Annuity article by Wade Pfau

[petulant]

A perpetuity is a bond that pays coupons with no redemption date. It goes on forever unless affirmative action is taken by the issuer to buy the bond back. Hence, a perpetuity can be inherited by heirs. The most famous example is the British consol, a perpetual bond issued prominently in the late 18th and then the 19th century. Plenty of ink has been spilled on 19th century British social relations based on the inheritance of consols. On the other hand, a SPIA has an end date when the buyer passes away. For the average 70-year-old annuitant, heirs will receive nothing else. A SPIA is absolutely not a perpetuity.

Yes I’m aware of the difference. But I’m also aware of the similarities, like how there is no maturity date or lump sum at the end

My "intuition" is not that a SPIA is a 17-year bond, i.e. a bond maturing in 17 years. I said clearly it should be compared at a first pass to a bond ladder. A bond ladder involves the purchase of bonds maturing each through a target year, with the maturing principal for that year plus interest from future years creating a cash flow. There are many threads on BH discussing bond ladders, most recently in the context of TIPS.

Fair enough

I invited you to actually do the work of creating a spreadsheet that shows bond ladder cashflows to see how much principal has to be returned in the first few years to create the target cash flow. If you had done so, you would know that about half of the amount returned in the first few years is principal. The return of principal means that the duration--the sensitivity of the NPV of future payments to interest rate changes--of a SPIA is much lower than the expected payout period. A rough analogy is to mortgage-backed securities. Although they are issued for 30 years--much longer than the lifespan of almost all 70-year-old annuitants--they have a much shorter duration in part because all mortgage payments include a return of principal (in addition to prepayments such as paying off debts, refinancing, and moving). The average duration of MBB, the iShares MBS ETF, is 6.04 years per the iShares website. The average yield to maturity reported by iShares is 5.10%. Even without prepayments from early payments, refinancing, moving, and so on, the duration of a 30-year mortgage with an interest rate of 5.10% would be around 11-12, much less than the mortgage life of 30. The duration of a 15-year mortgage with an interest rate of 5.10% would be around 7, much less than the mortgage life of 15.

I’m still not convinced that using the duration formula for perpetuity makes more sense for a SPIA.

Let’s take this definition of duration

Understanding the Macaulay Duration
The metric is named after its creator, Frederick Macaulay. Macaulay duration can be viewed as the economic balance point of a group of cash flows. Another way to interpret the statistic is that it is the weighted average number of years that an investor must maintain a position in the bond until the present value of the bond’s cash flows equals the amount paid for the bond.

https://www.investopedia.com/terms/m/ma ... ration.asp

That’s the big thing! When does the weighted average of cash flows received equal the amount paid for the bond. In your example the a SPIA had a duration of about 8 years. Well in the example I gave above a single male had a payout rate of about 8%. 8*8 is only 64% of the initial purchase price. Intuitively it makes no sense that 64% of 100 spread out over 8 years equals the purchase price made in the past.

The payout rate in the previous example wasn't 8%. It was 8.5%.

The duration concept you're talking about isn't the future year at which the nominal dollar value of cash received equals the price of the bond. It's the future year at which the present value of future cash flows equals the purchase price. To calculate it, it's not 8.5% * n years = %. If you review the article you linked, it requires taking the cash flow for each year, multiplying it by a discount rate, and then multiplying each year's cash flow by the number of years into the future, like so:

Code: Select all

Discount Rate = 4.2%
Life Expectancy = 17 years
SPIA Premium = $100,000
Payout Rate = 8.5%

Formula for Discounted = Payout/(1+Discount Rate)^Year
Formula for Disc*Yr = Discounted * Year

Year	Payout	Discounted	Disc*Yr
1	8500	8157		8157
2	8500	7828		15657
3	8500	7513		22539
4	8500	7210		28840
5	8500	6919		34597
6	8500	6640		39844
7	8500	6373		44611
8	8500	6116		48929
9	8500	5869		52826
10	8500	5633		56330
11	8500	5405		59465
12	8500	5188		62256
13	8500	4978		64726
14	8500	4778		66895
15	8500	4585		68785
16	8500	4400		70413
17	8500	4223		71798

Sum of Disc*Yr = 816675
Sum of Disc*Yr / SPIA Premium = 8.16

The duration is about 8.

A perpetuity has some duration. And if that duration is a shorter time frame than the time spent receiving the cash flows, how does it make any difference whether it’ll continue after death or not?

Duration isn't a payback period used to evaluate investments. Duration is a measure of sensitivity to interest rate changes used to evaluate risk. The value of a perpetuity would be measured as the net present value of future coupon payments with no maturity--if it was sold at a later time, then the price at that point would be the net present value of future coupon payments at that time, meaning that all of the value always comes from future coupon payments.

To use the 8.5% SPIA example, in order for a perpetuity to produce $8500 in income per year when prevailing interest rates are 4.2%, then the market price would be 8500/.042 = $202,380. (You can also double check the perpetuity by using a formula like =PV(.042,10000,-8500,0).) The SPIA producing $8500 per year for a 70-year-old cost $100,000. The perpetuity is worth twice as much. If that isn't enough to prove to you that they're fundamentally different instruments, I've got a bridge in Alaska to sell you.

What duration is saying for a perpetuity is that, because it will receive payments indefinitely, the market value of the perpetuity is very sensitive to interest rates. One little flick of the rate, and the market value will swing around. If we can imagine a SPIA as having a market value after purchase, its duration must be shorter than the perpetuity because it has an end date. Its interest rate sensitivity must be less. How much less, of course, depends on the life expectancy of the annuitant.

Another way of getting the intuition. Imagine a 40 year buys a SPIA. That person could literally collect for 70 years. Does that seem more like a perpetuity or a ladder with lump sums along the way?

It's possible that the person could collect for 70 years, but the expected period of collection for a 40-year-old buying a SPIA is more like 45 years. Undoubtedly the duration would be longer than for a 70-year-old purchasing a SPIA. One thing about NPV of future cash flow items is that as the period grows longer, the change in net present value is smaller since payments in the distant future are heavily discounted. For example, compare the NPV of a perpetuity paying $8500 per year when prevailing rates are 4.2%, which is about $202,380, to a 100-year mortgage with $8500 per year payments with a 4.2% interest rate. That mortgage's face value would be about $199,074. So, likewise, if a SPIA was going to last 50 years, its numbers would start to approach those of a perpetuity. But a 70-year-old's SPIA is not close to that yet.

An MBS doesn’t make sense, since as the principal gets paid down, there is less ongoing interest more principal gets paid off each month. A SPIA isn’t returning principal, or paying interest. It’s just a payout rate. There is no remaining balance or residual claim.

But under the hood, so to speak, a SPIA is returning principal. For example, the Internal Revenue Code taxes nonqualified annuities as if they were returning principal and paying a bit of interest over the life expectancy of the annuitant. After life expectancy, all of the income is taxable. Did you ever make the Treasury ladder spreadsheet I asked you to make? Do you know what a Treasury ladder is? If you looked at the cashflows, I think you would agree that a mortgage is probably the other best comparison.

[RationalWalk]

Might be a good idea to consider the real Macaulay duration. Nominal duration tells me how long it takes to recover my investment in nominal dollars but nothing about how long it might take to recover in real dollars. That's a problem when evaluating the cash flow provided by a nominal fixed payment annuity. Real duration is a function of the inflation rate and is a moving target in the case of a fixed annuity because it gets longer and longer as inflation compounds with time. With a TIPs ladder, I know the real duration. With a nominal annuity, not so much.

[StillGoing]

There used to be inflation indexed SPIAs but nobody wanted to buy them....

Why would they? Why would you give an insurance company 100k and get 4k/year which over 20 years will grow to 8k when you could give them 100k and get 8k/year? You need to live to like 90 to come out ahead... We had tons of threads on this board on how they were horrible deals and you were better off getting nominals. After a couple years of unexpected inflation people are thinking it might be a good idea to pay extra to off load this risk.

Just to take a real life example. A 65 year old in the UK with £100k can currently purchase a single life level annuity with a payout rate of £7317 per year (see https://www.hl.co.uk/retirement/annuiti ... -buy-rates).
Alternatively, our 65 year old could purchase a single life RPI linked annuity that will payout £4775. I note that this rate is considerably better than the historical 'safe' withdrawal rate for the UK of about 3.0-3.5%.

A 65 year old male in the UK has a 50% chance of reaching 85 years old, a 25% chance of living to 92 years, and a 10% chance of living to 96 years (i.e. periods of 20, 27, and 31 years, respectively). The odds are slightly better for a 65 year old female (see https://www.ons.gov.uk/peoplepopulation ... 2019-06-07)

In order for the income rate from the two annuities to be equal after 20 years, annualised inflation would need to run at 2.16%, after 27 years it would be 1.59% and 31 years, 1.39%. About 35% of 20 year periods in the UK had an annualised inflation less than 2.16% (it was 20% and 15% for the annualised inflation rates for 27 and 31 year periods, respectively).

In other words, historically the odds have been in favour of the RPI linked annuity. However, that is not to say that there haven't been retirements where selecting the level annuity would have led to a better outcome. In the extreme cases, after 25 years the income rate for the RPI annuity was about half that of the level annuity (e.g., during periods that had low inflation or deflation), while at the other extreme, the income rate from the level annuity was less than 20% of that of RPI annuity during periods of high inflation.

In reality, these have to be looked at in the context of combined annuity income and portfolio withdrawals.

cheers
StillGoing

[StillGoing]

A perpetuity is a bond that pays coupons with no redemption date. It goes on forever unless affirmative action is taken by the issuer to buy the bond back. Hence, a perpetuity can be inherited by heirs. The most famous example is the British consol, a perpetual bond issued prominently in the late 18th and then the 19th century. Plenty of ink has been spilled on 19th century British social relations based on the inheritance of consols. On the other hand, a SPIA has an end date when the buyer passes away. For the average 70-year-old annuitant, heirs will receive nothing else. A SPIA is absolutely not a perpetuity.

Yes I’m aware of the difference. But I’m also aware of the similarities, like how there is no maturity date or lump sum at the end

My "intuition" is not that a SPIA is a 17-year bond, i.e. a bond maturing in 17 years. I said clearly it should be compared at a first pass to a bond ladder. A bond ladder involves the purchase of bonds maturing each through a target year, with the maturing principal for that year plus interest from future years creating a cash flow. There are many threads on BH discussing bond ladders, most recently in the context of TIPS.

Fair enough

I invited you to actually do the work of creating a spreadsheet that shows bond ladder cashflows to see how much principal has to be returned in the first few years to create the target cash flow. If you had done so, you would know that about half of the amount returned in the first few years is principal. The return of principal means that the duration--the sensitivity of the NPV of future payments to interest rate changes--of a SPIA is much lower than the expected payout period. A rough analogy is to mortgage-backed securities. Although they are issued for 30 years--much longer than the lifespan of almost all 70-year-old annuitants--they have a much shorter duration in part because all mortgage payments include a return of principal (in addition to prepayments such as paying off debts, refinancing, and moving). The average duration of MBB, the iShares MBS ETF, is 6.04 years per the iShares website. The average yield to maturity reported by iShares is 5.10%. Even without prepayments from early payments, refinancing, moving, and so on, the duration of a 30-year mortgage with an interest rate of 5.10% would be around 11-12, much less than the mortgage life of 30. The duration of a 15-year mortgage with an interest rate of 5.10% would be around 7, much less than the mortgage life of 15.

I’m still not convinced that using the duration formula for perpetuity makes more sense for a SPIA.

Let’s take this definition of duration

Understanding the Macaulay Duration
The metric is named after its creator, Frederick Macaulay. Macaulay duration can be viewed as the economic balance point of a group of cash flows. Another way to interpret the statistic is that it is the weighted average number of years that an investor must maintain a position in the bond until the present value of the bond’s cash flows equals the amount paid for the bond.

https://www.investopedia.com/terms/m/ma ... ration.asp

That’s the big thing! When does the weighted average of cash flows received equal the amount paid for the bond. In your example the a SPIA had a duration of about 8 years. Well in the example I gave above a single male had a payout rate of about 8%. 8*8 is only 64% of the initial purchase price. Intuitively it makes no sense that 64% of 100 spread out over 8 years equals the purchase price made in the past.

The payout rate in the previous example wasn't 8%. It was 8.5%.

The duration concept you're talking about isn't the future year at which the nominal dollar value of cash received equals the price of the bond. It's the future year at which the present value of future cash flows equals the purchase price. To calculate it, it's not 8.5% * n years = %. If you review the article you linked, it requires taking the cash flow for each year, multiplying it by a discount rate, and then multiplying each year's cash flow by the number of years into the future, like so:

Code: Select all

Discount Rate = 4.2%
Life Expectancy = 17 years
SPIA Premium = $100,000
Payout Rate = 8.5%

Formula for Discounted = Payout/(1+Discount Rate)^Year
Formula for Disc*Yr = Discounted * Year

Year	Payout	Discounted	Disc*Yr
1	8500	8157		8157
2	8500	7828		15657
3	8500	7513		22539
4	8500	7210		28840
5	8500	6919		34597
6	8500	6640		39844
7	8500	6373		44611
8	8500	6116		48929
9	8500	5869		52826
10	8500	5633		56330
11	8500	5405		59465
12	8500	5188		62256
13	8500	4978		64726
14	8500	4778		66895
15	8500	4585		68785
16	8500	4400		70413
17	8500	4223		71798

Sum of Disc*Yr = 816675
Sum of Disc*Yr / SPIA Premium = 8.16

The duration is about 8.

A perpetuity has some duration. And if that duration is a shorter time frame than the time spent receiving the cash flows, how does it make any difference whether it’ll continue after death or not?

Duration isn't a payback period used to evaluate investments. Duration is a measure of sensitivity to interest rate changes used to evaluate risk. The value of a perpetuity would be measured as the net present value of future coupon payments with no maturity--if it was sold at a later time, then the price at that point would be the net present value of future coupon payments at that time, meaning that all of the value always comes from future coupon payments.

To use the 8.5% SPIA example, in order for a perpetuity to produce $8500 in income per year when prevailing interest rates are 4.2%, then the market price would be 8500/.042 = $202,380. (You can also double check the perpetuity by using a formula like =PV(.042,10000,-8500,0).) The SPIA producing $8500 per year for a 70-year-old cost $100,000. The perpetuity is worth twice as much. If that isn't enough to prove to you that they're fundamentally different instruments, I've got a bridge in Alaska to sell you.

What duration is saying for a perpetuity is that, because it will receive payments indefinitely, the market value of the perpetuity is very sensitive to interest rates. One little flick of the rate, and the market value will swing around. If we can imagine a SPIA as having a market value after purchase, its duration must be shorter than the perpetuity because it has an end date. Its interest rate sensitivity must be less. How much less, of course, depends on the life expectancy of the annuitant.

Another way of getting the intuition. Imagine a 40 year buys a SPIA. That person could literally collect for 70 years. Does that seem more like a perpetuity or a ladder with lump sums along the way?

It's possible that the person could collect for 70 years, but the expected period of collection for a 40-year-old buying a SPIA is more like 45 years. Undoubtedly the duration would be longer than for a 70-year-old purchasing a SPIA. One thing about NPV of future cash flow items is that as the period grows longer, the change in net present value is smaller since payments in the distant future are heavily discounted. For example, compare the NPV of a perpetuity paying $8500 per year when prevailing rates are 4.2%, which is about $202,380, to a 100-year mortgage with $8500 per year payments with a 4.2% interest rate. That mortgage's face value would be about $199,074. So, likewise, if a SPIA was going to last 50 years, its numbers would start to approach those of a perpetuity. But a 70-year-old's SPIA is not close to that yet.

An MBS doesn’t make sense, since as the principal gets paid down, there is less ongoing interest more principal gets paid off each month. A SPIA isn’t returning principal, or paying interest. It’s just a payout rate. There is no remaining balance or residual claim.

But under the hood, so to speak, a SPIA is returning principal. For example, the Internal Revenue Code taxes nonqualified annuities as if they were returning principal and paying a bit of interest over the life expectancy of the annuitant. After life expectancy, all of the income is taxable. Did you ever make the Treasury ladder spreadsheet I asked you to make? Do you know what a Treasury ladder is? If you looked at the cashflows, I think you would agree that a mortgage is probably the other best comparison.

Just to weigh in with a slightly different calculation of weighted maturity for a level annuity (SP is the gender neutral survival probability in the UK - I had these values to hand, DI is the discounted value, SWI is the survival weighted discounted value, and the weighted maturities is SWI*year).

Code: Select all

			Discount factor	4.20%		
			Nominal			
Age	Year	SP	Income	DI	SWI	Weighted maturities
65	0	1.000	10000	10000	10000	0
66	1	0.990	10000	9597	9503	9503
67	2	0.980	10000	9210	9024	18048
68	3	0.969	10000	8839	8562	25687
69	4	0.957	10000	8483	8117	32468
70	5	0.944	10000	8141	7686	38432
71	6	0.931	10000	7813	7270	43618
72	7	0.916	10000	7498	6866	48059
73	8	0.900	10000	7195	6474	51796
74	9	0.883	10000	6905	6094	54846
75	10	0.864	10000	6627	5724	57245
76	11	0.844	10000	6360	5365	59018
77	12	0.822	10000	6104	5016	60191
78	13	0.798	10000	5858	4677	60797
79	14	0.773	10000	5621	4347	60859
80	15	0.746	10000	5395	4027	60401
81	16	0.718	10000	5177	3715	59437
82	17	0.687	10000	4969	3411	57988
83	18	0.653	10000	4768	3116	56083
84	19	0.618	10000	4576	2828	53726
85	20	0.580	10000	4392	2549	50972
86	21	0.541	10000	4215	2279	47858
87	22	0.499	10000	4045	2020	44432
88	23	0.457	10000	3882	1772	40767
89	24	0.413	10000	3725	1539	36926
90	25	0.369	10000	3575	1320	33000
91	26	0.326	10000	3431	1117	29047
92	27	0.283	10000	3293	932	25152
93	28	0.242	10000	3160	764	21395
94	29	0.203	10000	3033	615	17836
95	30	0.167	10000	2911	485	14547
96	31	0.134	10000	2793	374	11586
97	32	0.105	10000	2681	281	8981
98	33	0.080	10000	2573	205	6749
99	34	0.059	10000	2469	144	4911
100	35	0.041	10000	2369	98	3433
101	36	0.028	10000	2274	64	2300
102	37	0.018	10000	2182	39	1453
103	38	0.011	10000	2094	22	852
104	39	0.006	10000	2010	12	462
105	40	0.003	10000	1929	6	224
106	41	0.001	10000	1851	2	99
107	42	0.001	10000	1776	1	37
108	43	0.000	10000	1705	0	7
109	44	0.000	10000	1636	0	0
				Ladder	Annuity	
			Total	209139	138461	9.5
			Rate	4.78%	7.22%	

The weighted maturity is 9.5 years. The duration will then depend on the coupons and yields of the individual bonds, but will be less than this. I also note that the annuity payout rate is 7.22%, but that may be down to different mortality statistics in the UK.

cheers
StillGoing

[randomguy]

There used to be inflation indexed SPIAs but nobody wanted to buy them....

Why would they? Why would you give an insurance company 100k and get 4k/year which over 20 years will grow to 8k when you could give them 100k and get 8k/year? You need to live to like 90 to come out ahead... We had tons of threads on this board on how they were horrible deals and you were better off getting nominals. After a couple years of unexpected inflation people are thinking it might be a good idea to pay extra to off load this risk.

Just to take a real life example. A 65 year old in the UK with £100k can currently purchase a single life level annuity with a payout rate of £7317 per year (see https://www.hl.co.uk/retirement/annuiti ... -buy-rates).
Alternatively, our 65 year old could purchase a single life RPI linked annuity that will payout £4775. I note that this rate is considerably better than the historical 'safe' withdrawal rate for the UK of about 3.0-3.5%.

A 65 year old male in the UK has a 50% chance of reaching 85 years old, a 25% chance of living to 92 years, and a 10% chance of living to 96 years (i.e. periods of 20, 27, and 31 years, respectively). The odds are slightly better for a 65 year old female (see https://www.ons.gov.uk/peoplepopulation ... 2019-06-07)

In order for the income rate from the two annuities to be equal after 20 years, annualised inflation would need to run at 2.16%, after 27 years it would be 1.59% and 31 years, 1.39%. About 35% of 20 year periods in the UK had an annualised inflation less than 2.16% (it was 20% and 15% for the annualised inflation rates for 27 and 31 year periods, respectively).

In other words, historically the odds have been in favour of the RPI linked annuity. However, that is not to say that there haven't been retirements where selecting the level annuity would have led to a better outcome. In the extreme cases, after 25 years the income rate for the RPI annuity was about half that of the level annuity (e.g., during periods that had low inflation or deflation), while at the other extreme, the income rate from the level annuity was less than 20% of that of RPI annuity during periods of high inflation.

In reality, these have to be looked at in the context of combined annuity income and portfolio withdrawals.

cheers
StillGoing

You haven't given enough info to say historically what is best. In the 2.16% case and under, the nominal is clearly winning. They hit 85 with the same income but the nominal person has 30-40k (that additional money that they were able to save over the first 20 years) to buy another annuity. At 85 you are getting like 10%+ payouts. You will be well north of 100 by the time the rpi annuity catches up. And it might never if you could buy annuities at 102. Those should have like 50%+ payouts:)

Now in the real world inflation is probably more like 3% so the RPI does better. You get income equality after like 15 years and parity in total income after another 10. So somewhere around 90 you break even. But as you say the odds of making it to 90 aren't tiny but not in your favor either.

Does that make RPI a bad deal? Well that depends on how much you are worried about living to like 95+ AND what your fear is of being in one of the high inflation 4%+ periods. The failure case for the 1966 nominal is pretty bad when your money is worth 1/3rd the starting value after like 15 years.

[AlwaysLearningMore]

Don't exaggerate. It is not negated. It is possibly greatly reduced some of the time and other times it is as expected or slightly better based on inflation expectations at the time of purchase.

I’m not exaggerating. The risk is wildly asymmetric. Just because we haven’t experienced it in the US (at least not for about 40 years) doesn’t mean it’s not there

viewtopic.php?t=382830

The exaggeration is to imply something is common that is not common. I agree on the asymmetry of extreme inflation. It is very asymmetric to run out of money and have to eat canned dog food at the age of 95, or to be robbed at the age of 85. These things are very common in elderly populations.

SPIA's don't help with the Weimer Republic, but not much did other than to leave. Very specifically, TIPS if they existed wouldn't have been good, because Germany defaulted on government debt during WWII (I believe there was litigation still pending a few years ago, a bit too late for any retirees I'm afraid).

Almost all asset classes are vulnerable to inflation unless you want to invest only in TIPS or try to create a hedge by shorting nominal treasuries and buying TIPS or better still can directly enter inflation swaps.

Ugh. Will this false equivalence never die…

viewtopic.php?p=7434785#p7434785

Not a false equivalence. Spending from a retirement portfolio is immediate, and real assets are prone to deep drawdown in real terms that don't work by themselves in a retirement portfolio. In the US these drawdowns have not been permanent (this is not true everywhere). Stocks and real estate and other real assets simply don't reliably go up during an inflation spike... as we've seen over the last few years. Even TIPS are not correlated to inflation in the short run... also as recent history shows. All real assets, as well as TIPs have an unfortunate tendency to be correlated to stocks during financial crisis.

If you are worried about tail risk, you simply need to dampen the volatility of a real asset portfolio with bonds or SPIAs. The SPIA is a way to both dampen the volatility as well as reduce mortality risk. Also, the SPIA better matches the duration of the retirees withdrawal needs (at least in nominal terms).

Unfortunately, real asset investments other than stocks are problematic for retirees, due to the lack of low cost, diversified, passive vehicles. Here "active" often means landlord.

There used to be inflation indexed SPIAs but nobody wanted to buy them....

I know. It makes me sad. But I remember it took index funds a long time to catch on, despite their obvious superiority. I hope the same thing happens here.

Don't be sad about the insurance market.

Also few and far between today, are SPIA's linked to the performance of an underlying stock fund. I am not talking about the common withdrawal benefits but a pure SPIA where the payment adjusted annually based on the stock markets return.

In your last paragraph, are you referring to immediate variable annuities?

[StillGoing]

There used to be inflation indexed SPIAs but nobody wanted to buy them....

Why would they? Why would you give an insurance company 100k and get 4k/year which over 20 years will grow to 8k when you could give them 100k and get 8k/year? You need to live to like 90 to come out ahead... We had tons of threads on this board on how they were horrible deals and you were better off getting nominals. After a couple years of unexpected inflation people are thinking it might be a good idea to pay extra to off load this risk.

Just to take a real life example. A 65 year old in the UK with £100k can currently purchase a single life level annuity with a payout rate of £7317 per year (see https://www.hl.co.uk/retirement/annuiti ... -buy-rates).
Alternatively, our 65 year old could purchase a single life RPI linked annuity that will payout £4775. I note that this rate is considerably better than the historical 'safe' withdrawal rate for the UK of about 3.0-3.5%.

A 65 year old male in the UK has a 50% chance of reaching 85 years old, a 25% chance of living to 92 years, and a 10% chance of living to 96 years (i.e. periods of 20, 27, and 31 years, respectively). The odds are slightly better for a 65 year old female (see https://www.ons.gov.uk/peoplepopulation ... 2019-06-07)

In order for the income rate from the two annuities to be equal after 20 years, annualised inflation would need to run at 2.16%, after 27 years it would be 1.59% and 31 years, 1.39%. About 35% of 20 year periods in the UK had an annualised inflation less than 2.16% (it was 20% and 15% for the annualised inflation rates for 27 and 31 year periods, respectively).

In other words, historically the odds have been in favour of the RPI linked annuity. However, that is not to say that there haven't been retirements where selecting the level annuity would have led to a better outcome. In the extreme cases, after 25 years the income rate for the RPI annuity was about half that of the level annuity (e.g., during periods that had low inflation or deflation), while at the other extreme, the income rate from the level annuity was less than 20% of that of RPI annuity during periods of high inflation.

In reality, these have to be looked at in the context of combined annuity income and portfolio withdrawals.

cheers
StillGoing

You haven't given enough info to say historically what is best. In the 2.16% case and under, the nominal is clearly winning. They hit 85 with the same income but the nominal person has 30-40k (that additional money that they were able to save over the first 20 years) to buy another annuity. At 85 you are getting like 10%+ payouts. You will be well north of 100 by the time the rpi annuity catches up. And it might never if you could buy annuities at 102. Those should have like 50%+ payouts:)

Now in the real world inflation is probably more like 3% so the RPI does better. You get income equality after like 15 years and parity in total income after another 10. So somewhere around 90 you break even. But as you say the odds of making it to 90 aren't tiny but not in your favor either.

Does that make RPI a bad deal? Well that depends on how much you are worried about living to like 95+ AND what your fear is of being in one of the high inflation 4%+ periods. The failure case for the 1966 nominal is pretty bad when your money is worth 1/3rd the starting value after like 15 years.

You are quite right that there wasn’t quite enough information – as I said in my last line, modelling a combined portfolio and annuity is an important consideration – so here goes.

For the modelling below I have used an initial portfolio of 50% total stock market and 50% total bond market with US returns derived from the Simba spreadsheet. I’ve used annual rebalancing and withdrawals over a 40 year horizon (acknowledging that it is unlikely that a 65 year old will reach the age of 105, but also noting that, in the UK, the chance of one member of a 65 yo M/F couple making it to 100 (i.e. a 35 year horizon) is about 8%. The combined annuity income and portfolio withdrawals were set to a constant inflation adjusted 4.0% of the initial portfolio value.

Three cases have been modelled
1) Portfolio only
2) 50% of the initial portfolio was used to purchase a single life level annuity with a payout rate of 7.317% (assuming a 65yo retiree).
3) 50% of the initial portfolio was used to purchase a single life RPI linked annuity with a payout rate of 4.775%.

As in a previous post (viewtopic.php?p=7457956#p7457956), after an annuity purchase the stock allocation was set to glide linearly from 100% to 50% over the 40 year period. I note that I am mixing UK annuity rates with US returns, but the outcomes should be broadly applicable in the event that index linked annuities ever become available again in the US.

In the following graph, the deciles of current portfolio value (CPV) expressed, in real terms, as a percentage of the initial portfolio value (%IPV) are plotted as a function of time since retirement for the portfolio only case (the lowest line is the zeroth percentile, i.e. worst case, the next lowest the 10th percentile, etc.).



There are no instances where the portfolio fell to zero in the first 30 years, but portfolio exhaustion occurred after 40 years in somewhere between 10 and 20% of historical retirements.

In the next two graphs, the same quantity is plotted for the level and RPI annuity cases.



The purchase of the level annuity resulted in a poorer performance in the worst historical cases than with portfolio only since portfolio exhaustion occurred before 30 years. However, the next decile of cases were improved by the purchase of the level annuity since, unlike with portfolio only, portfolio exhaustion no longer occurred.



With the purchase of the RPI annuity, unlike the level annuity or portfolio only, there were no cases of portfolio exhaustion prior to 40 years (although the worst case came close). However, it is worth noting, that using just under 84% of the portfolio to purchase the RPI annuity (rather than 50%) would have ‘guaranteed’ 4% income and, after about 20 years, would have seen larger portfolios in the lowest few deciles.

The following graph shows the deciles of the ratio of CPV with a level annuity to the CPV with the RPI annuity.



Here the level annuity has a clear advantage over the RPI annuity in terms of CPV except in the worst 20% of historic cases or so (CPV for the level annuity is worse, i.e. the ratio<1, after 12 years at the 0th percentile, 20 years for the 10th percentile, and about 34 years for the 20th percentile). In other words, in about 80% of historical retirements, the retiree who chose the level annuity had a larger portfolio than the one who chose the RPI annuity.

So, to summarise

1) The level annuity had the benefit of generally providing a larger portfolio, but, in poor retirements, this was at the cost of running out of money earlier than the portfolio only or RPI annuity cases.

2) The RPI annuity had the benefit of improving portfolio survivability in the worst cases (there were no instances of portfolio exhaustion before 40 years had elapsed) but, in the remaining 80% of cases the portfolio was smaller than when purchasing a level annuity. However, I note that where the payout rate for the RPI annuity exceeded the target withdrawal rate of 4%, using (in this particular case) just over 80% of the portfolio to buy the annuity would have guaranteed the required income for life but at the expense of a much reduced portfolio/legacy in the event of early death, but an increased portfolio in the event of living past life expectancy.

Of course, different relative annuity payout rates will change the outcomes and, clearly, inflationary conditions similar to or worse than those found historically will affect the outcome with the level annuity more than that with the RPI annuity.

So, I think the answer to the question “Which was best?” will depend on the retiree and whether other sources of fully inflation protected income exist (i.e., state pension/social security or DB pension) and what proportion of essential, lifestyle, or aspirational expenditure they cover. One approach would be to ensure that essential and at least part of lifestyle expenditure is covered by inflation protected sources of income (including RPI annuity where this is required and available), while the portfolio and, potentially, a level annuity covers the other part of lifestyle and aspirational expenditure.

cheers
StillGoing

[RationalWalk]

At least in the UK, nursing home care has soared.

The average weekly cost of residential care homes in the UK rose by 19% from 2021-22 to 2022-23, according to analysis of data from market researchers Laing Buisson.

If it's anything like this in the US, a nominal annuity will fall far short. Everything will fall far short. Good luck to all of us as we sail into the Last Port.

[000]

Yes it is. But since we're betting, I'd like to take the other side.

There are better bets on inflation than TIPS or a hypothetical CPI-linked annuity....

[Nahtanoj]

If you're interested in annuities, or even if you're interested in learning more about them in general, I though this interview with Christine Benz was terrific. Very straightforward, great questions (answering many in the thread), great answers. There's going to be something for everyone; I was particularly intrigued by their conversation regarding state guarantees. I also found the limitations regarding insurance company ratings very enlightening.

Here is a link to the interview you were likely referring to: https://www.morningstar.com/financial-a ... retirement.

[will23]

Also few and far between today, are SPIA's linked to the performance of an underlying stock fund. I am not talking about the common withdrawal benefits but a pure SPIA where the payment adjusted annually based on the stock markets return.

In your last paragraph, are you referring to immediate variable annuities?

Yes. The most consumer friendly products to protect against longevity risk are 1) fixed annuity (as a replacement for part of the bond portfolio) or 2) a fixed variable annuity (as a replacement for stocks or potentially bonds if using a bond VA).

It can be challenging to compare costs for (2) which may be partly why they are not popular... they have a general black box feel. Costs are the mortality guarantee which is evident in the initial payment and the fund management fee.

[randomguy]

So, to summarise

1) The level annuity had the benefit of generally providing a larger portfolio, but, in poor retirements, this was at the cost of running out of money earlier than the portfolio only or RPI annuity cases.

2) The RPI annuity had the benefit of improving portfolio survivability in the worst cases (there were no instances of portfolio exhaustion before 40 years had elapsed) but, in the remaining 80% of cases the portfolio was smaller than when purchasing a level annuity. However, I note that where the payout rate for the RPI annuity exceeded the target withdrawal rate of 4%, using (in this particular case) just over 80% of the portfolio to buy the annuity would have guaranteed the required income for life but at the expense of a much reduced portfolio/legacy in the event of early death, but an increased portfolio in the event of living past life expectancy.

Of course, different relative annuity payout rates will change the outcomes and, clearly, inflationary conditions similar to or worse than those found historically will affect the outcome with the level annuity more than that with the RPI annuity.

So, I think the answer to the question “Which was best?” will depend on the retiree and whether other sources of fully inflation protected income exist (i.e., state pension/social security or DB pension) and what proportion of essential, lifestyle, or aspirational expenditure they cover. One approach would be to ensure that essential and at least part of lifestyle expenditure is covered by inflation protected sources of income (including RPI annuity where this is required and available), while the portfolio and, potentially, a level annuity covers the other part of lifestyle and aspirational expenditure.

cheers
StillGoing

I am not sure about mixing different countries as I would be worried that you are ignoring currency risks and the acceptability of having high stock allocation (i.e. are you gong to have a heart attack when your 100% stocks portfolio drop 50%) which limit the ability to annuitize 50% of your portfolio but yes those are the basic findings that everyone comes to. On average you do better with a nominal one. Can you convince people to give up ~10% of their money on average to protect against inflation? Very tough sell in the 2000-2020 period. Can you convince them to annuitize money to protect against longevity at the cost of leaving less money if you die in the first 20 years in exchange for more money if you live to 90? This has also been a tough sell.

[StillGoing]

So, to summarise

1) The level annuity had the benefit of generally providing a larger portfolio, but, in poor retirements, this was at the cost of running out of money earlier than the portfolio only or RPI annuity cases.

2) The RPI annuity had the benefit of improving portfolio survivability in the worst cases (there were no instances of portfolio exhaustion before 40 years had elapsed) but, in the remaining 80% of cases the portfolio was smaller than when purchasing a level annuity. However, I note that where the payout rate for the RPI annuity exceeded the target withdrawal rate of 4%, using (in this particular case) just over 80% of the portfolio to buy the annuity would have guaranteed the required income for life but at the expense of a much reduced portfolio/legacy in the event of early death, but an increased portfolio in the event of living past life expectancy.

Of course, different relative annuity payout rates will change the outcomes and, clearly, inflationary conditions similar to or worse than those found historically will affect the outcome with the level annuity more than that with the RPI annuity.

So, I think the answer to the question “Which was best?” will depend on the retiree and whether other sources of fully inflation protected income exist (i.e., state pension/social security or DB pension) and what proportion of essential, lifestyle, or aspirational expenditure they cover. One approach would be to ensure that essential and at least part of lifestyle expenditure is covered by inflation protected sources of income (including RPI annuity where this is required and available), while the portfolio and, potentially, a level annuity covers the other part of lifestyle and aspirational expenditure.

cheers
StillGoing

I am not sure about mixing different countries as I would be worried that you are ignoring currency risks and the acceptability of having high stock allocation (i.e. are you gong to have a heart attack when your 100% stocks portfolio drop 50%) which limit the ability to annuitize 50% of your portfolio but yes those are the basic findings that everyone comes to. On average you do better with a nominal one. Can you convince people to give up ~10% of their money on average to protect against inflation? Very tough sell in the 2000-2020 period. Can you convince them to annuitize money to protect against longevity at the cost of leaving less money if you die in the first 20 years in exchange for more money if you live to 90? This has also been a tough sell.

Sorry, I should have been clearer, not literally mixing countries, merely taking the annuity rates for the UK (since we have actual ones for both level and RPI) and assuming the same rates could pertain to the US (I could also have used current TIPS rates to estimate the payout rate on an CPI annuity).

I agree with your assessment of the decisions that retirees would have to make. In the UK, where I have some data (https://www.fca.org.uk/data/retirement- ... ta-2021-22), from April 2018 to March 2022, between 83-87% of annuities sold in each 6 month period were level, with the remaining being 'escalating' (which includes RPI and fixed COLA - the figures are not broken down separately) this is in a period where only about 10% of retirement pots were used to purchase an annuity at all. While more recent data has yet to be published, there are some signs from the industry that, since the rise in bond yields, the number of annuities purchases has increased in 2023 (e.g. https://www.abi.org.uk/news/news-articl ... %20billion) and those with inflation protection of some kind are forming a greater fraction.

cheers
StillGoing

[AlwaysLearningMore]

Also few and far between today, are SPIA's linked to the performance of an underlying stock fund. I am not talking about the common withdrawal benefits but a pure SPIA where the payment adjusted annually based on the stock markets return.

In your last paragraph, are you referring to immediate variable annuities?

Yes. The most consumer friendly products to protect against longevity risk are 1) fixed annuity (as a replacement for part of the bond portfolio) or 2) a fixed variable annuity (as a replacement for stocks or potentially bonds if using a bond VA).

It can be challenging to compare costs for (2) which may be partly why they are not popular... they have a general black box feel. Costs are the mortality guarantee which is evident in the initial payment and the fund management fee.

Thank you for taking the time to respond.
Kerry Pechter mentioned them in a somewhat recent interview he did promoting his new Annuities for Dummies book. IIRC Bob Carlson also has a section on them at his website.

I've heard that Vanguard at one time sold them. (Pechter worked at Vanguard for years.)

Many years ago we purchased a low cost Vanguard variable annuity and one of the payout options is a variable payout using one of several mandated portfolios (one is the variable annuity version of Wellington fund, and the other is IIRC like a VG life strategy fund). The all-in cost for the Wellington version is 50 basis points, and it's the option we will likely use when we annuitize our contract.

Out of curiosity, I have looked for other low cost immediately variable annuity providers but could not come up with much. We would never 1035 into another annuity because I don't think we can duplicate what we have, but just wondered what else was out there.

[GaryA505]

I don't believe Wade Pfau's article was referring to Variable Annuities, which are a totally different beast from a SPIA, DIA, or FIA.

[will23]

Yes. The most consumer friendly products to protect against longevity risk are 1) fixed annuity (as a replacement for part of the bond portfolio) or 2) a fixed variable annuity (as a replacement for stocks or potentially bonds if using a bond VA).

It can be challenging to compare costs for (2) which may be partly why they are not popular... they have a general black box feel. Costs are the mortality guarantee which is evident in the initial payment and the fund management fee.

Thank you for taking the time to respond.
Kerry Pechter mentioned them in a somewhat recent interview he did promoting his new Annuities for Dummies book. IIRC Bob Carlson also has a section on them at his website.

I've heard that Vanguard at one time sold them. (Pechter worked at Vanguard for years.)

Many years ago we purchased a low cost Vanguard variable annuity and one of the payout options is a variable payout using one of several mandated portfolios (one is the variable annuity version of Wellington fund, and the other is IIRC like a VG life strategy fund). The all-in cost for the Wellington version is 50 basis points, and it's the option we will likely use when we annuitize our contract.

Out of curiosity, I have looked for other low cost immediately variable annuity providers but could not come up with much. We would never 1035 into another annuity because I don't think we can duplicate what we have, but just wondered what else was out there.

I looked into the vanguard annuity and chose not to purchase it because the tax benefits weren't clear enough in my situation, but I feel like you probably won't find a better deal. That was the short answer. The long answer is...

But you didn't find any because you are looking in the wrong place . I don't think variable immediate annuities are sold very much if at all. But what is sold are annuities like yours that have an option to annuitize; I think an annuity option may even be required, perhaps someone else knows. These work similar to your vanguard option, I believe. So for example from a paclife prospectus:

"For variable annuity payments, the tables are based on an assumed annual investment return of 5% and the 1983a Annuity Mortality
Table with the ages set back 10 years. If you elect a variable annuity, your initial variable annuity payment will be based on the
applicable variable annuity income factors in effect for your Contract on the Annuity Date which are at least the variable annuity
income factors under the Contract. You may choose any other annuity option we may offer on the option’s effective date. A higher
assumed investment return would mean a larger first variable annuity payment and a lower assumed investment return would mean a
lower first variable annuity payment. However, subsequent payments would increase only when actual net investment performance
exceeds the assumed rate and would fall when actual net investment performance is less than the assumed rate. If the actual net
investment performance is a constant 5% annually, annuity payments will be level. The assumed investment return is explained in
more detail in the SAI under THE CONTRACTS AND THE SEPARATE ACCOUNT."

The actual mortality tables may be and frequently are more favorable then those written in the prospectus and/or contract.

The paclife product mentioned (Pacific Odyssey) charges 30bps + fund fees as a charge. Seems like they have a 60/40 fund for 33 bips and a lot of other funds. https://pacificlife.onlineprospectus.ne ... 97PACLIFE/

Schwab has one for 45bps + fund fees (as low as 3bps). https://www.schwab.com/annuities/variab ... text-96791

There are many others targeted at fee only advisors.

I think it may be perfectly viable to buy one of these products and annuitize almost immediately, but I don't know one way or another if the annuitization options consistently have the full selection of funds. If someone went this route, they'd really need to call with a long list of questions.
The actual cost is quite complex, because there is a hidden charge for the mortality guarantee of the annuity. Ideally you would find 2-3 and call and find out what the payment would be with an assumed investment return of 4% or 5% so you could compare the initial payment which if the AIR was like-for-like would tell you which was the better deal. Then you'd have to compare fund fees.

With most of the products I mentioned above, there are many optional riders that increase the costs a lot and have questionable benefits. Anything on a variable annuity with the word "Guaranteed" or a charge higher than the "base contract" charge should be treated with a lot of skepticism.



More info: https://www.bogleheads.org/wiki/Immedia ... le_annuity

[will23]

I don't believe Wade Pfau's article was referring to Variable Annuities, which are a totally different beast from a SPIA, DIA, or FIA.

No, but he has in similar articles in the past and it is worth considering in this framework. He certainly doesn't mention variable SPIAs, because they provide low cost longevity protection and his interest is more in high cost products it would seem. Protection is a service whereby an insurance company pools the interest of a variety of retirees some of whom will die too young and some of whom will life to 100.

[GaryA505]

I don't believe Wade Pfau's article was referring to Variable Annuities, which are a totally different beast from a SPIA, DIA, or FIA.

No, but he has in similar articles in the past and it is worth considering in this framework. He certainly doesn't mention variable SPIAs, because they provide low cost longevity protection and his interest is more in high cost products it would seem. Protection is a service whereby an insurance company pools the interest of a variety of retirees some of whom will die too young and some of whom will life to 100.

Can you provide an example of a "variable SPIA"? I've never heard of such a thing.

FWIW, most of Wade Pfau's articles and books discuss SPIAs (which are low cost).

[AlwaysLearningMore]

Yes. The most consumer friendly products to protect against longevity risk are 1) fixed annuity (as a replacement for part of the bond portfolio) or 2) a fixed variable annuity (as a replacement for stocks or potentially bonds if using a bond VA).

It can be challenging to compare costs for (2) which may be partly why they are not popular... they have a general black box feel. Costs are the mortality guarantee which is evident in the initial payment and the fund management fee.

Thank you for taking the time to respond.
Kerry Pechter mentioned them in a somewhat recent interview he did promoting his new Annuities for Dummies book. IIRC Bob Carlson also has a section on them at his website.

I've heard that Vanguard at one time sold them. (Pechter worked at Vanguard for years.)

Many years ago we purchased a low cost Vanguard variable annuity and one of the payout options is a variable payout using one of several mandated portfolios (one is the variable annuity version of Wellington fund, and the other is IIRC like a VG life strategy fund). The all-in cost for the Wellington version is 50 basis points, and it's the option we will likely use when we annuitize our contract.

Out of curiosity, I have looked for other low cost immediately variable annuity providers but could not come up with much. We would never 1035 into another annuity because I don't think we can duplicate what we have, but just wondered what else was out there.

I looked into the vanguard annuity and chose not to purchase it because the tax benefits weren't clear enough in my situation, but I feel like you probably won't find a better deal. That was the short answer. The long answer is...

But you didn't find any because you are looking in the wrong place . I don't think variable immediate annuities are sold very much if at all. But what is sold are annuities like yours that have an option to annuitize; I think an annuity option may even be required, perhaps someone else knows. These work similar to your vanguard option, I believe. So for example from a paclife prospectus:

"For variable annuity payments, the tables are based on an assumed annual investment return of 5% and the 1983a Annuity Mortality
Table with the ages set back 10 years. If you elect a variable annuity, your initial variable annuity payment will be based on the
applicable variable annuity income factors in effect for your Contract on the Annuity Date which are at least the variable annuity
income factors under the Contract. You may choose any other annuity option we may offer on the option’s effective date. A higher
assumed investment return would mean a larger first variable annuity payment and a lower assumed investment return would mean a
lower first variable annuity payment. However, subsequent payments would increase only when actual net investment performance
exceeds the assumed rate and would fall when actual net investment performance is less than the assumed rate. If the actual net
investment performance is a constant 5% annually, annuity payments will be level. The assumed investment return is explained in
more detail in the SAI under THE CONTRACTS AND THE SEPARATE ACCOUNT."

The actual mortality tables may be and frequently are more favorable then those written in the prospectus and/or contract.

The paclife product mentioned (Pacific Odyssey) charges 30bps + fund fees as a charge. Seems like they have a 60/40 fund for 33 bips and a lot of other funds. https://pacificlife.onlineprospectus.ne ... 97PACLIFE/

Schwab has one for 45bps + fund fees (as low as 3bps). https://www.schwab.com/annuities/variab ... text-96791

There are many others targeted at fee only advisors.

I think it may be perfectly viable to buy one of these products and annuitize almost immediately, but I don't know one way or another if the annuitization options consistently have the full selection of funds. If someone went this route, they'd really need to call with a long list of questions.
The actual cost is quite complex, because there is a hidden charge for the mortality guarantee of the annuity. Ideally you would find 2-3 and call and find out what the payment would be with an assumed investment return of 4% or 5% so you could compare the initial payment which if the AIR was like-for-like would tell you which was the better deal. Then you'd have to compare fund fees.

With most of the products I mentioned above, there are many optional riders that increase the costs a lot and have questionable benefits. Anything on a variable annuity with the word "Guaranteed" or a charge higher than the "base contract" charge should be treated with a lot of skepticism.



More info: https://www.bogleheads.org/wiki/Immedia ... le_annuity

Thank you very much for all of that information. I reviewed the PacLife options and looked at the Schwab product to which you linked. You're right, it seems unlikely I'll find a better deal.

While there's no guarantee, here's to hoping that Wellington Fund's (VA version) performance increases over the 4% AIR and payouts increase.

[Harmanic]

I don't believe Wade Pfau's article was referring to Variable Annuities, which are a totally different beast from a SPIA, DIA, or FIA.

No, but he has in similar articles in the past and it is worth considering in this framework. He certainly doesn't mention variable SPIAs, because they provide low cost longevity protection and his interest is more in high cost products it would seem. Protection is a service whereby an insurance company pools the interest of a variety of retirees some of whom will die too young and some of whom will life to 100.

Can you provide an example of a "variable SPIA"? I've never heard of such a thing.

FWIW, most of Wade Pfau's articles and books discuss SPIAs (which are low cost).

He has presented some valuable information, but his credibility is being undermined by his affiliation with sketchy characters. For instance, he has appeared on podcasts that primarily promote the concept of "infinite banking" which I think is a scam.

[GaryA505]

I don't believe Wade Pfau's article was referring to Variable Annuities, which are a totally different beast from a SPIA, DIA, or FIA.

No, but he has in similar articles in the past and it is worth considering in this framework. He certainly doesn't mention variable SPIAs, because they provide low cost longevity protection and his interest is more in high cost products it would seem. Protection is a service whereby an insurance company pools the interest of a variety of retirees some of whom will die too young and some of whom will life to 100.

Can you provide an example of a "variable SPIA"? I've never heard of such a thing.

FWIW, most of Wade Pfau's articles and books discuss SPIAs (which are low cost).

He has presented some valuable information, but his credibility is being undermined by his affiliation with sketchy characters. For instance, he has appeared on podcasts that primarily promote the concept of "infinite banking" which I think is a scam.

Infinite Banking itself isn't a scam, but there are certainly some shady characters involved in some promotions of it. Basically "Infinite Banking" is just borrowing money from the cash value of your own life insurance. It's a legitimate financial strategy if implemented properly.

[Harmanic]

I don't believe Wade Pfau's article was referring to Variable Annuities, which are a totally different beast from a SPIA, DIA, or FIA.

No, but he has in similar articles in the past and it is worth considering in this framework. He certainly doesn't mention variable SPIAs, because they provide low cost longevity protection and his interest is more in high cost products it would seem. Protection is a service whereby an insurance company pools the interest of a variety of retirees some of whom will die too young and some of whom will life to 100.

Can you provide an example of a "variable SPIA"? I've never heard of such a thing.

FWIW, most of Wade Pfau's articles and books discuss SPIAs (which are low cost).

He has presented some valuable information, but his credibility is being undermined by his affiliation with sketchy characters. For instance, he has appeared on podcasts that primarily promote the concept of "infinite banking" which I think is a scam.

Infinite Banking itself isn't a scam, but there are certainly some shady characters involved in some promotions of it. Basically "Infinite Banking" is just borrowing money from the cash value of your own life insurance. It's a legitimate financial strategy if implemented properly.

It is a high cost strategy that is appropriate for a small number of wealthy families, but is marketed to people who will never have the funds to superfund one of these policies by sales agents who call 401(k)s a scam.

[GaryA505]

No, but he has in similar articles in the past and it is worth considering in this framework. He certainly doesn't mention variable SPIAs, because they provide low cost longevity protection and his interest is more in high cost products it would seem. Protection is a service whereby an insurance company pools the interest of a variety of retirees some of whom will die too young and some of whom will life to 100.

Can you provide an example of a "variable SPIA"? I've never heard of such a thing.

FWIW, most of Wade Pfau's articles and books discuss SPIAs (which are low cost).

He has presented some valuable information, but his credibility is being undermined by his affiliation with sketchy characters. For instance, he has appeared on podcasts that primarily promote the concept of "infinite banking" which I think is a scam.

Infinite Banking itself isn't a scam, but there are certainly some shady characters involved in some promotions of it. Basically "Infinite Banking" is just borrowing money from the cash value of your own life insurance. It's a legitimate financial strategy if implemented properly.

It is a high cost strategy that is appropriate for a small number of wealthy families, but is marketed to people who will never have the funds to superfund one of these policies by sales agents who call 401(k)s a scam.

Actually I don't think you need to be that wealthy to take advantage of it. It really depends on your tax situation. Loans from your own life insurance are not taxed, so if that works for someone tax-wise, it might be worth using. I looked at it myself but decided I don't need the tax advantages of it. You're right about the marketing though, there is never a shortage of unscrupulous insurance sales people.

[Harmanic]

Can you provide an example of a "variable SPIA"? I've never heard of such a thing.

FWIW, most of Wade Pfau's articles and books discuss SPIAs (which are low cost).

He has presented some valuable information, but his credibility is being undermined by his affiliation with sketchy characters. For instance, he has appeared on podcasts that primarily promote the concept of "infinite banking" which I think is a scam.

Infinite Banking itself isn't a scam, but there are certainly some shady characters involved in some promotions of it. Basically "Infinite Banking" is just borrowing money from the cash value of your own life insurance. It's a legitimate financial strategy if implemented properly.

It is a high cost strategy that is appropriate for a small number of wealthy families, but is marketed to people who will never have the funds to superfund one of these policies by sales agents who call 401(k)s a scam.

Actually I don't think you need to be that wealthy to take advantage of it. It really depends on your tax situation. Loans from your own life insurance are not taxed, so if that works for someone tax-wise, it might be worth using. I looked at it myself but decided I don't need the tax advantages of it. You're right about the marketing though, there is never a shortage of unscrupulous insurance sales people.

The problem is the agent commissions which are really high unless you over fund it by a large amount, which makes the commission smaller relative to the total balance. White Coat Investor has a good article on this in which he points out that it does not work even for most high net worth physicians.

[Rex66]

A favorite company that agents used for that strategy was Ohio national…….didn’t work out……

[ScubaHogg]

But under the hood, so to speak, a SPIA is returning principal. For example, the Internal Revenue Code taxes nonqualified annuities as if they were returning principal and paying a bit of interest over the life expectancy of the annuitant. After life expectancy, all of the income is taxable. Did you ever make the Treasury ladder spreadsheet I asked you to make? Do you know what a Treasury ladder is? If you looked at the cashflows, I think you would agree that a mortgage is probably the other best comparison.

I came around to your viewpoint on this, with the minor trivial exception of the MBS. The prepayment bit alone seems to make that pretty different, but you implied above that actually doesn’t matter that much

*of course all this is pretty irrelevant to my actual critique of nominal pensions/SPIAs