Should one diversify into annuities and not bonds?

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antiqueman
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Should one diversify into annuities and not bonds?

Post by antiqueman » Tue May 14, 2019 11:28 am

The above question is almost an exact quote from DBR in his response to the 60 year 100% stock allocation thread. In that thread, DBR stated "should one diversify into annuities instead of bonds [ in retirement]. DBR suggested he might consider that issue in another thread.

I think Pfau or Kites, also suggested that annuities should replace bonds in retirement.

DBR will you give us your thoughts on this question ? Also does today low interest rates affect the decision on whether to annuitize or not? At least if one keeps individual bonds and cds, when they mature one can get the current interest rate for a certain period. The rat of return is locked in with annuities.

Thoughts?

Thank you.

Beehave
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Re: Should one diversify into annuities and not bonds?

Post by Beehave » Tue May 14, 2019 11:56 am

I'd suggest diversity in fixed-income sources (admittedly at the expense of simplicity). Here's why.

1. Annuities are contracts with insurance companies. The post 2009 regulations restraining large insurance company behavior are apparently about to be rescinded. This may (or may not) be a red flag to you.

2. Annuities are fixed according to the terms of the original contract. The rates don't change. They cannot be cashed in. Bonds can be cashed in and if interest rates rise, your bond holdings ought to be able to adjust up over time.

3. If you want explicit inflation protection it will cost plenty if you buy a COLA feature for an annuity. Inflation protected bonds are backed by the government and (I'm not an expert but believe) at much lower cost for COLA adjustments than than for annuities.

4. Annuities have mortality credits buit-in. Bonds don't. Deferred annuities can be especially beneficial because of this. In fact as a cheap way of providing both for income and inflation protection, laddered deferred annuities may be a beautiful component of a solution, because the successively delayed start dates successively increase payouts for the same initial investment.

For these reasons, I'd suggest a mix of corporate, Treasury, and inflation protected bonds (and cash!) plus annuities.

Best wishes.

Topic Author
antiqueman
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Re: Should one diversify into annuities and not bonds?

Post by antiqueman » Tue May 14, 2019 1:31 pm

Thank you.

ThrustVectoring
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Re: Should one diversify into annuities and not bonds?

Post by ThrustVectoring » Tue May 14, 2019 2:02 pm

There's two big factors for annuities that you missed:

1. The mortality credits means that these contracts do not benefit your heirs or any charities in your estate. You might care a lot about this, and if so annuities are a poor choice.

2. Annuity contracts and their proceeds are often afforded better protection from creditors, especially in states like Texas. It isn't an asset you can sell, so if a medical billing snafu attempts to saddle you with a six-figure "debt" there's little they can do to force payment.
Current portfolio: 60% VTI / 40% VXUS

Stormbringer
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Re: Should one diversify into annuities and not bonds?

Post by Stormbringer » Tue May 14, 2019 2:10 pm

It depends on your situation. If you aren't worried about leaving excess money to anyone when you die, you can generally obtain a higher income stream with an annuity than you can with bonds while eliminating longevity risk.
"Compound interest is the most powerful force in the universe." - Albert Einstein

columbia
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Re: Should one diversify into annuities and not bonds?

Post by columbia » Tue May 14, 2019 3:16 pm

Stormbringer wrote:
Tue May 14, 2019 2:10 pm
It depends on your situation. If you aren't worried about leaving excess money to anyone when you die, you can generally obtain a higher income stream with an annuity than you can with bonds while eliminating longevity risk.
Since there’s no free lunch, you’ll be dead when it’s served. ;). I’m ok with that outcome (house takes the rest of the money) for the trade off of higher income for life.

Dandy
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Re: Should one diversify into annuities and not bonds?

Post by Dandy » Tue May 14, 2019 3:54 pm

For these reasons, I'd suggest a mix of corporate, Treasury, and inflation protected bonds (and cash!) plus annuities.
+1 agree that a variety of fixed income diversity often makes sense. Each one has pros and cons.

1. Annuities provide lifetime income but it not often inflation protected,
2. Inflation Protected securities proved some
protection for inflation
that is not really guaranteed by other fixed income.
3. Corporate bonds usually provide higher yields but usually at higher risk
4. Cash/cash like products provide safety and stability usually participating in rising rates but not asset losses but somewhat lower yields
5. Treasuries provide government guarantees and tend to rise when there is a flight to quality and avoid state income taxes
6. Muni bonds while not mentioned, avoid Federal and may avoid state taxes.

Total bond, Inflation protection, and cash-cashlike seem to cover a lot. Add annuities if you need to supplement your other retirement income so your portfolio drawdown is reasonable.

dbr
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Re: Should one diversify into annuities and not bonds?

Post by dbr » Tue May 14, 2019 4:17 pm

The thought has to do with diversification. That means risks that are independent of each other. So annuities insure longevity risk. No other investment does that explicitly. Annuities fix the annual payout. Withdrawals from assets are always subject to thinking and rethinking how much to withdraw, which will vary hugely depending on when you are alive. Annuity payout does depend on available interest rates at the time of purchase. I sometimes make a joke that annuities also provide absolutely risk free storage of principal. It is exactly zero from the beginning. Holding a set of assets subjects one to great uncertainty regarding the wealth one has/will have. I see this as an example of a trade-off to one extreme of a set of problems that can be compared to the opposite extreme of a set of problems. That would be a definition of diversification. Fixed annuities are subject to inflation risk. Bonds are also subject to inflation risk and so are stocks. It might be possible to escape inflation risk for annuities and in fact Social Security offers that, with some contingencies. Inflation indexed bonds exist. Ironically if you want inflation indexing it is just exactly stocks that do not have that, though one can hope stocks outrun inflation. Annuities can have agency risk that may be harder to diversify than buying a bond mutual fund.

One should not be confused that being more diversified means one can spend more money in retirement or become more wealthy. Those things are about return, and diversification is about risk.

I should add that all of this is dependent on what the individual perceives as the risks that are of greatest consequence to his own objectives and preferences.

Also, in many cases there is no choice. Many, maybe most, pensions do not offer a lump sum option, nor does Social Security except concerning whether to leave SS to age 70, which is effectively purchasing an inflation indexed actuarially neutral annuity. One can already argue that if a large fraction of income is willy-nilly already covered by pensions, annuities, and SS that one does not need bonds.

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JoMoney
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Re: Should one diversify into annuities and not bonds?

Post by JoMoney » Tue May 14, 2019 9:41 pm

antiqueman wrote:
Tue May 14, 2019 11:28 am
... Also does today low interest rates affect the decision on whether to annuitize or not? At least if one keeps individual bonds and cds, when they mature one can get the current interest rate for a certain period. The rat of return is locked in with annuities...
If you're not planning on withdrawing/selling your bonds to finance your retirement spending then maybe you can reinvest (potentially at higher rates)... but if it's not money you're planning on needing/spending, that also negates the main purpose of the SPIA.

In a bond portfolio you that you were in withdrawal from, some of it might be for far into the future and might theoretically get reinvested at higher rates, but not if you were buying a ladder of maturities at today's available rates. Let me frame it this way: Imagine you're 70 years old and had cash to invest in fixed income for the next 15 years (that you hope will last the rest of your life), for the money you will need 10 to 15 years from now do you buy bonds that will mature in 10 to 15 years or do you buy short-term bonds now and hope you'll be able to buy at higher rates in the future?
If you would build a bond ladder with maturities all the way out at today's rates, then I don't see why buying a SPIA at todays rates is any different.
If you would rather keep your bonds/CDs in shorter term length and hope rates go up when your short-term bonds mature, then a SPIA probably isn't the way to go.
"To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks." - Benjamin Graham

272 Sheep
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Re: Should one diversify into annuities and not bonds?

Post by 272 Sheep » Wed May 15, 2019 9:19 am

Beehave wrote:
Tue May 14, 2019 11:56 am
I'd suggest diversity in fixed-income sources (admittedly at the expense of simplicity). Here's why.

1. Annuities are contracts with insurance companies. The post 2009 regulations restraining large insurance company behavior are apparently about to be rescinded. This may (or may not) be a red flag to you.

2. Annuities are fixed according to the terms of the original contract. The rates don't change. They cannot be cashed in. Bonds can be cashed in and if interest rates rise, your bond holdings ought to be able to adjust up over time.

3. If you want explicit inflation protection it will cost plenty if you buy a COLA feature for an annuity. Inflation protected bonds are backed by the government and (I'm not an expert but believe) at much lower cost for COLA adjustments than than for annuities.

4. Annuities have mortality credits buit-in. Bonds don't. Deferred annuities can be especially beneficial because of this. In fact as a cheap way of providing both for income and inflation protection, laddered deferred annuities may be a beautiful component of a solution, because the successively delayed start dates successively increase payouts for the sdame initial investment.

For these reasons, I'd suggest a mix of corporate, Treasury, and inflation protected bonds (and cash!) plus annuities.

Best wishes.
+2

I, personally, would not want to over-commit to an annuity and lock-up money (in a potentially rising interest rate environment?) which ought to be kept liquid for health reasons, emergencies or even vacations. I think delaying S.S. to 70 yrs old is like buying a short-range deferred annuity which has COLA built in which my wife and I are doing.
Carl W.

dbr
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Re: Should one diversify into annuities and not bonds?

Post by dbr » Wed May 15, 2019 10:13 am

272 Sheep wrote:
Wed May 15, 2019 9:19 am

I, personally, would not want to over-commit to an annuity and lock-up money (in a potentially rising interest rate environment?) which ought to be kept liquid for health reasons, emergencies or even vacations. I think delaying S.S. to 70 yrs old is like buying a short-range deferred annuity which has COLA built in which my wife and I are doing.
Carl W.
Right, concentrating in annuities would be just exactly not diversifying. The whole idea of diversifying is avoiding the practice of trying to decide what is better among choices, and it is really hard to get people off that "what is best" track.

adam1712
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Re: Should one diversify into annuities and not bonds?

Post by adam1712 » Wed May 15, 2019 10:44 am

ThrustVectoring wrote:
Tue May 14, 2019 2:02 pm
...

1. The mortality credits means that these contracts do not benefit your heirs or any charities in your estate. You might care a lot about this, and if so annuities are a poor choice.

...
The flip side is someone might want to leave the same amount to their heirs whether they die young or die old. If you have all investments, your heirs benefit financially from you dying young in retirement. If you have all annuities (and saving some of the payments), your heirs benefit financially from you dying old. Annuitizing some makes it more equal.

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Re: Should one diversify into annuities and not bonds?

Post by XdUzHa3NtSeIkBkIGPVn » Wed May 15, 2019 11:14 am

I agree that diversifying your fixed income sources is a good idea. I'd go one step further and try to diversify the annuity sources, to minimize agency risk at the expense of portfolio complexity.

In a recession, especially a finance sector-driven recession like 2008, I'd feel much better with 3 annuity income streams than one. This effectively increases the amount you can put in annuities and still be fully covered if your state insures annuity payments.

Also, I would not underestimate inflation risk. Considering most annuities are fixed, I'd want most of my non-annuity fixed income in inflation-protected securities, especially if your stock allocation is relatively low at that point.

bikechuck
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Re: Should one diversify into annuities and not bonds?

Post by bikechuck » Wed May 15, 2019 1:59 pm

Stormbringer wrote:
Tue May 14, 2019 2:10 pm
It depends on your situation. If you aren't worried about leaving excess money to anyone when you die, you can generally obtain a higher income stream with an annuity than you can with bonds while eliminating longevity risk.
I would say "mitigating" longevity risk rather than "eliminating" longevity risk. Insurance companies can and occasionally do fail.

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Re: Should one diversify into annuities and not bonds?

Post by bikechuck » Wed May 15, 2019 2:01 pm

272 Sheep wrote:
Wed May 15, 2019 9:19 am
I think delaying S.S. to 70 yrs old is like buying a short-range deferred annuity which has COLA built in which my wife and I are doing.
Carl W.
I am deferring until 70 as well, however with the sad shape of the SS Trust Fund I am not so sure that it is a great decision.

The Wizard
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Re: Should one diversify into annuities and not bonds?

Post by The Wizard » Wed May 15, 2019 2:15 pm

antiqueman wrote:
Tue May 14, 2019 11:28 am
The above question is almost an exact quote from DBR in his response to the 60 year 100% stock allocation thread. In that thread, DBR stated "should one diversify into annuities instead of bonds [ in retirement]. DBR suggested he might consider that issue in another thread.

I think Pfau or Kites, also suggested that annuities should replace bonds in retirement...
I think this is confusing two separate issues: income streams in retirement and portfolio risk management.

I did start some Immediate Annuties at start of retirement in 2013 with TIAA. These give me over $5000/month income and only a portion of it is fixed. The majority of it is variable based on commercial real estate or the broad stock market. So it fights inflation to a degree.

My remaining portfolio is ~60% stocks, with the other 40% split between TIAA Traditional and TREA, no actual bond funds right now...
Attempted new signature...

Topic Author
antiqueman
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Re: Should one diversify into annuities and not bonds?

Post by antiqueman » Wed May 15, 2019 7:35 pm

Thank you to all who have responded.

272 Sheep
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Re: Should one diversify into annuities and not bonds?

Post by 272 Sheep » Wed May 15, 2019 8:42 pm

bikechuck wrote:
Wed May 15, 2019 2:01 pm
272 Sheep wrote:
Wed May 15, 2019 9:19 am
I think delaying S.S. to 70 yrs old is like buying a short-range deferred annuity which has COLA built in which my wife and I are doing.
Carl W.
I am deferring until 70 as well, however with the sad shape of the SS Trust Fund I am not so sure that it is a great decision.
I am betting that there is too much politics (either side of the aisle) built into S.S. to allow it to fail.
It usually takes a mad crisis at 5 min. to midnight of deadline (what is it, 2034?) before all sides agree and then fix it! :D

bikechuck
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Re: Should one diversify into annuities and not bonds?

Post by bikechuck » Thu May 16, 2019 1:34 pm

272 Sheep wrote:
Wed May 15, 2019 8:42 pm
bikechuck wrote:
Wed May 15, 2019 2:01 pm
272 Sheep wrote:
Wed May 15, 2019 9:19 am
I think delaying S.S. to 70 yrs old is like buying a short-range deferred annuity which has COLA built in which my wife and I are doing.
Carl W.
I am deferring until 70 as well, however with the sad shape of the SS Trust Fund I am not so sure that it is a great decision.
I am betting that there is too much politics (either side of the aisle) built into S.S. to allow it to fail.
It usually takes a mad crisis at 5 min. to midnight of deadline (what is it, 2034?) before all sides agree and then fix it! :D
They have already been eroding some of the value in ways that are not so visible. SS income was not subject to federal income tax until the Reagan administration. They have been gradually increasing the retirement age which is easier for office workers than blue collar workers and they have been adding Medicare surcharges for people that were responsible and saved throughout their lives for retirement and thus have enough income to have to pay the surcharges for Medicare part B and D.

Based on the above I have zero confidence that our full benefits will be there when the trust fund runs dry. I do have confidence that there will be some level of benefits.

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