Should I buy this annuity?

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statman
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Should I buy this annuity?

Post by statman » Thu May 07, 2020 6:54 pm

Age 80, retired, comfortable income. My wife and I have over $2 million in Vanguard Intermediate Tax-Exempt, current distribution yield about 2.5% tax free; expect this to decrease as SEC yield is 1.83%. I'm thinking of taking $500,000 of this to buy an SPIA from NY Life (rated A++), dual life, 100% to survivor. This would pay $37,368 per year until the second death, all non-taxable until the purchase price has been returned, at age 93. So we go from 2.5% tax-free to 7.47% tax-free yield on this $500,000. Of course, the $500,000 is gone, but we have provided generously for our children in other ways.

Tell me why we should not do this? What have I overlooked?

3504PIR
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Re: Should I buy this annuity?

Post by 3504PIR » Thu May 07, 2020 7:10 pm

On the surface it seems that if you needed extra from the muni fund you could just sell shares. I have no idea of the tax handcuffs to the shares you may have, but that would equally apply to the $500k as well. No idea about your overall tax situation either so it’s difficult on that end as well.

fabdog
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Re: Should I buy this annuity?

Post by fabdog » Thu May 07, 2020 7:29 pm

so you need more income? Remember that with the annuity, as you noted, the $500K is gone. the 7.47% tax free you are seeing is partially a return of your capital that you put in.

So unless you need a more stable source of income to act as a floor... it's not clear why you'd want t do this? If you both live many more years, it could turn out great... you win on the mortality credits... if not, you don't.

Mike

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Re: Should I buy this annuity?

Post by Trader Joe » Thu May 07, 2020 7:31 pm

statman wrote:
Thu May 07, 2020 6:54 pm
Age 80, retired, comfortable income. My wife and I have over $2 million in Vanguard Intermediate Tax-Exempt, current distribution yield about 2.5% tax free; expect this to decrease as SEC yield is 1.83%. I'm thinking of taking $500,000 of this to buy an SPIA from NY Life (rated A++), dual life, 100% to survivor. This would pay $37,368 per year until the second death, all non-taxable until the purchase price has been returned, at age 93. So we go from 2.5% tax-free to 7.47% tax-free yield on this $500,000. Of course, the $500,000 is gone, but we have provided generously for our children in other ways.

Tell me why we should not do this? What have I overlooked?
No, I would never do this.

aarondearu
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Re: Should I buy this annuity?

Post by aarondearu » Thu May 07, 2020 7:35 pm

I would look more closely into the “tax free” part.
Return of principal is tax free but the earnings are going to be taxable.

Allan
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Re: Should I buy this annuity?

Post by Allan » Thu May 07, 2020 7:38 pm

At your age, looks like a no-brainer to me. I would give strong consideration to doing it.

Allan

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David Jay
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Re: Should I buy this annuity?

Post by David Jay » Thu May 07, 2020 7:43 pm

As long as you go in with your eyes open, understanding the implications (including no inflation protection), this is a reasonable action. My one concern is that there will be some taxation in out-years, likely for the survivor who will be filing single which lowers the start point of the tax brackets. Taylor Larimore has done something similar, as I understand it.

I have considered something like this for my spouse if I had a terminal condition but enough time to get things completed. I was anticipating purchasing a 2% annual escalator, which approximates historic long term inflation.
Last edited by David Jay on Thu May 07, 2020 7:50 pm, edited 2 times in total.
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hudson
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Re: Should I buy this annuity?

Post by hudson » Thu May 07, 2020 7:49 pm

statman wrote:
Thu May 07, 2020 6:54 pm
Age 80, retired, comfortable income. My wife and I have over $2 million in Vanguard Intermediate Tax-Exempt, current distribution yield about 2.5% tax free; expect this to decrease as SEC yield is 1.83%. I'm thinking of taking $500,000 of this to buy an SPIA from NY Life (rated A++), dual life, 100% to survivor. This would pay $37,368 per year until the second death, all non-taxable until the purchase price has been returned, at age 93. So we go from 2.5% tax-free to 7.47% tax-free yield on this $500,000. Of course, the $500,000 is gone, but we have provided generously for our children in other ways.

Tell me why we should not do this? What have I overlooked?
You already said that the $500K would be gone. That's why I wouldn't do it. You sound like that your other income would make it work.
But...I believe that Taylor Larimore did exactly that and gave his children early inheritances.
If you do it, consider staying under your state's "annuity Insurance" limit by buying two annuities....but you probably already knew that.
You've probably already read W. Bernstein's comments on the safety of SPIAs. I'll try to find where it is and post it.

EDIT...ADDITION...BERNSTEIN COMMENTS ON SPIAs...
In W. Bernstein's Ages of the Investor, Page 25, Location 340, Bernstein said that you give up your nest egg...we already said that. There are no emergency withdrawals...you knew that. The annuity company might fail...you knew that. Lastly, he said that the state guarantee association might run out of cash if many annuity companies failed.
Last edited by hudson on Thu May 07, 2020 8:07 pm, edited 2 times in total.

GibsonL6s
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Re: Should I buy this annuity?

Post by GibsonL6s » Thu May 07, 2020 7:53 pm

statman wrote:
Thu May 07, 2020 6:54 pm
Age 80, retired, comfortable income. My wife and I have over $2 million in Vanguard Intermediate Tax-Exempt, current distribution yield about 2.5% tax free; expect this to decrease as SEC yield is 1.83%. I'm thinking of taking $500,000 of this to buy an SPIA from NY Life (rated A++), dual life, 100% to survivor. This would pay $37,368 per year until the second death, all non-taxable until the purchase price has been returned, at age 93. So we go from 2.5% tax-free to 7.47% tax-free yield on this $500,000. Of course, the $500,000 is gone, but we have provided generously for our children in other ways.

Tell me why we should not do this? What have I overlooked?
I would ask for a quote for life with a cash refund. Many companies offer this. If something happens to you and your spouse, the unpaid premium is returned to your heirs. So after one year if something happened to you both the heirs would get about $460k.

In many instances the monthly amount is not all that much lower. Additionally, there are annuities with a guaranteed period like 20 years. In the case of kids, I would rather have the unpaid premium refunded. It is worth it my opinion.

As an example I put in a husband and wife both 80 into the calculator at immediate annuities.com and a life only quote was $3,312 a month and life with return of premium was $2,997, so 315 less a month for this feature.

Good luck.

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Nestegg_User
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Re: Should I buy this annuity?

Post by Nestegg_User » Thu May 07, 2020 7:56 pm

looking at the "immediateanniuities" site:
for both age 80, NY, $500k invested gave:

$3312/mo ===> $39,744 per yr
for joint life

and $3235/mo ===> $38,820 per yr
for joint life and 10 yr certain
so you might be able to get slightly better numbers

Tal-
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Re: Should I buy this annuity?

Post by Tal- » Thu May 07, 2020 8:12 pm

I don't hate the idea, but I do want to clarify a few things:

1: It's inaccurate to compare the 2.5% and 7.47%. I hate to use the word, but comparing these percents is a trick frequently used by annuity companies. This is because you are preserving the $2M with the mutual fund (and thus can spend it later), but the $500K capital is gone with the annuity. Either way, these percents are not measuring the same thing, and shouldn't be compared. (I'm sure we can provide more detail if you'd like an example or a more in-depth description)

2: As other have noted, the $37K is probably not tax free. There's fine print here, but technically, a SPIA is taxed, albeit at a low rate.

3: If you get a SPIA, I would consider paying extra so that payments increase slightly each year (often pegged to inflation).

4: While I don't mind you getting a SPIA, you are yet to provide a good reason why you should go this route. The one reason that you listed, namely going from a 2.5% rate to a 7.47% rate, is not a valid comparison and thus, not a valid reason. You may have valid reasons that you didn't include.

5: Sharks sharks sharks. Not all annuity salesmen are bad, but some of them - even lots of them - are simply con artists. As such, if you decide you want to consider this as an option, please please please get the final *contract* in hand, and then have it looked at by a professional such as an hourly financial planner. DON'T BE RUSHED INTO SIGNING!!! Getting the contract checked will cost you some money, but has a good chance to save you tens of thousands of dollars.
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wesgreen
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Re: Should I buy this annuity?

Post by wesgreen » Thu May 07, 2020 9:11 pm

To me, it seems that the inflation risk may have grown for the medium term, as a result of the US's response to the Corona virus. The situation looks very different compared to 3 months ago.

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Re: Should I buy this annuity?

Post by grabiner » Thu May 07, 2020 10:23 pm

wesgreen wrote:
Thu May 07, 2020 9:11 pm
To me, it seems that the inflation risk may have grown for the medium term, as a result of the US's response to the Corona virus. The situation looks very different compared to 3 months ago.
The best way to protect against this risk is to buy TIPS, since inflation-linked annuities are now rare. TIPS are subject to federal tax but not state tax, and with low yields, the tax cost on TIPS will be fairly low.
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Re: Should I buy this annuity?

Post by FoolStreet » Thu May 07, 2020 10:40 pm

statman wrote:
Thu May 07, 2020 6:54 pm
Age 80, retired, comfortable income. My wife and I have over $2 million in Vanguard Intermediate Tax-Exempt, current distribution yield about 2.5% tax free; expect this to decrease as SEC yield is 1.83%. I'm thinking of taking $500,000 of this to buy an SPIA from NY Life (rated A++), dual life, 100% to survivor. This would pay $37,368 per year until the second death, all non-taxable until the purchase price has been returned, at age 93. So we go from 2.5% tax-free to 7.47% tax-free yield on this $500,000. Of course, the $500,000 is gone, but we have provided generously for our children in other ways.

Tell me why we should not do this? What have I overlooked?
If you need the income, then SPIAs seem reasonable as others have posted.

Looking at it slightly differently... you are comparing a 1.85 sec yield to a 7% income stream. A middle ground is the so-called 4% Safe Withdrawal Rate. It has its issues because it assumes you split the 500k into a conservative AA stock:bonds. I get the sense you don’t want the risk of the stocks. But far all we know you might have stocks in a different “bucket” eg, for the kids.

What is nice about the SPIA is that it removes the behavioral aspects of managing your own lump sum.

Let us know what you decide and thanks for sharing.

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statman
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Re: Should I buy this annuity?

Post by statman » Fri May 08, 2020 7:58 am

Thank you for forcing me to understand this issue better. For the first 13 years (rounding slightly), the $37,368/yr paid by the annuity is entirely return of capital and hence not taxable. During this period, simply withdrawing $37,368 annually from the muni fund wins -- earn interest on what remains of the $500,000, and if both die in this period the remainder goes to heirs or charity. After 13 years (my age 93), the annual withdrawal has exhausted $500,000, but the annuity continues to pay $37,368/yr until the 2nd death -- all now taxable as ordinary income. So the annuity provides insurance against living to extreme old age and should be purchased only if this is needed. But after 13 yrs of 2% inflation, the annual payout valued in current dollars is only $28,887. So if insurance against extreme old age is wanted, purchase an annuity with a 2% annual inflation adjustment, which will of course provide less income during the initial 13 years. Decision: don't buy the annuity.

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Re: Should I buy this annuity?

Post by bsteiner » Fri May 08, 2020 8:10 am

statman wrote:
Fri May 08, 2020 7:58 am
Thank you for forcing me to understand this issue better. For the first 13 years (rounding slightly), the $37,368/yr paid by the annuity is entirely return of capital and hence not taxable. ...
Are you sure the basis comes out first rather than being prorated?
statman wrote:
Fri May 08, 2020 7:58 am
... the annuity provides insurance against living to extreme old age and should be purchased only if this is needed. ....
Correct.

hudson
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Re: Should I buy this annuity?

Post by hudson » Fri May 08, 2020 8:34 am

grabiner wrote:
Thu May 07, 2020 10:23 pm
The best way to protect against this risk is to buy TIPS, since inflation-linked annuities are now rare. TIPS are subject to federal tax but not state tax, and with low yields, the tax cost on TIPS will be fairly low.
I agree with Grabiner.
NOTE: Statman, the OP has decided to pass on the annuity.
With his resources, he could almost go all fixed income and just draw down his portfolio.
Inflation is always a risk.

mickroark
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Re: Should I buy this annuity?

Post by mickroark » Fri May 08, 2020 8:40 am

If were in your situation I would go on an extended vacation to Hawaii and live it up. I would want to spend my money before I passed. People today pass with way to much green. :greedy

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Re: Should I buy this annuity?

Post by #Cruncher » Fri May 08, 2020 9:53 am

Tal- wrote:
Thu May 07, 2020 8:12 pm
  1. It's inaccurate to compare the 2.5% [yield on a bond mutual fund] and 7.47% [payout of an annuity]. ...
  2. As other have noted, the $37K is probably not tax free. …
The return of an annuity (as opposed to its payout) depends on how long it runs. This one ($37,368 annual payout on $500,000 cost) must continue more than 13 years before it has a positive return, which then starts to rise rapidly each additional year either annuitant is alive.

Code: Select all

Years   Return
   12   (1.8%)
   13   (0.4%)
   14    0.6% 
   15    1.6% 
   16    2.3% 
   17    3.0% [*]
   18    3.5% 
   19    4.0% 
   20    4.4% 
   21    4.8% 
   22    5.1% 
   23    5.3%
Regarding taxation, I believe (no expert -- could be wrong) this type of annuity is covered by the IRS General Rule:
Under the General Rule, the tax-free part of each annuity payment is based on the ratio of your investment in the contract to the total expected return.
If this is correct, then one is supposed to determine the "expected return" using the joint life expectancy from Table VI (scroll down from here). If the wife is also age 80, it is just 12.8. Multiplying this by the $37,368 annual payment gives an expected return of only $478,000. Since this is less than the $500,000 cost, it looks like with these ages all of the money received would be non-taxable.

* Example calculation assuming annuity collected for 17 years until last person dies. (Uses Excel RATE function.)
3.0% = (1 + RATE(17 * 12, 37368 / 12, -500000, 0, 0)) ^ 12 - 1

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