Rates on Annuities

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bluestar
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Rates on Annuities

Post by bluestar »

Patrick posted a nice table recently that shows annuity rate examples by type and age. http://www.principal.com/retirement/inc ... income.htm

When to purchase a SPIA seems to be a large timing decision- not only at what age but what the rates are at the time as well. Does anyone have an data showing historic sample rates as shown in the chart? Do the rates track treasuries very closely? Would there be an annuity curve for the age taken that changes slope based on interest rates/market conditions?

For those that have purchased a SPIA, were the current rates offered a factor in the timing decision?
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bob90245
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Re: Rates on Annuities

Post by bob90245 »

bluestar wrote:Do the rates track treasuries very closely?
This chart uses corporate bonds instead of treasuries.

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Taylor Larimore
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Why it usually pays to wait before buying life annuities.

Post by Taylor Larimore »

bluestar wrote:Patrick posted a nice table recently that shows annuity rate examples by type and age. http://www.principal.com/retirement/inc ... income.htm

When to purchase a SPIA seems to be a large timing decision- not only at what age but what the rates are at the time as well. Does anyone have an data showing historic sample rates as shown in the chart? Do the rates track treasuries very closely? Would there be an annuity curve for the age taken that changes slope based on interest rates/market conditions?

For those that have purchased a SPIA, were the current rates offered a factor in the timing decision?
Hi Bluestar:

We own two SPIAs purchased about the time we turned 80. Yes, I considered current rates and many other factors. I once had a license to sell annuities and have been studying them for years. I have always been intrigued by the fact that they provide the largest guaranteed lifetime income. They eliminate the real risk of running out of money in retirement.

We waited until age 80 to purchase our two SPIAs for these reasons:

* Less inflation risk (I felt it was no longer necessary to purchase an expensive inflation rider).

* Less risk of company failure.

* We avoided wasted premiums if we died before age 80.

* We avoided wasted premiums if ill health reduced our life expectancy (annuities are best for those in good health).

* At age 80, most of the company's income comes from those who die early, not company investments. Therefore, current interest rates (your question) are less significant when buying at older age.

You can read more in this study by Milevsky and Young:

Optimal Asset Allocation and
The Real Option to Delay Annuitization


Best wishes
Taylor

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Re: Rates on Annuities

Post by yobria »

bluestar wrote:When to purchase a SPIA seems to be a large timing decision- not only at what age but what the rates are at the time as well.
And most importantly, health.
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Re: Why it usually pays to wait before buying life annuities

Post by ThePrune »

Taylor Larimore wrote:You can read more in this study by Milevsky and Young:
Optimal Asset Allocation and The Real Option to Delay Annuitization
Thanks for the reference. I always appreciate they way that Prof. Milevsky explains the qualitative truths with a simple example before diving into the deep end of the mathematical pool. This article has really given me some new ideas to factor into my own thinking about eventual annuitization.
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Milevsky on when to annuitize

Post by bobcat2 »

From Financial Education and Annuities by Jeffrey Brown
Of course, actuarially unfair pricing may not simply result in consumers deciding not to purchase an annuity at all: it may also lead consumers to delay annuitization. If prices are higher than actuarially fair levels, Milevsky and Young (2007) show that there may be advantages to delay. For example, it may be optimal to delay annuitization if returns on investment in the future might exceed current returns or if annuities purchased later in life are priced more favorably than those purchased earlier. Relatedly, they show that an "all-or-nothing" annuitization decision at a single point in time is sub-optimal, and that most consumers would be better off initially annuitizing a lump sum (if they do not already have this minimum level from pre-existing defined benefit pensions like Social Security) and then gradually purchasing additional life annuities over time.
Link to J. Brown paper.
http://www.oecd.org/dataoecd/38/0/44509379.pdf

From the conclusion section of paper, Annuitization and Asset Allocation by Milesvsky and Young. This is the final version of the paper Taylor Larimore cited earlier in this thread. Larimore is citing from an earlier preliminary version of the paper.
Thus, in contrast to the all-or-nothing pension structure, in the case of an open system where annuities can be purchased on an ongoing basis, we find that individuals prior to age 70 should have a minimal amount of annuity income and should immediately annuitize a fraction of wealth to create this base level of lifetime income if they do not already have this from pre-existing defined benefit pensions. We reiterate that individuals should always hold some annuities, even in the presence of a bequest motive, as long as z0(t) in Proposition 6.2 is less than infinity.
Link to paper - http://www.google.com/#hl=en&expIds=172 ... 155c57878e

All-or-nothing pension structure examples would be Social Security and most defined benefit pensions. An open system would be purchasing private life annuities (SPIAs).

Milevsky's advice boils down to doing some annuitization at retirement to help provide a floor of safe retirement income. But then continue to annuitize in steps during retirement. Milevsky in the paper shows that annuitizing over time in increments is a strategy that dominates one time annuitization, regardless of the one time picked. Furtheremore, if you are faced with an institutional all-or-nothing annuitization decision, i.e. Social Security and sometimes DB pensions, Milevsky and Young find that there is "an incentive to delay that is substantially valuable at younger ages.

BobK
Last edited by bobcat2 on Fri Jun 29, 2012 8:31 am, edited 1 time in total.
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Re: Rates on Annuities

Post by ThePrune »

bobcat2, I can't seem to get either of your article links to do anything other than taking me to the Google homepage. Am I forgetting to hold down some special key :?:
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sscritic
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Re: Rates on Annuities

Post by sscritic »

Try looking at the results (although it would have been nicer if BobK had given the direct links to the papers and not just links to searches for the papers).

http://www.oecd.org/dataoecd/38/0/44509379.pdf
http://www.ifid.ca/pdf_workingpapers/WP2003OCT15.pdf
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Dick Purcell
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Re: Rates on Annuities

Post by Dick Purcell »

Bob90245 --

Your graph is very informative for me -- and shatters my expectation. I would think that "return" of lifetime annuities would vary considerably less than current interest rate at time of purchase, expecting that the actuaries would anticipate some interest rate reversion toward the mean over the many years ahead.

Bob90245 and others --

Does it make sense to you that LIFETIME annuity payouts are so completely determined by interest rate at the SPECIFIC TIME of purchase??

Dick Purcell
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bob90245
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Re: Rates on Annuities

Post by bob90245 »

Dick Purcell wrote:Bob90245 and others --

Does it make sense to you that LIFETIME annuity payouts are so completely determined by interest rate at the SPECIFIC TIME of purchase??
I would say, it does make sense that current interest rates largely, but not completely, determines life annuity payouts. The poster "gw" made a very persuasive analysis how payouts are determined, which you can read in this thread from two years ago:

http://www.bogleheads.org/forum/viewtop ... 423#907423
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Re: Rates on Annuities

Post by Bongleur »

>This chart uses corporate bonds instead of treasuries.

This is the average yield of all AAA ? How does that correlate to what the insurance company actually buys?

How does the insurance company choose the duration of its portfolio?

Without prepayment risk, they should choose the longest bonds available, shouldn't they?

Otherwise the duration with the least prepayment risk?

Without knowing the company's strategy, how is that chart of any use?
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Dick Purcell
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Re: Rates on Annuities

Post by Dick Purcell »

Bob90245 –-

Major thanks for that rec and link to the earlier thread with gw’s annuity “return” pricing formulation. It has lots of good discussion, including gw’s formulation and a post from dpbsmith at the very bottom.

1. It seems to me gw’s formulation blows away my reasoning for expecting annuity payouts to vary less than interest rates, but supports my conclusion that they “should”. I think his formulation is based on the insurance company matching assets to liabilities, rejecting my implication that they “should” consider forecasts of future interest rates reverting toward some mean. BUT – in the gw formulation the major component of annuity “return” or payout is mortality (which does not vary with interest rate – heh heh). So as interest rates rise and fall, payouts of annuities purchased at various times “should” vary much less. This conflicts with the actual history shown in your graph. ???????

2. In that same earlier thread, way down at the bottom there’s a post from dpbsmith that I think is a must-read. It argues in favor of buying SPIA now, rather than delaying the purchase or spreading purchases over years. In too-brief summary, the argument is that every year’s payout includes a mortality component and every year of delay amounts to missing that year’s mortality component. But to understand the reasoning ya gotta read that dpbsmith post.

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Re: Rates on Annuities

Post by bobcat2 »

Hi Dick,

You wrote.
...there’s a post from dpbsmith that I think is a must-read. It argues in favor of buying SPIA now, rather than delaying the purchase or spreading purchases over years. In too-brief summary, the argument is that every year’s payout includes a mortality component and every year of delay amounts to missing that year’s mortality component.
That's true and it is a good argument for some annuitization at retirement. But there is also value in delaying some annuitization. Interest rates may rise substantially in the future or you may be diagnosed with terminal cancer in the next few years, and given those uncertainties it is better to spread out the annuity purchases. By spreading out annuity purchases over time and across different insurance providers you will minimize the risk of insurance company failure. In addition by spreading out annuity purchases over time you will have freed yourself from the burden of making a single, irrevocable lifetime decision. Finally, you will have retained flexibility in making your retirement investment decisions.

BobK
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Re: Rates on Annuities

Post by yobria »

Bongleur wrote:>This chart uses corporate bonds instead of treasuries.

This is the average yield of all AAA ? How does that correlate to what the insurance company actually buys?
I'd keep in mind it's no only a question of what they buy, but what they are. An insurance company can buy all treasuries, and still go bankrupt. So in that sense you are buying a corporate bond.

Nick
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Re: Rates on Annuities

Post by Dick Purcell »

Bob90245 –

a – HA! I note that in your graph, the two Y axes are not zero-based, and do not scale down to the same zero level. If you clicked your button for “redraw with common zero level,” your graph would show that proportionally, annuity payout rate varies less steeply than interest rate at time of purchase. This means that in general, low interest rate is best time to buy the SPIA, because low interest rate hurts SPIA payout rate less than it hurts prospects for money kept out of the SPIA.

BobK –

I sure agree with your counsel to spread SPIA purchase among purveyors. And I like agreeing with you.

But I disagree with delaying in anticipation that interest rate might rise -- disagree for the reason suggested just above to Bob90245. If interest rate rises, SPIA purchase becomes less favorable, because the opportunity for conservative investing outside SPIA gains favorability more than SPIA.

And your other arguments for delay seem to me to amount to “drive into the fog of future uncertainty” (which some call “risk” – but those people call everything that moves “risk”). This appears to me to conflict with the Bodie / BobK general advice to avoid the uncertainty that they call “risk.”

There’s also the argument of nailing the whole plan down while thinking about all these intricacies most clearly. For SOME of us, clarity of thinking about all this stuff may begin to decline as we age . . .

Dick Purcell
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Re: Rates on Annuities

Post by trico »

There are some annuities now that give you a guarantee of 8%. But you must be able to understand the contract. These are equity index annuities with a guarantee income rider. There has been a recent post discussing all the pros and cons about these new products, and the conclusion was they are approriate for some people. They are complicated but no so much as to not to look at them. Annuities are a bad subject on the boglehead forum, but can be a solution to some financial planning. As Warren Buffett has said he would not buy one, but Warren Buffett doesn't need to buy one. Its all on what your needs are, not what the financial community tells you what your needs are. An also remember annuities are sold and not bought, so buyer beware. Kind of like buying a new car.
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Re: Rates on Annuities

Post by jbaron »

I agree with Dick Purcell on this, that a low interest rate environment is the best time to purchase an SPIA.

I also noticed that in Bob90245's original graph, the Y axes do not scale to zero together. I'd also imagine that for different ages (70 instead of 65, for example), the axis mismatch is more pronounced.

What this says to me is that the SPIA payout is composed of a part that relates to mortality, and a part that relates to interest rates. As interest rates decrease to zero for example, the percentage of the payout that is based on mortality goes up, while the percentage of the payout that is based on interest rates goes down, making it easier to purchase the mortality part.

Our investments already have the "low interest rate" characteristic via our portfolios. The fixed income part of our portfolios are already producing at low rates - we are already taking that hit. Whether or not we take the interest rate risk by buying the annuity now, or holding bonds and then buying it later, the risk is, I'd imagine, fairly similiar. Ergo, it seems to me that the best time to puchase an annuity would be when you can purchase something that's as close to possible as pure mortality risk. That is, "I already made my money when interest rates declined precipitously over the past year" - now I am better off by taking that found money and investing it in an annuity."

I'm sorry that this isn't more clear, but the more I ponder it, the more it seems to make sense to me.

Jeff
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Re: Rates on Annuities

Post by bobcat2 »

When you buy a life annuity when interest rates are low you lock in that low payout for life. Conversely, when you buy a life annuity when interest rates are high you lock in that high payout for life. Neither of these conditions hold when you buy bonds.

You buy a life annuity from a highly rated insurance company. You buy another life annuity 8 years later. The first company is still in business but their credit rating is now lower. The second annuity is purchased from another insurance company that has a higher rating. By spreading the purchases over time you have lowered the risk of owning life annuities.

BobK
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Re: Rates on Annuities

Post by bob90245 »

bobcat2 wrote:When you buy a life annuity when interest rates are low you lock in that low payout for life. Conversely, when you buy a life annuity when interest rates are high you lock in that high payout for life. Neither of these conditions hold when you buy bonds.
But you can buy an individual bond of 30 year maturity and lock in the coupon.

But my criticism is that this is stage one thinking, i.e. simple and linear. Ask yourself, what would cause interest rates to rise in the first place? If you answer higher expected inflation, you would be correct.

But then what does this mean in dollars and cents? It means that higer inflation will cause your cost of living to go up. And I would imagine that any advantage of locking in a higher annuity payout will be largely eaten up by having to pay more for goods and services. So when all is said and done, it will likely be a wash.
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Re: Rates on Annuities

Post by trico »

You cannot purchase a long term bond that gives you a guaranteed 8% with no loss of principal.
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Re: Rates on Annuities

Post by bobcat2 »

But you can buy an individual bond of 30 year maturity and lock in the coupon.
But you are exposed to considerable reinvestment risk with a 30 year coupon bond. It's the total return you want to lock in - not the coupon. With the annuity the total return is locked in. Locking in the coupon is a so what.
But my criticism is that this is stage one thinking, i.e. simple and linear. Ask yourself, what would cause interest rates to rise in the first place? If you answer (sic) higher expected inflation, you would be correct.
Not necessarily. Real interest rates can change. I bought some 10 year TIPS several years ago with a real coupon of about 4.25%. Today real rates on 10 year TIPS are negative. That's a big swing in rates and has nothing to do with inflation.

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Re: Rates on Annuities

Post by bob90245 »

bobcat2 wrote:
But you can buy an individual bond of 30 year maturity and lock in the coupon.
But you are exposed to considerable reinvestment risk with a 30 year coupon bond. It's the total return you want to lock in - not the coupon. With the annuity the total return is locked in. Locking in the coupon is a so what.
So you are expecting this 60-ish, 70-ish person to live more than 30 years? :roll:
bobcat2 wrote:
But my criticism is that this is stage one thinking, i.e. simple and linear. Ask yourself, what would cause interest rates to rise in the first place? If you answer (sic) higher expected inflation, you would be correct.
Not necessarily. Real interest rates can change. I bought some 10 year TIPS several years ago with a real coupon of about 4.25%. Today real rates on 10 year TIPS are negative. That's a big swing in rates and has nothing to do with inflation.
And you're magically thinking investors will again be offered TIPS with a real coupon of 4.25? :shock: Or are you waiting for something extraordinary like a repeat of the 2008-2009 financial crisis that will cause real yields to jump? :(
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Reinvestment risk and real rates

Post by bobcat2 »

If you buy a 30 year nominal Treasury at 9% there is no guarantee that you will be reinvesting the coupons at anything like 9%. You may find that ten years after the auction interest rates are 4.5%, and thus your total return including reinvestment of the coupons will be considerably less than 9% over the 30 years. That's the nature of reinvestment risk. OTOH there is no reinvestment risk with a life annuity.

Real interest rates can move. In the summer of 2007 the yield on 10 year TIPS ranged from 2.3% to 2.8%. Recently the yield on 10 year TIPS has been as low as -0.3%. That's a swing of over 300 basis points. Current interest rates aren't low simply because of low expectations about inflation. Certainly that is big part of the reason, but it is also true that real interest rates are currently low by historical standards.

Irving Fisher pointed out over a hundred years ago that the interest on a nominal bond consists of two components- the expected rate of inflation and the real interest rate - and neither is a constant. A real bond, OTOH, consists of only the real rate. So while it is true that nominal bonds current low yields are partly due to low inflation expectations, they are also low because real interest rates are low.

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Re: Reinvestment risk and real rates

Post by Bongleur »

bobcat2 wrote:If you buy a 30 year nominal Treasury at 9% there is no guarantee that you will be reinvesting the coupons at anything like 9%. You may find that ten years after the auction interest rates are 4.5%, and thus your total return including reinvestment of the coupons will be considerably less than 9% over the 30 years. That's the nature of reinvestment risk. OTOH there is no reinvestment risk with a life annuity.
BobK
But you are not reinvesting the Treasury coupons -- you are spending them to live on. Otherwise you are not correctly comparing it to an Annuity.
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Re: Rates on Annuities

Post by sscritic »

Stop thinking about yourself. The insurance company is going to be paying you for 30 years. Now think of the investment they will make in order to match their liability to pay you a fixed amount for the next 30 years. Hey, how about a 30 year bond?

So yes, I think 30 year bond yields are matched to annuity payments that insurance companies make. The fact that those are the payments you receive is an artifact of what an annuity is. And it has nothing to do with whether you could reinvest the interest if you were to purchase a 30 year bond for yourself. You are not an insurance company; you can't pool yourself. You must realize this on some level, or you would not be buying an annuity.
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Re: Rates on Annuities

Post by trico »

As my annuity salesman told me, the insurance company has way more money pooled, so they can get a better deal on the bonds from Wall Street. So say a company cam buy 100 billion dollars of bonds, they can get a better deal than you and I. Also can you think about the use of leverage on that kind of money? WOW And they do use leverage and probably derivitives.
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bluestar
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Re: Rates on Annuities

Post by bluestar »

Thank you for the comments and bob90245 for the graph. I converted the annuity income into yield to allow all to be plotted on the same scale per the comments. I also added 30 year Treasury yield. It does paint a little different picture to me showing annuity rates have held up better than long-term Treasury yields in recent years.
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Re: Rates on Annuities

Post by yobria »

sscritic wrote:Stop thinking about yourself. The insurance company is going to be paying you for 30 years. Now think of the investment they will make in order to match their liability to pay you a fixed amount for the next 30 years. Hey, how about a 30 year bond?
In practice, the corporate finance departments that make these decisions don't arrive at the office, say "how about 30 year bonds" and head home. If you look at the financial statements, they hold a complex, ever changing mix of investments that varies according to their funding needs, the yield curve, the regulatory enviorment, etc.

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Re: Rates on Annuities

Post by jbaron »

The notion of "waiting to purchase" until rates go up is nothing if not market timing. I am (frankly) amazed that people think that there's a free lunch here - that only if the purchaser "waits a while," the deal will be better. For a 70 year old, how long is too long to wait? What if rates continue to go down for the next year rather than up - what then? And what about the fact that if rates do indeed go up, the fixed income portion of the portfolio will be worth correspondingly less, and as a result, you may be able to only puchase 90% of what you were able to purchase today, when rates were lower? We do have large, fixed income allocations, right?

All portfolios with fixed income components have benefitted, more or less depending, on the recent fall in rates, and their purchasing powers should be higher now than it was a year ago. For a 70 year old that has seen a 15% run up in their matched 10-year duration portfolios, for example, I'd imagine that that 15% run up, coupled with the fact that he is 1 year actuarially more advanced, would result in him being able to purchase MORE annuity cash flow with those proceeds, not less. If the same 70 year old had all of his money in shorter term instruments rather than matching assets to requirements, I'd call that a planning mistake, not a problem caused by the markets.

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Re: Rates on Annuities

Post by alec »

jbaron wrote:The notion of "waiting to purchase" until rates go up is nothing if not market timing. I am (frankly) amazed that people think that there's a free lunch here - that only if the purchaser "waits a while," the deal will be better. For a 70 year old, how long is too long to wait? What if rates continue to go down for the next year rather than up - what then? And what about the fact that if rates do indeed go up, the fixed income portion of the portfolio will be worth correspondingly less, and as a result, you may be able to only puchase 90% of what you were able to purchase today, when rates were lower? We do have large, fixed income allocations, right?

All portfolios with fixed income components have benefitted, more or less depending, on the recent fall in rates, and their purchasing powers should be higher now than it was a year ago. For a 70 year old that has seen a 15% run up in their matched 10-year duration portfolios, for example, I'd imagine that that 15% run up, coupled with the fact that he is 1 year actuarially more advanced, would result in him being able to purchase MORE annuity cash flow with those proceeds, not less. If the same 70 year old had all of his money in shorter term instruments rather than matching assets to requirements, I'd call that a planning mistake, not a problem caused by the markets.

Jeff
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Re: Rates on Annuities

Post by bobcat2 »

The notion of "waiting to purchase" until rates go up is nothing if not market timing. I am (frankly) amazed that people think that there's a free lunch here - that only if the purchaser "waits a while," the deal will be better.
I can't speak for others, but that's not I mean. I intend to annuitize with real life annuities in chunks over time. However, the size of the early chunks will be partially determined by the payout rate at the time of early annuitization. If the payout rate is relatively low, because of relatively low real interest rates at that time, I will buy relatively less of the early annuity chunk because in that case the higher mortality credit I receive by waiting becomes more attractive. Conversely if the payout rate is relatively high, because of relatively high real interest rates at the time, I will buy relatively more of the early annuity chunk because the higher early payout will be attractive compared to waiting for the higher mortality credit. It's more the tradeoff between today's payout rate and the future gain in mortality credit than timing interest rate changes. Nor will it result in huge changes. I might buy 20% or so more in the first chunk if real interest rates are significantly higher than their historical norm, and conversely 20% or so less in the first chunk if interest rates are significantly lower than their historical norm. I would consider a 20 year real rate of 2% to be 'normal'.

In 2007 the payout rate for a real life annuity for a 65 year old male was a little over 6%. Today the payout rate for a real life annuity for a 65 year old male is about 5% or a little less. If your lifetime is long that change in payout rates makes a difference. And nearly all of that difference can be attributed to today's lower real interest rates.

BobK
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Re: Rates on Annuities

Post by wade »

bluestar wrote:Thank you for the comments and bob90245 for the graph. I converted the annuity income into yield to allow all to be plotted on the same scale per the comments. I also added 30 year Treasury yield. It does paint a little different picture to me showing annuity rates have held up better than long-term Treasury yields in recent years.
Image
That's a great image!

Here is an image I made which I hope helps to explain as well about why annuity rates hold up better than bond yields. In describing the image, I benefited a lot and cited from the discussions in this thread, and also the older thread from the end of 2010 that bob90245 shared. Thanks!

Image
Source: my blog
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bobcat2
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Re: Rates on Annuities

Post by bobcat2 »

Hi Wade,

It seems to me that the graphs show that annuity payouts vary a lot less than than interest rates, but don't go into the why. However, the why is no mystery. Annuity payout rates consist of repayment of principal and mortality credits as well as prevailing interest rates. The graphs are consistent with that set of facts.

BobK
In finance risk is defined as uncertainty that is consequential (nontrivial). | The two main methods of dealing with financial risk are the matching of assets to goals & diversifying.
dshibb
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Re: Rates on Annuities

Post by dshibb »

Since this is my first post here and there really is no better place to do this, let me introduce myself. I'm dshibb. I've known about you guys and have been a lurker for a few years. Some of you may already know me(online of course) since I post quite a bit over at FWF. Thought I would see if might be some use over here. Just to pre-warn you guys I do have a bit of a reputation for being a little blunt so I'm sorry if I come off a little strong ever which at FWF I'm not alone, but here I'm less sure.

I have a queued list of a few threads I wanted to comment on so I just figured I'd start here.


Okay from my lurking around here I have already realized that Bogleheads are mostly fixated on the accumulation phase of investment. There isn't much talk on here about distribution phase. And so you see a lot of posts(like that occurred on this thread) that confuse rate of return(ror) with safe withdrawal rate(swr). First of all as Bob eloquently pointed out just above me an annuity withdrawal(as with all withdrawal rates) will or at least may dip into principal and so the % that pops up may be higher for that reason.

But there is a dangerous part to people mistaking ROR with SWR. I don't care if you point to an 8% AAA bond you are making a huge mistake if you take that as your withdrawal rate in distribution phase. You stand a very high chance of running out of money and doing so pretty quickly. So no matter how good of assets your holding the debate over SWR usually peaks at about 4% a year which a lot of people do. Many do 3.5% and still many do less. If you think this is low look at these two calculators(1 of which comes from Vanguard).

https://retirementplans.vanguard.com/VG ... main=false

http://firecalc.com/ The simulator is the small box on the right, but all the customization(which is a lot more detailed that vanguard's) is at the top in the tabs that say "other income", "your portfolio", etc. the current selection is Total Market, but you can really customize it anyway you want.

Now what you will discover(in the second one) is that the date of your retirement is actually the biggest predictor of whether or not you will run out of money(we call this "retirement date risk". But even under certain high withdrawal rates its greater than 50% odds that you will come out ahead. But who wants a 30%, 20%, or even 10% chance of going broke in retirement?

Now in regards to annuities. First I'm going to say that all of them are **horrible** accumulation vehicles. They are all horrible vehicles at death(I mean there are other vehicles that don't get a step up in basis, but at least a 401k to TIRA got the deduction at the beginning). Now they do have 1 very good purpose, but first I'll say that if you can avoid them(for the 2 prior reasons) your family will likely inherent more money when you die. But when it comes down to it for those that would rather have the extra income for themselves than leave more to their kids(which is a lot of people) an annuity with a lifetime guaranteed income rider(and without that its useless) is probably the single best distribution vehicle in the country today. And the reason is that they will pool retirement date risk so that nobody ends up running out while giving a higher SWR than what you can safely take while invested in the markets. For example a 60 year old they'll easily grant you 6% plus withdrawal rates(depending if you want terminal value or not it can be considerably higher which I can explain later). Run 6%(granted their are minor differences here) in those 2 calculators and see what it pops out. Hell run 5% once in those calcs and you'll see what I mean.

So why is that you can't duplicate the annuity and how does the insurance company make money then?

Well first lets be on the conservative side and use 5% SWR on $1 million using 50/50 stock/bond for 30 years. If your investments returned the mean performance(in both ROR and volatility because they both matter now) you walk away with $415,000. If your the best you walk away with just over $3 million. And if your the worst you will have exceeded zero enough to produce more than a $1 million dollar loss(assuming you had the access to credit to keep on falling which you wouldn't so zero).

Now picture a bell curve once with $3.3 million on the far left, -$1.2 million on the far right and $415k at the middle of the bell curve. Also a little bit to the right of the middle you see zero. Everything to the right of that zero representing 45% of possibilities are all highlighted and they all produce zero. They all produce an outcome of running out of money and being stuck with nothing but social security. So this the deal the insurance carrier makes with you on a guaranteed income rider annuity, we(the carrier) will issue you an annuity that guarantees you 6%+ forever, but since we get to aggregate these deals we will take the money that falls in above that(in most cases) zero line which will result in us averaging an amount a little lower than $415k minus some likely volatility premium and that is how they make their money(through the law of large numbers) and the fact that you don't have to be one of those people that runs out under any normal allocation makes it a smart decision if you need the money. That said if you have so much that you can live comfortably on a 2% SWR and leave whatever is left to heirs you would be smart to *not take out an annuity than*. But for most of the population they retire with not enough instead of too much so its probably the best decision for them to get one.


A few other notes. Terminal value as I referenced before means that if you die quickly after you elect guaranteed income for life is there anything left? For most standard fixed income annuities the answer is no. But they give the highest SWRs. For variable annuities the answer is yes, but the give the worst withdrawal rates. For indexed annuities they have somewhat close withdrawal rates to fixed, but *they do have terminal value* which is why I think is part of the reason that is driving that market(in addition to the people that are duped into thinking that a 2% floor and a 6% cap is anything special and hold them during accumulation phase). And for those that get that(and annuitize right away) I think they're probably making the best decision.

Taking out an annuity before you need to retire/take the income stream is stupid. You do not hold these things during any point of accumulation phase. The smart way to use an annuity outside of some very rare circumstances is to immediately annuitize after taking them out. So if your intention is to use one you still need to use stocks, bonds, etc. while your still accumulating and only buy the annuity when you decide to immediately annuitize otherwise you'll get sub par performance while its being deferred.

What about the subjects of performance, internal fixed crediting, internal indexed crediting, variable performance, fees, etc.? This is going to seem strange, and this is the only thing I can think of where this is true. Practically none of these things matter when you elect to annuitize a guaranteed income annuity. The reason is that almost all of that exclusively affects performance during accumulation phase and after annuitization it only affects the terminal value in the event of early death. Basically outside of the stream of income a "phantom account" exists for the purposes of keeping track of that terminal value and that phantom account is subject to the crediting method that exists on the contract. But practically all of them deplete a little bit after the half way point between the start date and your life expectancy. Now what actually judges the performance the contract(outside of early death--terminal value) is the SWR and the length of time you live especially if its beyond your life expectancy. So really all you should focus on(after lets say making sure you get a contract with terminal value for example) is how high the SWR is on the assets. Everything else doesn't matter. So you may ask well there is got to be fees in this. And I'll say yeah, but its really implicit at this stage. Basically find the company with the highest SWR and every company that has a lower one has a higher implicit annual fee.

Sorry for the book, but I hope you enjoy the read.
Last edited by dshibb on Mon Feb 20, 2012 10:05 am, edited 8 times in total.
antiqueman
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Re: Rates on Annuities

Post by antiqueman »

. For example a 60 year old they'll easily grant you 6% plus withdrawal rates(depending if you want terminal value or not it can be considerably higher which I can explain later). Run 6%(granted their are minor differences here) in those 2 calculators and see what it pops out.


Where can a 60 year old obtain 6% on a spia? The number I have obtained from Berkshire and others seem to just annunitize based on my life expecteancy via whatever the bond rate is. When I did the math I didnt come anywhere near 6% over my expected life. What am I missing ( or dont understand)
555
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Re: Rates on Annuities

Post by 555 »

bobcat2 wrote:Hi Wade,
It seems to me that the graphs show that annuity payouts vary a lot less than than interest rates, but don't go into the why. However, the why is no mystery. Annuity payout rates consist of repayment of principal and mortality credits as well as prevailing interest rates. The graphs are consistent with that set of facts.
BobK
Those curves are almost straight lines with slope 1/2. It's worth thinking about why the slope should be this.
yobria
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Re: Rates on Annuities

Post by yobria »

jbaron wrote:The notion of "waiting to purchase" until rates go up is nothing if not market timing. I am (frankly) amazed that people think that there's a free lunch here - that only if the purchaser "waits a while," the deal will be better.
Not necessarily. There may be a certain level at which I'll give up my lump sum for an annuity, just like there's a certain price level at which I'll buy an apple. Doesn't mean there's any free lunch involved. If the "deal gets better", I'll buy, otherwise I'll prefer to keep my money. Just like with that apple.
trico
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Re: Rates on Annuities

Post by trico »

Antique man, the 6% comes from an annuity that has a guarantee lifetime income benefit rider, that you purchase on the side. These are avalible with Variable and Equity Index annuities. I havn't seen one for a spia annuity, but I might be wrong.
dshibb
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Re: Rates on Annuities

Post by dshibb »

antiqueman wrote:. For example a 60 year old they'll easily grant you 6% plus withdrawal rates(depending if you want terminal value or not it can be considerably higher which I can explain later). Run 6%(granted their are minor differences here) in those 2 calculators and see what it pops out.


Where can a 60 year old obtain 6% on a spia? The number I have obtained from Berkshire and others seem to just annunitize based on my life expecteancy via whatever the bond rate is. When I did the math I didnt come anywhere near 6% over my expected life. What am I missing ( or dont understand)
First are you referring to the SWR or the rate of return? Don't get those confused. They are different. The SWR includes distribution of principal. A rate of return doesn't. SWR should then be higher. If you are talking about SWR...

Search harder and don't limit yourself to just SPIA's. Let me ask you this. What stops you from electing to annuitize a deferred annuity as soon as you can which pretty much turns it into a SPIA? If a deferred annuity offers a higher SWR than a SPIA then just take the deferred annuity and then treat it like a SPIA.

A guess as to why a deferred annuity might pay a higher SWR than a SPIA(and I'm not positive about this) is because in a deferred annuity the insurance carrier might determine that the average person who holds one will defer it for lets say 8 years(I.e. 8 years of mistakes of which they should have never taken them out). So they might obtain enough explicit fees and implicit fees on the dumb money holding them and deferring them to offer a higher SWR. If you buy and immediately annuitize then your taking advantage of that situation for your benefit. So that's a guess. Honestly I'm not very sure why the difference would show up.

But obviously it pays to hunt for the highest SWR you can get just like it pays to hunt for the lowest interest on a mortgage for example.
dshibb
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Re: Rates on Annuities

Post by dshibb »

555 wrote:
bobcat2 wrote:Hi Wade,
It seems to me that the graphs show that annuity payouts vary a lot less than than interest rates, but don't go into the why. However, the why is no mystery. Annuity payout rates consist of repayment of principal and mortality credits as well as prevailing interest rates. The graphs are consistent with that set of facts.
BobK
Those curves are almost straight lines with slope 1/2. It's worth thinking about why the slope should be this.
Simple life expectancy. You are one year closer to the average year they expect for you to die.
555
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Re: Rates on Annuities

Post by 555 »

dshibb wrote:
555 wrote:
bobcat2 wrote:Hi Wade,
It seems to me that the graphs show that annuity payouts vary a lot less than than interest rates, but don't go into the why. However, the why is no mystery. Annuity payout rates consist of repayment of principal and mortality credits as well as prevailing interest rates. The graphs are consistent with that set of facts.
BobK
Those curves are almost straight lines with slope 1/2. It's worth thinking about why the slope should be this.
Simple life expectancy. You are one year closer to the average year they expect for you to die.
Irrelevant. Look at the axes on the graph.
travellight
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Re: Rates on Annuities

Post by travellight »

that is a helluva first post, dshibb!
364
dshibb
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Re: Rates on Annuities

Post by dshibb »

555 wrote:
dshibb wrote:
555 wrote:
bobcat2 wrote:Hi Wade,
It seems to me that the graphs show that annuity payouts vary a lot less than than interest rates, but don't go into the why. However, the why is no mystery. Annuity payout rates consist of repayment of principal and mortality credits as well as prevailing interest rates. The graphs are consistent with that set of facts.
BobK
Those curves are almost straight lines with slope 1/2. It's worth thinking about why the slope should be this.
Simple life expectancy. You are one year closer to the average year they expect for you to die.
Irrelevant. Look at the axes on the graph.
Oh sorry I took a quick glance at the table and thought that the difference was caused by change in age by 1 year after a certain age(something that was discussed in another thread I also had up and had just read).


So I'll give you the correct answer now that I know what that graph actually alluding to. As interest rates rise more of the payment of SWR comes from earnings than return of principal. With low interest rates a lot of each payment is return of principal to life expectancy. As interest rates rise return of principal makes up for less of each income payment.
dshibb
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Re: Rates on Annuities

Post by dshibb »

travellight wrote:that is a helluva first post, dshibb!

Thanks. As you'll likely find out I am the type that writes large walls of posts. But I figure that true value comes in explaining something inside and out the best I can instead of just a quick response with only a couple details.
Rlc250
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Re: Rates on Annuities

Post by Rlc250 »

Thanks dshibb for the post.
Annuities seem to be a "dirty word" to BH on this forum. I faithfully followed BH principle during accumulation phase and was pleased and did well. Following recent retirement, and reading Jim Otar's book, I decided to buy annuities with a large portion of my investments. Enought to cover all of my rather extensive expenses. Sort of felt like I betrayed BH but your post outline my thought process very well. You are right that it is what the lifetime income riders pays for the rest of you and your wife's life relative to your original premium that matters. Thanks for being a voice for the minority on this forum and reinforce our extremely risk adverse position. For BHer ,I still believe in BH philosophy and still have 1mil in Wellesley and Target Income Fund , but I just could not stomach any significant loss on income so the annuities. There must be some out there like me.
dshibb
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Re: Rates on Annuities

Post by dshibb »

Rlc250 wrote:Thanks dshibb for the post.
Annuities seem to be a "dirty word" to BH on this forum. I faithfully followed BH principle during accumulation phase and was pleased and did well. Following recent retirement, and reading Jim Otar's book, I decided to buy annuities with a large portion of my investments. Enought to cover all of my rather extensive expenses. Sort of felt like I betrayed BH but your post outline my thought process very well. You are right that it is what the lifetime income riders pays for the rest of you and your wife's life relative to your original premium that matters. Thanks for being a voice for the minority on this forum and reinforce our extremely risk adverse position. For BHer ,I still believe in BH philosophy and still have 1mil in Wellesley and Target Income Fund , but I just could not stomach any significant loss on income so the annuities. There must be some out there like me.
Well in defense of the BHers on here they are 'dirty word' for asset accumulation . They aren't good if your goal is to end up with more money after a period of time. They are good if you want to take more money out(distribution phase) while mitigating your risk of running out of money. This denotation of accumulation phase vs. distribution phase should IMO become more prevalent on here because not everybody that participates here is still in their working years(like most posters on here) and any advice that pertains to accumulation phase could be bad advice to someone in distribution phase.

I used to think the way that BHers think towards everything and that is the only goal of someone should be to maximize wealth in every situation. But after you contemplate a little on the subject of something like death and what that means for an investor you realize that their are a few exceptions to the ideal of maximizing wealth. Take for instance a reverse mortgage. By any objective measure one of the worst possible decisions you could make(the income you receive is extremely expensive against the asset), but if your of the mindset that you want every dollar during your lifetime and damn the heirs then that may change things. I wouldn't be caught dead touching them, but I'm also not surprised to see others doing them nor can I really say much if their attitude is "well the only person who gets screwed is my heirs with less inherited wealth, but I don't care."
newstreetnj
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Re: Rates on Annuities

Post by newstreetnj »

Hello Friends,

I'm in TIAA but have not purchased an annuity yet.

My sense with TIAA annuities is that there is a guaranteed rate of 2.5% but that in most years there is a extra payment("dividend", I think) based on the return on the investments. So, for this particular company, even if one were to annuitize when rates were low, the payout would eventually increase as the return on the investments increased.

The other factor with TIAA is the "vintage" of the contributions that you and your employer made. So, if you have a vintage dating back to the 1970s, your annuity payout would be substantially higher than more recent vintages.

I realize that some of you may not have this option available but my sense is that TIAA is, nonetheless, a major annuity player.

Bob
555
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Re: Rates on Annuities

Post by 555 »

dshibb wrote:
555 wrote:
dshibb wrote:
555 wrote:
bobcat2 wrote:Hi Wade,
It seems to me that the graphs show that annuity payouts vary a lot less than than interest rates, but don't go into the why. However, the why is no mystery. Annuity payout rates consist of repayment of principal and mortality credits as well as prevailing interest rates. The graphs are consistent with that set of facts.
BobK
Those curves are almost straight lines with slope 1/2. It's worth thinking about why the slope should be this.
Simple life expectancy. You are one year closer to the average year they expect for you to die.
Irrelevant. Look at the axes on the graph.
Oh sorry I took a quick glance at the table and thought that the difference was caused by change in age by 1 year after a certain age(something that was discussed in another thread I also had up and had just read).
So I'll give you the correct answer now that I know what that graph actually alluding to. As interest rates rise more of the payment of SWR comes from earnings than return of principal. With low interest rates a lot of each payment is return of principal to life expectancy. As interest rates rise return of principal makes up for less of each income payment.
Here's a more quantitative explanation of why "those curves are almost straight lines with slope 1/2". If interest rates are 2% more then you should get an extra 2% per year on "your current balance"*. But on average "your current balance" (as it goes from initial balance down to zero over time) is about** 1/2 of "your initial balance". So you get about 1% of "your initial balance" per year extra.

* Obviously there's no such thing as "your current balance", since you're part of a pool, but the idea still works.

** A reasonable approximation for low interest rates.
dshibb
Posts: 72
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Re: Rates on Annuities

Post by dshibb »

newstreetnj wrote:Hello Friends,

I'm in TIAA but have not purchased an annuity yet.

My sense with TIAA annuities is that there is a guaranteed rate of 2.5% but that in most years there is a extra payment("dividend", I think) based on the return on the investments. So, for this particular company, even if one were to annuitize when rates were low, the payout would eventually increase as the return on the investments increased.

The other factor with TIAA is the "vintage" of the contributions that you and your employer made. So, if you have a vintage dating back to the 1970s, your annuity payout would be substantially higher than more recent vintages.

I realize that some of you may not have this option available but my sense is that TIAA is, nonetheless, a major annuity player.

Bob
Are you talking about guaranteed income annuitization or annuitization over a specific amount of years? They are different. In either case I can assure you that your SWR/return plus principal will not be 2.5%(even without "dividends" which I guess is a reasonable way of categorizing it) it will be higher. 2.5% plus dividends is your rate of return its not your SWR. SWR will include return of principal. And unless this is a strange annuity you wont be receiving any additional payments during annuitization. They will just calculate SWR based on the current rate if you annuitizing over a specific amount of years and they will give you the SWR that is specified in the contract if you intend to do guaranteed income for life.
Last edited by dshibb on Sun Feb 19, 2012 11:15 pm, edited 1 time in total.
dshibb
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Re: Rates on Annuities

Post by dshibb »

555 wrote: Here's a more quantitative explanation of why "those curves are almost straight lines with slope 1/2". If interest rates are 2% more then you should get an extra 2% per year on "your current balance"*. But on average "your current balance" (as it goes from initial balance down to zero over time) is about** 1/2 of "your initial balance". So you get about 1% of "your initial balance" per year extra.

* Obviously there's no such thing as "your current balance", since you're part of a pool, but the idea still works.

** A reasonable approximation for low interest rates.
I'm sorry I don't follow and the key areas for me to understand is for you to define "current balance" and "initial balance" and how they are different.
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