Taylor: Request for immediate annuity advice

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Ozonewanderer
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Taylor: Request for immediate annuity advice

Post by Ozonewanderer »

Mr. Larimore,
In another thread you recently posted a link to your interview with Motley Fools. An excellent interview indeed!

In that interview you stated the following:
"Immediate annuities are the only kind of annuity I would consider, and then, only in good health and well into retirement."

I understand two of the three points you make in this statement, but I would appreciate clarification an why you only recommend an annuity "well into retirement." I am retired, and I had been strongly considering purchasing an IA when interest rates rose to an acceptable level, which I might hope would be when I am in my early 60's. Are you advising deferring an IA until later in my retirement? If so, when and why?

I greatly appreciate all the wisdom that you have given and garnered for us all!
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Taylor Larimore
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Gone sailing

Post by Taylor Larimore »

Hi Ozonewanderer:

It is a beautiful morning in Miami and I am scheduled to participate in an early sailing regatta. I'll give you a response later when I get back. Meanwhile, I am sure you will get good replies.
"Simplicity is the master key to financial success." -- Jack Bogle
dpbsmith
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Post by dpbsmith »

I tried to deal with this question in this posting:

http://www.bogleheads.org/forum/viewtop ... 876#697876

Mel Lindauer paid me the compliment of pointing to it in his recent article, For Some Retirees, This Annuity Makes Sense.

In brief, a fixed annuity, simply in the nature of the beast, has both investment-like and insurance-like characteristics. People who dislike them think, mistakenly, that an annuity is just a way to irrevocably lock up your money and pay an insurance company for the privilege of having them pay you back your own principal and its interest earnings. What makes an annuity useful is that it is more than that--"mortality credits" kick in. The irrevocable principal paid in by shorter-lived annuitants is what finances the payments to the longer-lived annuitants.

But it is a gradual process. An annuity starts out "investment-y" at the beginning and becomes more "insurance-y" over time. So the case for an annuity becomes more and more compelling over time. But there's no hard-and-fast line, nobody can say there's a specific age. See my earlier post for more details.
The Wizard
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Post by The Wizard »

I have investments in TIAA-CREF which I can annuitize if I choose to when I quit fulltime work in the next decade.
If you manage your own investment pool in retirement, we typically say that 4% is a Safe Withdrawal Rate per year.
But annuity payouts can be around 7% per year, depending on your age when you annuitize.
If you try withdrawing that much from a personally managed accumulation, you will likely run out of funds 20 to 25 years down the road.

But many folks are uncomfortable giving up complete control of a large sum to an annuity company.
I think it comes partly down to: what are your plans and needs for financial assets after your death?
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bob90245
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Re: Taylor: Request for immediate annuity advice

Post by bob90245 »

Ozonewanderer wrote:... I would appreciate clarification an why you only recommend an annuity "well into retirement."
The basis of this claim only considers the fixed immediate annuity in isolation from the rest of retirement portfolio. Taking the rest of the retirement portfolio into consideration will reveal a different perspective.

Let's consider two sets of scenarios. In the first set, your portfolio earns a constant return of 6 percent per year.

Image

Blue line = annuity purchased at age 65
Pink line = annuity purchased at age 70
Green line = annuity purchased at age 75
Red line = annuity purchased at age 80

Notice that the path of the portfolio in all scenarios ends up very similar

Now let's look at a second set of scenarios. This time, the portfolio experiences -7% returns in the first two years with +7% returns thereafter.

Image

Notice that the portfolio path of only blue line with the annuity purchased at age 65 held up.

A detailed discussion can be found in the article I wrote here:

Immediate Annuities in Retirement
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
kenbrumy
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Post by kenbrumy »

Before you actually give money to an insurance company for a SPIA, I suggest you consider funding a sinking fund investment to pay you your social security equivalent until age 70. Deferring SS to age 70 is the best buy available for acquiring an inflation adjusted, US govt guaranteed annuity. The cost for deferring an age 70 SS check between 66 and 70 is a little less than $140,000 and increase a top end SS check from about $29,000 per year to around $39,000. These sums increase with inflation which most SPIAs will not.

The reason you would want a SPIA is that you are expecting or afraid you will significantly outlive your mortality table life span. Right now for males, that's about age 79. I've run numbers in the past and found that you have to live about 5 years past your mortality table life span to break even against conservative bond funds where you nibble into the principal. Feel free to run some current numbers.

The insurance company knows that if they sell 100 annuities to 65 yo males today that only fifty of them will still be collecting money at age 79. They also know that only 1 or 2 will be alive at 100. Unfortunately, most individuals don't know where they will be in the real world at any age. In effect you buy a SPIA to extend the reach of your financial assets beyond your mortality table life span.

Unfortunately, an SPIA is usually burdened with not allowing for inflation which will greatly reduce your spending power. Buying at 65 exposes you to 10 years of uncertainty as to inflation and your changing health situation than if you buy at 75. Also, as you age you are more likely to know if you look like you might be one of the real long lived individuals. I don't think most people know this at 65.

Another thing to consider is that a SPIA for a 65 yo is priced more as an investment vehicle that the insurance company expect to pay off on over 15 years or so (on average). At 75 there is more of a longevity factor in their rates. You aren't expected to live as long (on average) so there is a shorter period in their annuity calcs.

Here's a counter to the wait to 75 suggestion. If you truly live to be 100, you will receive significantly more money at the lower annuity rate at 65 than the higher 75 rate. Of course, on average half the people won't make 80.

bob90245 had a lot of numbers showing how a SPIA protects you from an overall portfolio drop. His calcs didn't adjust for what most people do that don't buy a SPIA which is to increase their bond allocation. A SPIA is a bond surrogate to most people when they establish their AA. Obviously, the friend of annuities is a collapsing stock market provided the insurance company and industry funded insurance pools don't fail. Their enemy is inflation which erodes purchasing power.
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Post by Ron »

kenbrumy wrote:A SPIA is a bond surrogate to most people when they establish their AA.
I guess I fall into the group that considers itself "special", since I did not change my AA even though I have an SPIA.

I look at the SPIA in the same manner that I look at SS, pension, or any other retirement income source. It just reduces the amount of required income in retirement from non-guaranteed sources (such as your portfolio). Maybe it's because I don't do any AA adjustments for any of these income sources either (e.g. SS as a bond discussion).

I/we did not forumulate our target AA based upon the SPIA or any other current/future income source. We look at the AA strictly from a risk vs. goal view. In our case, our target AA in early retirement is probably higher than most folks would consider prudent at our age; however we are not only investing for ourselves, but also for the next generation and can afford "dips" along the way. The SPIA did not impact that decision at all.

Just a view from somebody who is in the actual situation.

- Ron
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Post by kenbrumy »

Ron wrote:
I look at the SPIA in the same manner that I look at SS, pension, or any other retirement income source. It just reduces the amount of required income in retirement from non-guaranteed sources (such as your portfolio).

I/we did not forumulate our target AA based upon the SPIA or any other current/future income source. We look at the AA strictly from a risk vs. goal view. In our case, our target AA in early retirement is probably higher than most folks would consider prudent at our age; however we are not only investing for ourselves, but also for the next generation and can afford "dips" along the way. The SPIA did not impact that decision at all.

Just a view from somebody who is in the actual situation.

- Ron
But you probably did without realizing it. With the SPIA, you need less income from your portfolio (as you stated) and can be more aggressive (as you stated). Without the SPIA, you might be more risk averse than you are now and have a bit more in the fixed income department.
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Post by dpbsmith »

kenbrumy wrote:Before you actually give money to an insurance company for a SPIA, I suggest you consider funding a sinking fund investment to pay you your social security equivalent until age 70. Deferring SS to age 70 is the best buy available for acquiring an inflation adjusted, US govt guaranteed annuity....
Valid observation. This seems like one of the very few problems for which one of Fidelity's "income replacement" funds might be a solution.

Based on the experience of Nonnie and Bob U, repaying Social Security, which for some reason is getting a lot of press lately, does not sound like anything for the faint of heart. Deferring Social Security accomplishes about the same thing, and is easy to do.

It should be noted that whether you give your money to an insurance company or spend it down to meet expenses while deferring Social Security, it is just as "irrevocably" gone either way. Of course, spending down is gradual and can be stopped. But under your suggestion, you are still effectively making an irrevocable purchase of an SPIA, even though it's better than a commercial SPIA and even though you are doing it on the installment plan.
Unfortunately, an SPIA is usually burdened with not allowing for inflation which will greatly reduce your spending power.
I agree with you, to the point of saying that it seems foolish to buy a SPIA that makes level nominal-dollar payouts if your life expectancy is more than, say, ten years.

CPI-adjusted SPIAs are really the most rational option, but choices are very limited. What I call "you-guess-the-rate" SPIAs, those that allow you to specify fixed annual percentage increase (like 3%), are available from many companies. People who (for whatever reason) want an SPIA but don't like any of the CPI-indexed choices should consider at least get one that has an increasing payout over time.
insurancerenegade
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Post by insurancerenegade »

Ozonewanderer-

Actually Taylor, dpbsmith, Bob90245 and kenbrumy are all correct. The benefit of a SPIA is the mortality effect which enables you to consume your retirement potfolio as if you were going to die exactly on the date expected for people of your age. The longer you wait to buy a SPIA, the shorter your life expectancy and the bigger the SPIA payout if you have the same or greater capital available to invest.

My view is you should pick a portfolio with an asset allocation that has an comfortable risk profile (I think 50% stocks/50% bonds is too risky for someone who is retired.) As long as growth from that portfolio exceeds your withdrawal rate and you will have a higher net worth at the end of the year, you should wait to buy a SPIA. At the point where you expect your withdrawal rate to exceed your portfolio growth, you are now dipping into capital and should consider buying a SPIA.

In Bob90245's example, if instead of a 50/50 portfolio, you were invested in a 100% long bond portfolio yielding 4.5% after tax (150 bps above inflation), you could wait for 5 years (until you are 70)before inflation increased your withdrawals to more than your portfolio growth. That would be the point to consider a SPIA.

If long term interest rates had gone up in the interim, you would take a loss on the sale of the bond portfolio, but SPIA pricing reflects changes in bond yields, so you would get an offset.

Inflation is always the biggest threat to bond income (think of a SPIA as a "super bond" that pays a very high coupon as long as you live) , especially an unexpected increase in inflation. Inflation adjusted SPIA's and maximizing your monthly payout from Social Security (the most cost effective inflation adjusted SPIA available) can mitigate this risk. Also, holding TIPS in your remaining asset allocation post SPIA purchase can help reduce the inflation impact as well.

Hope this helps,
Ren
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Post by Ron »

kenbrumy wrote:But you probably did without realizing it. With the SPIA, you need less income from your portfolio (as you stated) and can be more aggressive (as you stated). Without the SPIA, you might be more risk averse than you are now and have a bit more in the fixed income department.
If you say so. Let's just say I did not make a conscious effort to target my AA depending on the SPIA (or any other guaranteed income source).

- Ron
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Taylor Larimore
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Why wait to purchase a lifetime annuity?

Post by Taylor Larimore »

Hi Ozonewanderer:
I would appreciate clarification an why you only recommend an annuity "well into retirement."
I'm back home. We placed second in a fleet of five one-design sailboats. I am happy to see that you have received some very good replies.

I will list the reasons I think it usually a good idea to wait until we are in our 70s or 80s to purchase a single premium life annuity (SPIA):

1. You may find you do not need the annuity because your portfolio increases in value; unexpected windfall, serious illness, early death, etc..

2. Once you've paid the premium, you have lost access to your money in most SPIAs.

3. Interest rates are currently very low and are likely to increase--resulting in higher lifetime benefits when stocks and interest rates rise.

4. At older ages inflation is less likely to erode spending power. There are a few inflation-adjusted SPIAs but their cost is significantly higher.

5. Shorter pay-out periods means less risk of the insurance company going broke.

6. At younger ages earnings (currently low) are more important than principal resulting in lower payouts. These are examples of monthly income for a one-time premium of $100,000 for men and women taken from immediateannuities.com:

AGE..MALE..FEMALE
60......$568......$533
65......$625......$579
70......$717......$645
75......$841......$754
80...$1,042......$928

Below are two articles on the subject:

It Pays to Delay by Jonathan Clements

Insuring Your Income -- Immediate annuities do just that, but don't rush into a contract -- Bloomberg

Not everyone should wait. If your portfolio is barely large enough to afford the the purchase of a life income annuity needed for income, it is probably better to buy the annuity now, rather than risk a portfolio decline resulting from a bear market or overspending.

I hope your question has been answered.
"Simplicity is the master key to financial success." -- Jack Bogle
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bob90245
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Re: Why wait to purchase a lifetime annuity?

Post by bob90245 »

Taylor Larimore wrote:6. At younger ages earnings (currently low) are more important than principal resulting in lower payouts. These are examples of monthly income for a one-time premium of $100,000 for men and women taken from immediateannuities.com:

AGE..MALE..FEMALE
60......$568......$533
65......$625......$579
70......$717......$645
75......$841......$754
80...$1,042......$928
These numbers, while true, do not consider what might happen to the portfolio while delaying beyond age 65 and tapping your nest egg. If your portfolio is light on stocks, you might not have to worry so much about volatility. But don't expect much growth, either.

If your portfolio is balanced with stocks, then volatility, especially poor returns early in retirement while you delay the annuity purchase, increases the risk of portfolio depletion.
Taylor Larimore wrote:3. Interest rates are currently very low and are likely to increase--resulting in higher lifetime benefits when stocks and interest rates rise.
While this is true, people have been lamenting low interest rates for the good part of the decade.

Image
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
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Post by kenbrumy »

Ron wrote: If you say so. Let's just say I did not make a conscious effort to target my AA depending on the SPIA (or any other guaranteed income source).

- Ron
You must not be a techno nerd like me and bob90245. BTW, you should go to Bob's website if you haven't. It has a lot of interesting articles.

I've sliced and diced my expected SS, pensions and withdrawal strategies way too many times. The more of my living expenses that can be covered by "guaranteed" funds the more aggressive I can be with the assets remaining based on the lifestyle desired.

Eventually, I came to believe the most reasonable approach is to do layers of funding. My pensions are relatively small but not insignificant. By deferring SS to 70, DW and I can live comfortably on the combined pension and SS income. She might not like it but we won't starve. A second layer of conservative investments (fixed income) brings life up to where DW would like to be. Equities (all index funds) will hopefully generate enough in gains and dividends to fund some traveling before it's too late.

Doing this approach requires more assets than simply getting to a bare bones 4% SWR lifestyle. However, I think it's more reasonable to have contingencies for what I do when the market melts down, inflation shoots up and interest rates wobble.

I might be personally more receptive to a SPIA if my SS and pensions (nothing but a SPIA bought for me by a former employer) didn't cover what I believe to be a basic cost of living.
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Post by Ron »

kenbrumy wrote:You must not be a techno nerd like me...
True; I left that life behind when I retired :lol: ...

- Ron
Last edited by Ron on Sun Aug 08, 2010 8:23 am, edited 2 times in total.
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Post by dpbsmith »

kenbrumy wrote:Eventually, I came to believe the most reasonable approach is to do layers of funding.
I think it was bob90245 who called my attention to a very sensible article entitled--yep, it was him, Google found it on his website--Tools and Pools. Very good. I think you'd appreciate it.
I might be personally more receptive to a SPIA if my SS and pensions (nothing but a SPIA bought for me by a former employer) didn't cover what I believe to be a basic cost of living.
Precisely. The appeal of an SPIA is a balancing act. The most important factor is the relationship of portfolio to the expenses it must supply. If the portfolio is, say, >30 times annual expenses, an SPIA is unappealing because there's no reason to make any of the tradeoffs involved. SPIAs become interesting when the portfolio size is "just barely enough."

The second most important factor is the "bequest motive," because an annuity assists you at the expense of your heirs.

I believe it is accurate to say in general that one shouldn't buy insurance that one doesn't need--that is, if one can self-insure. There is always a wide grey area in which it is theoretically possible to self-insure but a sane person could decide not to, because of a preference for paying a known small premium rather than tying up a large sum for a contingency that might never arise. But the general principal is don't insure if you don't need to. In the case of annuitization, that means if you can easily support yourself to age 110 without an annuity, there's no compelling reason to get one.

Where I get an emotional head of steam up is that I believe many people who are in the grey area of "only just barely enough" have only been shown the investment solution--straining for the investment mix that produces the highest safe withdrawal rate and so forth--without seriously presenting the SPIA as part of the toolkit. If what you want is a 5%-then-COLAed income stream, you should know that an annuity can provide that, with no market risk (yes, I'm dodging the insurer insolvency issue), whereas any attempt to do it with investments is risky. You just can't derive a safe 5%-then-COLAed from a risky asset. Of course there's been much more written about annuities lately and maybe my notion that people don't know about SPIAs has become (or always was) a straw man.

I tried to summarize the decision factors in Chapter 7 of the Bogleheads' Guide to Retirement Planning, thus:
<table><tbody>
<tr><th>Weighing in Favor</th><th>Weighing Against</th></tr>
<tr><td>Lower retirement savings </td><td>Higher retirement savings</td></tr>
<tr><td>Not concerned with money going to heirs</td><td>Important to leave money to heirs</td></tr>
<tr><td>Concerned about financially independence if very long-lived</td><td>Willing to accept help in very late life if needed</td></tr>
<tr><td>Risk-averse </td><td>Risk-tolerant</td></tr>
<tr><td>Older age</td><td>Younger age</td></tr>
<tr><td>Good health with family history of longevity</td><td>Poor health (unless medical underwriting can be obtained)</td></tr>
<tr><td>Willing to commit money irrevocably</td><td>Unwilling to lose control of money</td></tr>
<tr><td>Willing to trust an insurance company</td><td>Skeptical about insurance companies</td></tr>
<tr><td>Expect 10-year Treasury interest rates to fall in future</td><td>Expect 10-year Treasury interest rates to rise in future</td></tr>
<tr><td>Main concern: how many dollars a month will I get?</td><td>Main concern: how many dollars total will I get back over my lifetime? </td></tr>
</tbody></table>
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Ozonewanderer
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Post by Ozonewanderer »

I thank everyone for their helpful tips. There are clearly several solid reasons to buy an annuity late in retirement, or early in retirement, or not at all. Knowing the way I handle such financial decisions with so many competing factors to consider I'll probably be dead by the time I decide.

Or I may hedge my bets by laddering the purchase of SPIAs every 3-5 years, after interest rates move up.
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Post by kenbrumy »

Ozonewanderer wrote:Knowing the way I handle such financial decisions with so many competing factors to consider I'll probably be dead by the time I decide.
That's my usual recommendation. :D

Laddering purchases if you decide to buy is also the way to do it. Once you sign on the dotted line and give them the check you can't get your cash back. Buyers remorse is common amongst annuity buyers and it can't be undone. Wading into things slowly with low amounts of your assets lets you see how you react and see how it works for you.
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Post by kenbrumy »

dpbsmith wrote:I think it was bob90245 who called my attention to a very sensible article entitled--yep, it was him, Google found it on his website--Tools and Pools. Very good. I think you'd appreciate it.
It was interesting. It's similar to what I've come up with but with one extra pool. He also talked about buying extra fixed and variable annuities in a pool which isn't any part of my plan.

One thing he said which I hadn't really thought of was using the RMD calculation for withdrawals. Treating my personal IRAs like they were inherited (RMDs before 70 1/2) would significantly reduce the cash I was planning to dedicate to my safe money amount above the SS and pension amount. I'll think about that.

Thanks to you and bob90245
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Post by bob90245 »

kenbrumy wrote:Buyers remorse is common amongst annuity buyers and it can't be undone. Wading into things slowly with low amounts of your assets lets you see how you react and see how it works for you.
May I ask you to cite your source that "buyers remorse" is common?

I quick Google search for "satisfaction survey among fixed annuitants" produced this survey:

http://www.tiaa-crefinstitute.org/pdf/r ... on0410.pdf
www.tiaa-crefinstitute.org wrote:Satisfaction levels among annuitized retirees are high. Over one-half (57%) of annuitants are very satisfied with the decision to purchase a payout annuity and an additional 32% are somewhat satisfied; 6% are not satisfied, with 5% not responding.
I skimmed the rest of the paper and thought this table had more useful information from the survey:

Table 2
Reasons for Purchasing a Payout Annuity

For the regular monthly income 27%
Seemed like a good, safe investment for retirement 22%
An advisor said to purchase an annuity 21%
For income that is guaranteed for life 16%
No choice since the annuity was provided by their employer 9%
To supplement other income and investments 8%
Secure investment that won’t lose money 4%
Other reasons 5%
Don’t know 9%
Ignore the market noise. Keep to your rebalancing schedule whether that is semi-annual, annual or trigger bands.
kenbrumy
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Post by kenbrumy »

bob90245 wrote: May I ask you to cite your source that "buyers remorse" is common?

I quick Google search for "satisfaction survey among fixed annuitants" produced this survey:

http://www.tiaa-crefinstitute.org/pdf/r ... on0410.pdf
www.tiaa-crefinstitute.org wrote:Satisfaction levels among annuitized retirees are high. Over one-half (57%) of annuitants are very satisfied with the decision to purchase a payout annuity and an additional 32% are somewhat satisfied; 6% are not satisfied, with 5% not responding.
I skimmed the rest of the paper and thought this table had more useful information from the survey:

Table 2
Reasons for Purchasing a Payout Annuity

For the regular monthly income 27%
Seemed like a good, safe investment for retirement 22%
An advisor said to purchase an annuity 21%
For income that is guaranteed for life 16%
No choice since the annuity was provided by their employer 9%
To supplement other income and investments 8%
Secure investment that won’t lose money 4%
Other reasons 5%
Don’t know 9%
I have talked with numerous people over the years so I guess the best I can claim is anecdotal references. Most of the people I've talked with had had years to reflect on their purchase. In many cases there had been some sort of problem ranging from failure to rapidly changing interest rates/inflation greatly depressing the purchasing power of their purchase. Somehow, I have more faith in the people I've talked with than a study put out by a company that sells vast numbers of annuities.

Ask Coke and Pepsi if people like their product and I'm sure you'll find they have a study to support their claim they're loved by one and all. Who's right?

On this forum there are many people that vigorously affirm their happiness with their SPIA or deferred annuity for that matter. There are many paths to happiness. If you have an annuity and like it, that's great. I'm just a voice that expresses another view. I certainly don't make money off of people not buying annuities.

I personally have several SPIAs but they are the result of working for several different employers with defined benefit plans. Some I managed to stay with long enough to vest. Some were taken over and terminated their plans which resulted in immediate vesting. All in all, I have the NPV of a couple of hundred thousand dollars in these plans. Unfortunately, even several hundred thousand doesn't buy very much in annuity income. Even though it's not that much, I'm still glad it's there when I calculate my retirement plan.

If given a chance, I'd love to entertain a cash buy out but I don't think that's an option. On the plus side, a pension based SPIA is guaranteed by the Federal government. With all their problems, I still trust them far more than the state guarantee plans which are ultimately only backed by the insurance companies doing business in your state.
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Post by dpbsmith »

kenbrumy wrote:On the plus side, a pension based SPIA is guaranteed by the Federal government. With all their problems, I still trust them far more than the state guarantee plans which are ultimately only backed by the insurance companies doing business in your state.
That doesn't bother me as much as the fact that the protection limit in most states is $100,000, apparently because few states have ever adjusted them for inflation. That in turn is probably because very few people even know that the protection exists, so who is going to complain?

Another problem is that the law doesn't spell out exactly what the consumers gets; the guaranty association decides how to handle each event on a case-by-case basis, in accordance with law, but a law that gives them very broad scope. Perhaps the the latitude and flexibility that gives them actually works in the consumer's benefit, but I tend to doubt it.

Another problem is that the quality of insurance regulation varies widely from state to state.

There's no law of nature that says insurance should be state-regulated, and in fact in 1944 the Supreme Court ruled that insurance was interstate commerce--followed rapidly by Congress passing a law largely exempting insurance companies from Federal regulation. Personally, I don't see why ordinary consumers' life insurance, long-term-care insurance, and annuity policies aren't analogous to bank accounts and don't deserve similar protection. We accept deposit insurance as being in the public interest and as worth the cost of whatever "moral hazard" it creates.

I think the near-secrecy of the guaranty associations is a problem. I don't know how much of it is for perfectly valid "moral hazard" reasons, and how much of it is just because it is convenient for insurers and state insurance divisions, who get to balance the interests of insurers and consumers as they think best without pesky interference from the public.
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