Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

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vertigo
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Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by vertigo » Sat May 16, 2015 10:52 am

Hi everyone,

What are your thoughts regarding this article by Wade Pfau?

http://www.forbes.com/sites/wadepfau/20 ... annuities/

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by sometimesinvestor » Sat May 16, 2015 12:03 pm

I read the article though not the paper but taken as a whole these two sentences do not make sense to me . Perhaps the paper explains

they can invest $14,281 per year in their 401(k) if they choose term life insurance, and they can invest $9,000 per year in their 401(k) if they choose whole life insurance.

In the average outcome (median), their 401(k) balance is 13% less if they use whole life insurance instead.

$14281 is almost 60% more than $9000

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by rrouse » Sat May 16, 2015 12:28 pm

I think that annuities, when viewed as what they are (insurance, not an investment) can be a really good thing.

Consider two individuals saving for retirement. Their life expectancy might be 80 years, but because neither knows how long they will actually live, they have to plan for the possibility of living to be 90 years old. Let assume they each calculate that they will need $1.5M at retirement to achieve this.

Person A lives to be 90, and everything works out as planned.
Person B dies at age 70, leaving a substantial amount of money behind.
On average, they lived to 80 years (the life expectancy for both).

Collectively, they saved too much for retirement. Each of them deferred consumption (vacation, new cars, upgrades for the house, etc.) and had a lower standard of living in order to save for retirement. That worked out okay for Person A, but Person B got screwed.

What if they had a way to pool that risk? If each of them only had to plan for their life expectancy (80 years) they would both enjoy a higher standard of living by not having to save so much. Maybe they would have only needed to save $1.2M (instead of $1.5M) to accomplish this.

This is what annuities can do.

(To keep it simple, I am ignoring children and other heirs -- just a selfish analysis!)
Last edited by rrouse on Sat May 16, 2015 1:32 pm, edited 1 time in total.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by chessmannextmove » Sat May 16, 2015 12:35 pm

sometimesinvestor wrote:I read the article though not the paper but taken as a whole these two sentences do not make sense to me . Perhaps the paper explains

they can invest $14,281 per year in their 401(k) if they choose term life insurance, and they can invest $9,000 per year in their 401(k) if they choose whole life insurance.

In the average outcome (median), their 401(k) balance is 13% less if they use whole life insurance instead.

$14281 is almost 60% more than $9000
That's because term is unlikely to pay off (most people make it past 65) while whole life usually does (people always die, but giving up the policy is not necessary).

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by nedsaid » Sat May 16, 2015 12:37 pm

I am not an advocate of whole life insurance though there are cases where it might make sense. For most people, buy term and invest the rest seems to be the better solution.

The sequence of returns problems for retirees and the advantages of Single Premium Immediate Annuities have been discussed on many threads. I do think that all retirees should consider annuitizing a portion of their retirement nest egg in retirement. The problem is that the things that can go wrong in retirement are almost limitless and there is no strategy that can avoid every imaginable negative outcome. What you do is cover the most likely risks the very best you can.
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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by jaj2276 » Sat May 16, 2015 12:46 pm

chessmannextmove wrote:
sometimesinvestor wrote:I read the article though not the paper but taken as a whole these two sentences do not make sense to me . Perhaps the paper explains

they can invest $14,281 per year in their 401(k) if they choose term life insurance, and they can invest $9,000 per year in their 401(k) if they choose whole life insurance.

In the average outcome (median), their 401(k) balance is 13% less if they use whole life insurance instead.

$14281 is almost 60% more than $9000
That's because term is unlikely to pay off (most people make it past 65) while whole life usually does (people always die, but giving up the policy is not necessary).
Huh? What does pay-off from term vs. whole life have to do with the 401k balance at the end of their contribution periods?

If I put $14,281/yr in a 401k for 30 years at 6% I get $1.2M. If I put in 9k/yr for 30 yrs at 6%, I get 750k. $9k is 37% less than $14,281 and $750k is 37% less than $1.2M. It doesn't make much sense then for the article to state that the 401k ending balances differ by 13% when the contributions themselves differ by much more.

Seems like both 401k plans would be affected by the same simulated returns but maybe there's something we're missing.

Off to read the whitepaper!

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by ResearchMed » Sat May 16, 2015 12:47 pm

Here is the "flaw" in Pfau's piece.

For the "term life" example, he states the following:

"At retirement, the couple who used term-life is assumed to avoid insurance products and aims to get their retirement income using only withdrawals from their investment portfolio."

That is, his comparisons do NOT include a "term life plus SPIA" combo, whereas the "whole life" example uses both a different type of insurance *and* annuities.

It would be interesting to see the examples with "term plus SPIA", especially given how much writing there has been about how much SPIA's can add.
(Didn't Pfau himself write about this?)

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by wade » Sat May 16, 2015 12:58 pm

Hi everyone, this is Wade, who authored the article.

Two quick points before I have a chance to review the thread more carefully.

In the whitepaper, there are 3 scenarios. Scenario 2 is Investments + Term Life + Joint Life SPIA. I didn't mention this scenario in the Forbes column, because I was trying to shorten and summarize the whitepaper as much as possible. It's in the whitepaper though.

About the issue of the median 401(k) balance being only 13% less at age 65, there are two factors at work. First, the annual $15,000 savings amount grows with inflation, while the insurance premiums stay fixed. This reduces the discrepancies over time. Second, with whole-life, I consider the cash value of the policy as part of the fixed income portfolio, so the 401(k) asset allocation becomes more aggressive. Since I keep the historical equity risk premium as part of the Monte Carlo simulations, which is being quite generous to the investments strategy, this does help the 401(k) piece to grow more quickly. At the 10th percentile of the distribution, the 401(k) lags by 19% at retirement when using whole life.

Edit: one more reason for the smaller difference in 401(k) balances at age 65. When the couple gets going with this strategy, they already have $65k in their 401(k). The 401(k) is not starting from $0.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by jaj2276 » Sat May 16, 2015 1:08 pm

wade wrote:Hi everyone, this is Wade, who authored the article.

Two quick points before I have a chance to review the thread more carefully.

In the whitepaper, there are 3 scenarios. Scenario 2 is Investments + Term Life + Joint Life SPIA. I didn't mention this scenario in the Forbes column, because I was trying to shorten and summarize the whitepaper as much as possible. It's in the whitepaper though.

About the issue of the median 401(k) balance being only 13% less at age 65, there are two factors at work. First, the annual $15,000 savings amount grows with inflation, while the insurance premiums stay fixed. This reduces the discrepancies over time. Second, with whole-life, I consider the cash value of the policy as part of the fixed income portfolio, so the 401(k) asset allocation becomes more aggressive. Since I keep the historical equity risk premium as part of the Monte Carlo simulations, which is being quite generous to the investments strategy, this does help the 401(k) piece to grow more quickly. At the 10th percentile of the distribution, the 401(k) lags by 19% at retirement when using whole life.

Edit: one more reason for the smaller difference in 401(k) balances at age 65. When the couple gets going with this strategy, they already have $65k in their 401(k). The 401(k) is not starting from $0.
Hi Wade,

I was just about to come back and post that the difference was due to a more aggressive allocation in the 401k under the whole-life policy scenario. I guess that makes sense given the "safety" of the monies in the whole life policy.

One thing I wonder about is the ramifications for missing a given year of "full investment." In the buy-term-and-invest, the bogey is the $719 to keep the life insurance. In subsequent years the couple can continue to invest and it shouldn't have a huge impact.

In the whole-life scenario, it's $5000 which is obviously more difficult to achieve. As the life insurance amounts increase (and the term and whole-life premiums increase accordingly), it makes it even more likely that a year might occur where a large annual premium cannot be made and the whole-life scenario falls apart.

Regardless, a great article. Much appreciated.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by lack_ey » Sat May 16, 2015 1:15 pm

There are a lot of assumptions flying around here, and Wade is clear about those in the paper itself. These have a large influence on the range of outcomes, so it would probably be best to review the stipulations and see the actual numbers before commenting on the contents and implications. (As such, having not read the paper yet beyond a cursory skim, I will need to excuse myself...)

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by dhodson » Sat May 16, 2015 1:42 pm

is this the one where the assumptions include paying an advisor 0.75% and the average ER 0.84%?
Wasnt the work also sponsored by the insurance industry?

Maybe im being harsh but im not sure im going to spend much additional time on that...

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by backpacker » Sat May 16, 2015 2:09 pm

Well, the results of the paper are interesting. If your portfolio has an expense ratio of 1.59%. :shock: :shock:
Wade Phau wrote: We also set mutual fund fees equal to the 0.84% average portfolio administration cost as determined by Morningstar in the same report. A financial advisory fee of 0.75% is also charged to these assets. Therefore, the total fees equal 1.59% on all retirement savings assets.
Bogleheads get an extra 1.5% annualized return on their investments as compared to Wade's hapless investors. That adds up to about 50% higher returns for an investor making regular contributions 21-66. Wade's investor has a 3.5% withdrawal rate, but is still losing 1.5% to fees in retirement. That means a Boglehead could withdraw 5% with the same amount of risk. Combining that with the higher returns means that the Boglehead can spend more than twice as much as Wade's ill-fated investor without taking any risk.
Last edited by backpacker on Sat May 16, 2015 2:29 pm, edited 1 time in total.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by chessmannextmove » Sat May 16, 2015 2:27 pm

jaj2276 wrote:
chessmannextmove wrote:
sometimesinvestor wrote:I read the article though not the paper but taken as a whole these two sentences do not make sense to me . Perhaps the paper explains

they can invest $14,281 per year in their 401(k) if they choose term life insurance, and they can invest $9,000 per year in their 401(k) if they choose whole life insurance.

In the average outcome (median), their 401(k) balance is 13% less if they use whole life insurance instead.

$14281 is almost 60% more than $9000
That's because term is unlikely to pay off (most people make it past 65) while whole life usually does (people always die, but giving up the policy is not necessary).
Huh? What does pay-off from term vs. whole life have to do with the 401k balance at the end of their contribution periods?

If I put $14,281/yr in a 401k for 30 years at 6% I get $1.2M. If I put in 9k/yr for 30 yrs at 6%, I get 750k. $9k is 37% less than $14,281 and $750k is 37% less than $1.2M. It doesn't make much sense then for the article to state that the 401k ending balances differ by 13% when the contributions themselves differ by much more.

Seems like both 401k plans would be affected by the same simulated returns but maybe there's something we're missing.

Off to read the whitepaper!
The total return on the strategies is affected by life insurance payoffs.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Independent » Sat May 16, 2015 2:46 pm

backpacker wrote:Well, the results of the paper are interesting. If your portfolio has an expense ratio of 1.59%. :shock: :shock:
Wade Phau wrote: We also set mutual fund fees equal to the 0.84% average portfolio administration cost as determined by Morningstar in the same report. A financial advisory fee of 0.75% is also charged to these assets. Therefore, the total fees equal 1.59% on all retirement savings assets.
Bogleheads get an extra 1.5% annualized return on their investments as compared to Wade's hapless investors. That adds up to about 50% higher returns for an investor making regular contributions 21-66.
Yes, investment fees are a big deal in the "buy term and invest the difference" scenarios.

For some reason, WP believes that our 35 year old couple is so naive regarding asset allocations that they need to pay 75 bp to an adviser to get them into the right mix of stock and bond funds. And, that adviser buys funds with average expenses of 84 bp.

But, when that couple buys a WL policy, they suddenly get so sophisticated that they can run their own asset allocation strategy that involves annually offsetting the bond allocation with the WL cash values.

I don't buy it. They are either sophisticated in both cases or naive in both cases.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Independent » Sat May 16, 2015 2:50 pm

backpacker wrote:Wade's investor has a 3.5% withdrawal rate, but is still losing 1.5% to fees in retirement. That means a Boglehead could withdraw 5% with the same amount of risk. Combining that with the higher returns means that the Boglehead can spend more than twice as much as Wade's ill-fated investor without taking any risk.
It appears that he reduces his fees to 0.5% after retirement. It's not entirely clear because he's offsetting a number of things, but that's what I get from the first paragraph on page 17.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Independent » Sat May 16, 2015 2:57 pm

Wade Pfau explicitly says that he is not buying inflation-indexed SPIAs. That leads to higher initial payouts at the cost of keeping up with inflation.
But, the 3.5% SWR rate assumes that the retiree will increase IRA withdrawals annually with inflation.

So, when he compares income at age 65, he is showing the most favorable SPIA situation. At any other age, inflation would be taking a toll in Scenarios 2 and 3, but not in Scenario 1.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by backpacker » Sat May 16, 2015 3:43 pm

Independent wrote:
backpacker wrote:Wade's investor has a 3.5% withdrawal rate, but is still losing 1.5% to fees in retirement. That means a Boglehead could withdraw 5% with the same amount of risk. Combining that with the higher returns means that the Boglehead can spend more than twice as much as Wade's ill-fated investor without taking any risk.
It appears that he reduces his fees to 0.5% after retirement. It's not entirely clear because he's offsetting a number of things, but that's what I get from the first paragraph on page 17.
I think the .5% fee is the fee WP used to determine that a 2.88% withdrawal rate was safe in a previous paper, the results of which he is briefly mentioning on page 17. But in this paper, investment fees are 1.59% throughout an investor's career.
Last edited by backpacker on Sun May 17, 2015 8:15 am, edited 1 time in total.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by dhodson » Sat May 16, 2015 4:05 pm

Nor does it consider the facts that over 80% of people who buy permanent life insurance surrender it. "Bond like" returns only occur/illustrated with that continuing.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by jaj2276 » Sat May 16, 2015 4:16 pm

chessmannextmove wrote:
jaj2276 wrote:
chessmannextmove wrote:
sometimesinvestor wrote:I read the article though not the paper but taken as a whole these two sentences do not make sense to me . Perhaps the paper explains

they can invest $14,281 per year in their 401(k) if they choose term life insurance, and they can invest $9,000 per year in their 401(k) if they choose whole life insurance.

In the average outcome (median), their 401(k) balance is 13% less if they use whole life insurance instead.

$14281 is almost 60% more than $9000
That's because term is unlikely to pay off (most people make it past 65) while whole life usually does (people always die, but giving up the policy is not necessary).
Huh? What does pay-off from term vs. whole life have to do with the 401k balance at the end of their contribution periods?

If I put $14,281/yr in a 401k for 30 years at 6% I get $1.2M. If I put in 9k/yr for 30 yrs at 6%, I get 750k. $9k is 37% less than $14,281 and $750k is 37% less than $1.2M. It doesn't make much sense then for the article to state that the 401k ending balances differ by 13% when the contributions themselves differ by much more.

Seems like both 401k plans would be affected by the same simulated returns but maybe there's something we're missing.

Off to read the whitepaper!
The total return on the strategies is affected by life insurance payoffs.
Sure, but the poster you were responding to was asking only about the 401k amounts.

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Improving Retirement Outcomes

Post by Taylor Larimore » Sat May 16, 2015 5:45 pm

Bogleheads:

I try to never forget Mr. Bogle's wise advice:

"When there are multiple solutions to a problem, choose the simplest."

Best wishes
Taylor
"Simplicity is the master key to financial success." -- Jack Bogle

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by itstoomuch » Sat May 16, 2015 8:44 pm

It is something to consider.
I did the F & W funds till late 2008, then modified philosophy from a balanced investment model to a protected investment model.
Currently I want the markets to increase and other times I want the market to make a drastic decline.
Age 65/68. I win both ways but I think I will win bigger when everyone else is fully invested in stocks and bonds.
Doesn't really matter now; Got the Number.
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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by wade » Sat May 16, 2015 9:10 pm

Hi gang,

The 1.59% fee assumption on investments doesn't apply to Bogleheads who view personal finance as a hobby and who take the time and energy needed to understand and live by the Bogleheads philosophy. This isn't the typical American though. Even many who COULD manage their own personal finances still prefer to delegate it for a fee, in order to save their time and energy for other pursuits.

That being said, and investments-only strategy will gain some of its lost ground if fees are essentially 0%. Perhaps not as much as some commentators believe, because as lack-ey kindly pointed out, it could be useful to actually read the paper to know what is going on. The integrated strategy in scenario 3 includes INVESTMENTS, a single-life SPIA, and whole life insurance. It's not either/or. That's the whole point. And so 0% fees would also applies the the investments in scenario 3 as well.

And so with 0% fees, for the median outcomes, the integrated strategy's 401(k) balance lags the investments strategy by 14% at age 65, the integrated strategy provides 24% more income at the start of retirement, and by age 100 the integrated strategy's legacy wealth still lags by 4%.

As other commentators point out, the SPIAs I use are not inflation-adjusted. For the scenarios in the whitepaper, though, total income still stays ahead for the most part throughout retirement, as by the time inflation starts to have a big impact on the real income of the annuity, we start seeing investment portfolio depletion show up as well.

On Monday, I'll make charts for this 0% fee case. I think it is probably the case that the real income from the integrated strategy is going to drop below the investments strategy at some point in retirement. For DIY Bogleheads, the benefits of the integrated strategy are less clear cut, though they are not gone. It seems much closer to a draw at the median with more initial income, but a much longer breakeven to get the legacy wealth higher. And it's also definitely not obviously inferior, as some believe. These are just the median outcomes. In the 10th percentile of the distribution, the investments only strategy still experienced portfolio depletion with no available income or legacy, while the integrated strategy still has the annuity income, and the cash value of the whole life policy. Risk pooling is very valuable.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by wade » Sat May 16, 2015 9:12 pm

Another point which has been coming up is that most people lapse on their whole life policies before collecting the death benefit.

Obviously, for this strategy I'm discussing to work properly, it's important NOT to do that!

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by itstoomuch » Sat May 16, 2015 9:23 pm

One must have a good amount current income to afford WL premiums at purchase and purchased in the correct amount, for WL to provide retirement income.
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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by wade » Sat May 16, 2015 9:25 pm

On the subject about using the illustrated whole life policy in the simulations, this is something I considered a lot. For the median and 90th percentile outcomes for investments, I do think it is reasonable to expect that the illustration will hold.

It may be harder for the illustration to hold in the 10th percentile of investment outcomes. And so readers may wish to take a haircut for legacy wealth at age 100. One might also annuitize less income at 65 if the actual death benefit is less than the illustrated amount.

I would love to be able to simulate actual whole life policies, but that is significantly complicated than simulating just investments. Perhaps in the future.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by dhodson » Sat May 16, 2015 9:26 pm

That's less than 20% of people who purchase whole life.


If lapse rates decreased whole life returns would plummet.

Assuming the average non boglehead will pay those high fees but some how not be in the majority who lapse seems questionable at best.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by chessmannextmove » Sat May 16, 2015 9:36 pm

jaj2276 wrote:
chessmannextmove wrote:
jaj2276 wrote:
chessmannextmove wrote:
sometimesinvestor wrote:I read the article though not the paper but taken as a whole these two sentences do not make sense to me . Perhaps the paper explains

they can invest $14,281 per year in their 401(k) if they choose term life insurance, and they can invest $9,000 per year in their 401(k) if they choose whole life insurance.

In the average outcome (median), their 401(k) balance is 13% less if they use whole life insurance instead.

$14281 is almost 60% more than $9000
That's because term is unlikely to pay off (most people make it past 65) while whole life usually does (people always die, but giving up the policy is not necessary).
Huh? What does pay-off from term vs. whole life have to do with the 401k balance at the end of their contribution periods?

If I put $14,281/yr in a 401k for 30 years at 6% I get $1.2M. If I put in 9k/yr for 30 yrs at 6%, I get 750k. $9k is 37% less than $14,281 and $750k is 37% less than $1.2M. It doesn't make much sense then for the article to state that the 401k ending balances differ by 13% when the contributions themselves differ by much more.

Seems like both 401k plans would be affected by the same simulated returns but maybe there's something we're missing.

Off to read the whitepaper!
The total return on the strategies is affected by life insurance payoffs.
Sure, but the poster you were responding to was asking only about the 401k amounts.
And?

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by bsteiner » Sat May 16, 2015 10:09 pm

wade wrote:... The 1.59% fee assumption on investments doesn't apply to Bogleheads who view personal finance as a hobby and who take the time and energy needed to understand and live by the Bogleheads philosophy. This isn't the typical American though. Even many who COULD manage their own personal finances still prefer to delegate it for a fee, in order to save their time and energy for other pursuits ....
1.59% seems high. For about 1% you can get a bank or trust company or an independent firm to manage a portfolio of individual securities without a second level of fees. Or if you hire an advisor who doesn't manage individual securities, he/she could recommend lower cost mutual funds so there's only a small cost at the fund level. Some people who need help figuring out how to invest their money might drop their advisor after a few years if they're comfortable that they're on the right path.

In a 401(k) plan, there need only be one level of costs (the fund expenses); and many plans offer lower cost funds.

If you buy both life insurance and an annuity, that's like betting on both teams in the same game. Why would someone do that?
dhodson wrote:Nor does it consider the facts that over 80% of people who buy permanent life insurance surrender it. ....
At some point many people no longer need life insurance, so it's reasonable that they drop it, or exchange it for an annuity.
dhodson wrote:... If lapse rates decreased whole life returns would plummet. ...
Why is that? I've heard that several times but I never understood why that would be the case. It would seem that it should be the opposite.

I would think that the insureds who are in substantially below average health would keep their policies if at all possible, whereas the insureds in average or better than average or even slightly below average health would drop their policies when they no longer needed them. If more healthy insureds kept their policies, it would seem that the insurance companies would make more money, some of which they could share with the policyholders.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by 209south » Sun May 17, 2015 4:54 am

Thanks, Wade, for another very well done piece - your past work has convinced me to consider DIAs and SPIAs in the future, and I will read this more closely to determine whether there is a role in my plan for whole life (as a boglehead I presume the conclusion will be 'no' in my case). It is frightening that the average US investor may incur annual costs of 1.59% to manage their portfolios, but that is likely close to the truth, and another reason why I think many of the new robo-advisors are a godsend for the uninterested/uneducated investors out there - any of schwab, betterment or wealthfront will save an investor 75-100bps vs. your analysis and perhaps change the conclusion on the value of whole life in generic portfolios?

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by smashhand » Sun May 17, 2015 7:03 am

Thanks, Wade, for doing the work on this article. Owning paid-up life insurance for the past thirty-five years has given me and DW invaluable peace of mind and with a guaranteed four percent return on policy cash, the asset is even better nowadays, although I certainly never thought I'd say that at the time of the original purchase decision. Granted, every investor is unique, but including whole life with our Boglehead index investments has served us very well. By the way, thanks also for taking the time to swap posts with us here on the forum.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by dodecahedron » Sun May 17, 2015 7:08 am

bsteiner wrote: If you buy both life insurance and an annuity, that's like betting on both teams in the same game. Why would someone do that?
Great question, given the fees and sales loads on both policies. I am guessing the only possible source of advantage would be tax arb. The cash buildup in the life policy ultimately becomes part of the death benefit which escapes taxation at death (so, if you are going to hold fixed income assets anyway, might as well hold some of them inside your permanent life policy.) The earnings on your annuity do not escape taxation but the taxes on the earnings inside them can at least be partially deferred.
bsteiner wrote:
dhodson wrote:... If lapse rates decreased whole life returns would plummet. ...
Why is that? I've heard that several times but I never understood why that would be the case. It would seem that it should be the opposite.
I am guessing the reason is that insurance companies often offer permanent life policies that on paper look like great deals and in fact ARE great deals IF you hold on tenaciously. But if everyone did that, the company would go under. The company offers the policies anyway because their actuaries have analyzed the lapse rates and it looks profitable based on projected lapse rates. (I think LTC policies were originally priced that way--the assumption was that lapse rates would be high and the company could afford to offer what looked like positive expected value deals for the purchasers. Unfortunately,the actual lapse rates turned out higher than projections causing a number of issues.)

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by dhodson » Sun May 17, 2015 8:14 am

Lapse rates for LTCi were actually lower than permanent insurance which is why they caused a problem. They had to pay out more benefits then they anticipated.

One has to realize that these products have been around for over 100 years but they mostly lapse. Thats going to continue or as mentioned above, likely the insurance companies would go under especially in this low interest rate environment. Just look at the Japan experience of a long low interest rate environment. You might conclude permanent insurance isnt as safe of an investment as you previously thought. Insurance companies even use this in their pricing which they refer to as lapse support pricing.

Roughly 1/3 of people surrender very early on and get almost nothing back which greatly helps the insurance company. These contracts are front loaded to the extreme. Another 1/3 surrender before they even break even especially when you consider inflation. A small percentage keep it long enough that there is some sort of return. It aint great but its positive and another small percentage keep until death and get the best return. The return is always best within the death benefit. If you arent going to keep one in force until death, then pretty much you should never buy it.

I dont see how someone can recommend whole life to the masses expecting the illustrated returns knowing most have to surrender it and thus get a very poor return in order for just a few to get the returns they are talking about.

As mentioned above, the work was not peer review and it was industry sponsored.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Independent » Sun May 17, 2015 9:16 am

wade wrote:On the subject about using the illustrated whole life policy in the simulations, this is something I considered a lot. For the median and 90th percentile outcomes for investments, I do think it is reasonable to expect that the illustration will hold.

It may be harder for the illustration to hold in the 10th percentile of investment outcomes. And so readers may wish to take a haircut for legacy wealth at age 100. One might also annuitize less income at 65 if the actual death benefit is less than the illustrated amount.

I would love to be able to simulate actual whole life policies, but that is significantly complicated than simulating just investments. Perhaps in the future.
One test of the apples-to-apples question would be a simple discussion with one of the actuaries involved in the illustrated dividends. He/she should be able to give you the gross interest rate (before investment expenses) used in the dividend calculations. You can compare that rate to the median bond yields in the mutual funds.

I did an extremely crude calculation that tried to back into that rate. I got numbers close to 5%. That looks out of line with your median bond yield assumption.

Insurance companies sometimes use "portfolio average" interest rates instead of "investment year segmented" interest rates when calculating dividends. The nice numbers in the WL illustration could be the result of new business living off the portfolio yields.

(I'm assuming that the WL numbers you're using come from a policy issued by the company that is funding your research. So it would seem that they would be willing to share this information with you, even if they do not want the exact number disclosed publicly.)

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by White Coat Investor » Sun May 17, 2015 9:34 am

vertigo wrote:Hi everyone,

What are your thoughts regarding this article by Wade Pfau?

http://www.forbes.com/sites/wadepfau/20 ... annuities/
I thought the assumptions gave an unfair advantage that caused the conclusions to lean more toward the inclusion of whole life insurance in the portfolio/financial plan. 0.84% ERs and 0.75% advisory fees as I recall. Take those away and I'm not sure he'd end up at the same place. I've had readers email me questioning "Isn't Pfau one of the good guys? Why is he shilling for life insurance companies?" While I have no doubt insurance companies will use this paper to sell more insurance, I think the reader has the duty to read the "methods" section prior to determining if he agrees with the conclusion.

Using SPIAs is old news, of course.
1) Invest you must 2) Time is your friend 3) Impulse is your enemy | 4) Basic arithmetic works 5) Stick to simplicity 6) Stay the course

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by backpacker » Sun May 17, 2015 10:35 am

wade wrote: The 1.59% fee assumption on investments doesn't apply to Bogleheads who view personal finance as a hobby and who take the time and energy needed to understand and live by the Bogleheads philosophy. This isn't the typical American though. Even many who COULD manage their own personal finances still prefer to delegate it for a fee, in order to save their time and energy for other pursuits.
Even typical 35 year old investors (like the hypothetical investors in the paper) use target date funds and services like Betterment. In my own family, I'm the Boglehead. My wife would prefer to do other things. But even if she were on her own, her 401k would automatically put her in an age-appropriate Vanguard target date fund with an expense ratio of .17%. If she were using Betterment, her fees would be somewhere around .3%. Both fees are higher than .09%, but nowhere near 1.59%.
wade wrote:Another point which has been coming up is that most people lapse on their whole life policies before collecting the death benefit. Obviously, for this strategy I'm discussing to work properly, it's important NOT to do that!
We need to either compare typical investors or ideal investors. Typical investors pay 1.59% in portfolios fees, but they also typically surrender their whole life insurance policies. If we are going to assume that an investor is competent enough to not surrender her whole life policy, we should also assume that she is competent enough to at least invest her money in a Vanguard target date fund.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Tamales » Sun May 17, 2015 10:55 am

EmergDoc wrote: I thought the assumptions gave an unfair advantage that caused the conclusions to lean more toward the inclusion of whole life insurance in the portfolio/financial plan. 0.84% ERs and 0.75% advisory fees as I recall.
The article states those numbers came from Morningstar. Doesn't seem out of line as an average to me, based on things I've read.

Availability of low cost funds doesn't translate into participants moving to those options.

I haven't seen broad data on this, but in a recent discussion with my megacorp's retirement plan administrator, even though our company offers low cost index funds, a shocking 80%+ of participants stick with the default target date funds (which target year depends on participant age using a simple formula) and their associated ~1.5% expenses. They noted this includes some top-level executives so it's not something that is confined to low earners. Most people apparently want no active role in their retirement, or are too baffled by the options and the learning curve to do anything about it.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by itstoomuch » Sun May 17, 2015 1:24 pm

IMO, Sometime in a person's retirement planning/plan, the person will come to a realization that a secure source of income can secure cashflow.

https://www.oneamerica.com/wps/wcm/conn ... 0b0ef95d91

read the introduction to this paper.

We came to that realization in Nov 2008. :oops:
:annoyed
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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by FactualFran » Mon May 18, 2015 1:11 pm

In Scenario 3, upon Steve's death, "If necessary, Susie could then use part of the death benefit to buy another single-life income annuity." It would have been useful to have including this in the calculations. As is, Scenario 3 has an advantage over Scenario 2 because Scenario 3 does not account for Susie replacing the income from Steve's single-life annuity.

Combining the two concerns of retirement income and legacy wealth may result in a higher efficiency than keeping the concerns separate. For me, simplicity with acceptable efficiency is preferable to complexity with optimal efficiency.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by bsteiner » Mon May 18, 2015 1:37 pm

dhodson wrote:... Roughly 1/3 of people surrender very early on and get almost nothing back which greatly helps the insurance company. These contracts are front loaded to the extreme. Another 1/3 surrender before they even break even especially when you consider inflation. A small percentage keep it long enough that there is some sort of return. It aint great but its positive and another small percentage keep until death and get the best return. The return is always best within the death benefit. If you arent going to keep one in force until death, then pretty much you should never buy it. ....
If it made sense for healthy people to keep their policies even after they no longer need the coverage, then wouldn't there be a demand for such policies on the secondary market the way there is for policies on the lives of insureds in below average health?

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Independent » Mon May 18, 2015 1:40 pm

I think I see what you mean, but I'll rephrase it for my own benefit.

The median Scenario 3, before tax, "Legacy Wealth at Age 100", is $1.46 million. That number assumes that Steve lives to be 100. Susie probably died earlier, or may still be alive, but the important thing is that Steve makes it that far.

On the other hand, suppose Steve had died earlier and Susie had survived. In that case the life insurance policy was used to buy an annuity for Susie. Susie's only remaining assets would be the residual balance in the 401k. It looks like it would have a before tax value of about $90,000. (I'm basing that on the ratio of 401k withdrawals at age 65)

So, comparing death orders:
Susie dies first, Steve lives to 100: Legacy value = $1,460,000
Steve dies first, Susie lives to 100: Legacy value = $....90,000

It's hard to imagine a couple that really wants that result.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by dhodson » Mon May 18, 2015 3:18 pm

bsteiner wrote:
dhodson wrote:... Roughly 1/3 of people surrender very early on and get almost nothing back which greatly helps the insurance company. These contracts are front loaded to the extreme. Another 1/3 surrender before they even break even especially when you consider inflation. A small percentage keep it long enough that there is some sort of return. It aint great but its positive and another small percentage keep until death and get the best return. The return is always best within the death benefit. If you arent going to keep one in force until death, then pretty much you should never buy it. ....
If it made sense for healthy people to keep their policies even after they no longer need the coverage, then wouldn't there be a demand for such policies on the secondary market the way there is for policies on the lives of insureds in below average health?
Not really those aren't good for the owner either
It's about as good a deal as the commercials asking if you have some settlement coming to you. They really want to help.....

All you need to do though is look at an in force illustration and calculate the returns going forward at that point. Most of those people don't understand sunk costs or are desperate for money.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Minot » Mon May 18, 2015 3:47 pm

Fortunately, being single and expecting to continue so, I don't have to figure out whether Wade's article has value for me; it clearly does not apply.

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Re: Forbes article by Wade Pfau: Improving Retirement Outcomes with Investments, Life Insurance, and Income Annuities

Post by Independent » Sat Jun 06, 2015 4:03 pm

wade wrote: On Monday, I'll make charts for this 0% fee case.
This thread started on Saturday, May 16. Wade was good enough to respond to a number of comments, then said he wanted to do some further analysis. I think the thread kind of died as people waited for Wade to get back.

I found an interview dated June 2 where he is talking about the paper. At the very end he says "For do-it-yourself investors using very low-cost index funds, the argument for the integrated strategy is less compelling (though the argument doesn’t go away)."
http://www.marketwatch.com/story/your-r ... 6-02/print

Presumably, this says that he did the calculation, but forgot to paste the results here. I'd like to see them.

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