in those cases anyway.
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